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p. 15 of 68 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 Asia The Pacific III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Taipei,China

The economy gradually recovered in 2002 from its worst recession in three decades, helped by robust export and industrial performance, which in turn stemmed from the mild recovery of the global economy. High unemployment, however, remains one of the major challenges to the economy in the short and medium run, while a prolonged epidemic of SARS would impact the economy, especially tourism.

Macroeconomic Assessment

In 2002, the economy steadily recovered. The monitoring indicator compiled by the Council for Economic Planning and Development in Taipei,China signaled "stable" since April that year, after 15 months of a weak signal. GDP grew by 4.8% and 4.2% in the third and fourth quarters, respectively, compared with the same periods in 2001, for an outturn of 3.5% GDP growth for the whole year. Much of the recovery was based on the growth of exports and industrial production, in particular among electronics and information technology (IT) products. However, this was to a large extent offset by weak consumer sentiment arising from job insecurity, falling earnings, and the negative wealth effect that falling stock prices had already caused.

Private consumption expanded by only 1.9% in 2002, and private investment remained moderate due to the uncertainty of both the global and domestic economic recoveries. Private investment started to strengthen in the third quarter of 2002, ending seven consecutive quarters of contraction, and resulted in a small increase of 1.6% for the whole of 2002. Government consumption and investment contracted further in 2002 by 0.9% and 10.9%, respectively, from the previous year's level. Consequently, gross fixed investment continued to shrink, by 2.0% in 2002. As a result, domestic demand strengthened by only 1.3%.

Services sector growth was a modest 2.7%, but the industry sector strengthened more rapidly due to increased exports. Value added in industry improved by 5.4% in 2002 over the 2001 level, driven largely by a 6.6% broad-based expansion in manufacturing: production in electronics and IT rose by 11.4%, basic metals by 10.3%, machinery by 5.8%, and chemicals by 4.4%. Production related to the food industry contracted by 4.5%. Construction declined by 2.9%.

Compared with 2001, the employed labor force rose by 0.8% in 2002, but the unemployed labor force increased by 14.5%, resulting in an unemployment rate of 5.2%, the highest in the past three decades (Figure 2.5). The major factor was the closure or downsizing of enterprises in response to sluggish economic performance and ongoing structural transition. Accordingly, average monthly earnings for manufacturing workers fell by 1.2% over the year. The slow growth in domestic demand contributed to a continuation of downward price pressures with the general level of consumer prices, as measured by the CPI, declining by 0.2%. However, the core CPI (excluding fresh vegetables, fruit, aquatic products, and energy) rose by 0.7% due to surcharges on goods such as wine, cigarettes, and other products that were imposed as a result of agreements between Taipei,China and other WTO members after the island's entry into WTO. The wholesale price index increased marginally in 2002 both due to the depreciation of the New Taiwan dollar against the US dollar and to higher prices of raw materials (such as petrochemicals and metal products) in the global market.

Exports strengthened by 6.4% in 2002 as external demand conditions improved throughout the year, particularly the second half, with the global economy recovering further. Exports started to increase in April and began growing at double-digit rates from July. Strong demand from the PRC, particularly for IT-related goods, provided support for exports, offsetting soft demand from the US and Japan. The high volume of transit trade to the PRC resulted in Hong Kong, China replacing the US as the primary destination for exports, accounting for 23.6% of the total. Exports to Hong Kong, China consisted mainly of supplies to firms from Taipei,China that relocated production facilities to the PRC, indicating the increasing importance of indirect trade between Taipei,China and the PRC. The US (20.5%), EU (13.0%), and ASEAN countries (10.1%) were the other major export markets.

Total export orders improved by 11.2% in 2002. By category, orders for information and communications products showed the largest gain, followed by basic metals, machinery, and other electronics products. Textile products recorded a small contraction. In terms of destination, orders from Hong Kong, China strengthened the most (up 25%), followed by Japan, EU, and US.

