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p. 13 of 81 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia People's Republic of China Hong Kong, China Republic of Korea Mongolia Taipei,China Southeast Asia South Asia Central Asian Republics The Pacific III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Taipei,China

After a recession in 2001 induced by an export slump in the ICT sector, economic growth is expected to resume in 2002. Restocking and some support from a moderate upturn in exports in the second half of 2001 will help stimulate GDP growth in the medium term, but structural unemployment will remain a concern as elements of the manufacturing base continue to move offshore.

Macroeconomic Assessment

Economic growth decelerated rapidly in 2001 to register a contraction of 1.9%, representing the worst economic performance in 30 years. Much of the slowdown stemmed from the slump in exports of ICT products and the transmission of the export slowdown to private consumption and gross fixed investment. The economy’s ICT exports account for more than 50% of exports of goods and services. The poor trade performance and associated recession in manufacturing pushed all components of domestic demand growth into negative territory in the second half of the year.

Taipei,China faced substantial spare capacity in manufacturing in 2001. Partly due to this, unemployment reached a historic high of 5.3% during the year (Figure 2.5). Combined with rapid worsening of the economic outlook, firms moving production to the mainland to cut labor costs, declining consumer confidence, and a negative wealth effect from a falling stock market, private consumption and fixed investment contracted in 2001. Adding to the downward pressure of falling investment, overdue loans reached a high of 7.5% of total loans. The severity of the downturn was exacerbated by a rising inventory-to-shipment ratio, indicating that the downward adjustment of stocks had not been large enough to adjust to falling sales. This partly explains why industrial production contracted over most of 2001. In the services sector, employment relative to that in industry increased by roughly 2% of the total labor force. However, employment growth in services did not fully offset the shrinkage of employment in manufacturing.

Price pressures remained subdued in 2001 with a negligible inflation rate as measured by the consumer price index, compared with 1.3% in 2000. Weakening domestic demand and a sharp fall in food and oil prices were the main factors. A 1.3% fall in the wholesale price index helped moderate the effect of the downturn by reducing the costs of production.

On the external account, the trade surplus rose in 2001, to $20 billion from $14 billion in the previous year, reflecting the adjustment of imports to slowing demand conditions. Merchandise exports contracted by 17.3%, after 21.8% growth in 2000. Toward the end of 2001, on a year-on-year basis, merchandise exports and imports showed some signs of recovery. The sharp decline in trade flows was accompanied by a drop in services imports of insurance and transport-related items, in addition to an overall drop in services imports, which were hit by the collapse in domestic demand. As a result, the current account balance rose to $19 billion in 2001.

On the fiscal policy front, the public debt-to-GDP ratio of around 28% of GDP has become a concern. (This figure does not include other contingent liabilities related to health care and pension funds.) Therefore, rather than cut taxes to stimulate demand, the authorities relied on expenditure policy in the form of a supplementary fiscal package of NT$111.5 billion. They also considered tax cuts, but eventually decided that such cuts would be difficult to phase out once a sustainable recovery took hold. In addition, tax cuts are limited by a prescribed link between revenues and spending: new government borrowing cannot exceed 15% of the total budget (which includes debt repayments and contingent liabilities).

The discount rate was cut by 250 basis points in 2001 to 2.13%. However, monetary policy has proven to be rather ineffective as bank lending and monetary growth were low in 2001, in spite of falling interest rates. The banks are reluctant to lend, due to the high and increasing level of nonperforming loans (NPLs) and to concerns over corporate creditworthiness.

Policy Developments

The two key concerns for the authorities are going to be the ability to use fiscal policy as a countercyclical measure and the growing level of NPLs. On the first point, the authorities’ freedom to maneuver will be restricted due to the 15% ceiling on new borrowing and a high public debt-to-GDP ratio. This will be a particular concern in 2002 since domestic demand conditions are expected to remain quite weak until the economy makes a significant export rebound. A proposal to change the 15% limit (of the total budget) to 3% of GDP was considered by both the Legislative Yuan and the Economic Development Advisory Council in 2001, but was defeated. This proposal may be reconsidered in 2002. If it is approved, it is estimated that borrowing can be increased by roughly 1% of GDP.

On the second concern, if economic contraction continues in the first half of 2002, banking sector balance sheets could deteriorate further and NPLs may rise. The authorities have already put together an asset management company, the Financial Rehabilitation Fund, to transfer NPLs from banks, extend the coverage of deposit insurance schemes, and set up universal banks. However, the experience of Indonesia and Thailand suggests that the sale of these distressed assets by asset management companies would be difficult without the authorities engaging in at least a partial bank recapitalization to improve asset quality. This bailout would be possible without putting pressure on the fiscal balance only if the limit on new government borrowing was relaxed. Otherwise, banks’ continuing weak balance sheets will hamper credit growth and prospects for economic recovery. Consequently, the authorities have little scope to use fiscal or monetary policy for countercyclical measures.

The investment outlook is constrained by uncertainty over ICT exports and the movement of production to the mainland. Both components of domestic demand should rise as external demand conditions improve, but the relocation of investment to the mainland and associated high unemployment rates are structural features of the island’s economy that restrict growth potential in the medium term. Reflecting pressure to relax trade and investment relations with the PRC, the upside for domestic demand is quite limited over this period. The process of restructuring will require Taipei,China to become a provider of high value-added services to the region, rather than a manufacturing hub. Furthermore, greater integration with ASEAN economies and, possibly, the countries of South Asia may open up new markets for Taipei,China, and this may be a more fruitful approach than exclusive reliance on the PRC, where it faces stiff competition from Hong Kong, China.

Outlook for 2002-2003

The strength of recovery in 2002 and early 2003 will be determined by domestic demand conditions and the pace of recovery in industrial countries. So far, the backdrop for an upturn in private consumption and investment looks quite weak. Private consumption is unlikely to stage a sustained recovery since broad monetary aggregates have yet to show signs of an upturn, unemployment remains at historic highs, and spending continues to be sensitive to wealth effects. Some boost to inventory investment may take place in the second half of 2002 due to the low-base effect of 2001; a more sustained restocking may be seen in 2003 if exports show strong growth. This assumes that the inventory-to-shipment ratio finally starts dropping significantly in the first half of 2002.

Consequently, GDP growth is forecast at 2.8% in 2002 and 4.0% in 2003. With weak domestic demand conditions, the cyclical situation should allow interest rates to remain low for the whole of 2002 without running the risk of a sharp spike in inflation. The consumer price index is forecast to rise by 0.7% in 2002 and 2.1% in 2003. Assuming that the 15% limit on new government borrowing remains in place, the fiscal deficit as a proportion of GDP is forecast to stay at around 4%. The trade balance will stay positive, although import growth will exceed export growth in both years. This will result in a decline in the current account surplus to a projected 3.4% of GDP in 2003 from 6.7% in 2001.

ICT exports are an important component of overall exports, and the US is their most important market. Thus, US new orders of the product lines in which the economy specializes, such as personal computers and office equipment, and semiconductors and components, are crucial. Together, they account for 57% of exports of goods and services. Analysis of trends suggests that the island’s exports lag US new orders of ICT equipment by one quarter. The recovery of Taipei,China’s exports to the US will therefore likely be slow, given the current outlook for the ICT industry in the US. This could be followed by a moderate rise in the second half of 2002 as US (and EU) growth accelerates further. On the basis of these elements, exports are forecast to grow by 5.5% in 2002 and 8% in 2003, and imports by 8% and 10%, respectively, over these years.

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