Imports rose by 3.2% compared with 2001, due largely to higher levels of imported intermediate goods and higher oil prices; this was despite the fact that household spending remained weak. Capital goods imports declined in both 2001 and 2002, by 31.6% and by 3.5%, respectively, as a result of weak private and public investment. Consequently, the trade surplus increased to $24.7 billion in 2002, or 22.4% higher than in the previous year.

Reflecting the rather uncertain and slow recovery of the global economy, stock prices fluctuated and interest rates fell. The stock market was volatile in 2002, growing by 11% in the first quarter, and then falling back both in price and volume terms in the second and third quarters. In November, the stock market began rising again, but overall its value fell by 11.2% during the year. The weak domestic investment climate and the negative impact of the turbulence occurring in the US stock market—particularly in the second half of 2002—contributed to domestic stock market weakness. At the end of December 2002, the Taiwan Stock Exchange Weighted Index stood at 44% of its peak in February 2000.

The Central Bank of China (CBC) continued its accommodative monetary policy in 2002. To stimulate the slowly recovering economy, CBC cut its official rediscount rate twice (in June and November), and has cut interest rates 14 times since December 2000. The rediscount rate was reduced from 2.125% in December 2001, to 1.875% in June 2002, and further to 1.625% in November. Average lending rates offered by commercial banks and rates on commercial paper and government bonds also declined. However, despite the reduction in the rediscount rate, commercial banks remained reluctant to lower their lending rates. CBC responded with a series of measures aimed at improving the transmission mechanisms of monetary policy. For example, an adjustable rate mortgage was introduced, which linked loan rates to benchmark interest rates both to bring the former more into line with prevailing interest rates set by CBC and to make rates more transparent to borrowers.

The demand for liquidity remained moderate due to the subdued nature of the economic recovery. M2 grew by only 3.6 % in 2002, compared with 5.8% in the previous year. Nevertheless, the continuous decline in interest rates has made bank deposits less attractive to investors. As a result, liquidity has been transferred from bank deposits into the bond market. The combined growth rate of M2 and bonds was 5.6% in 2002 compared with 6.5% in 2001. Overall, CBC's relatively loose monetary stance has been a significant factor in promoting the revival of economic activity in Taipei,China. Given the efforts of both the authorities and the banking system, the NPL ratio among domestic banks declined from 8.04% in March to 6.12% in December 2002.

Policy Developments

In 2002, the relatively high levels of NPLs and of public debt remained the two pressing issues for the authorities. On the first point, some long-term measures have been taken to address the problem. The Legislative Yuan, the law-making body, passed the Financial Institution Merger Law and Financial Holding Company Law in 2001 to allow financial institutions to have greater flexibility to merge and to provide a wider range of financial services. It also passed the Financial Assets Securitization Statute in June 2002 to reinvigorate the financial and real estate market and to boost liquidity.

In 2002, the authorities used the Financial Restructuring Fund of NT$140 billion, established in 2001, to restructure 44 problematic financial institutions, and assisted in the establishment of 16 asset management companies (AMCs) to start the reduction of NPLs. AMCs are designed to serve as an intermediary for the authorities to deal with NPLs, since the ultimate goal is to develop the secondary market, through which NPLs can be traded. The plan is to use financial asset securitization to accelerate the reduction of NPLs. AMCs in Taipei,China started operations in 2002, buying NPLs amounting to NT$211 billion. To expedite efforts to reduce NPLs, the Ministry of Finance proposed an increase in the size and scope of the Financial Restructuring Fund, including allowing the authorities to become directly involved in NPL trading. The Ministry's proposal is still under debate in the Legislative Yuan.

On the second point, the public debt-to-GDP ratio has worsened as a result of the continued large central government budget deficit in 2002. The weak economy, combined with accumulated tax incentives offered by the authorities, caused tax revenues to decline by 2.6% in 2002. The ratio of the central government deficit to GDP widened slightly from 2.5% in 2001 to 3.0% in 2002. In financing the rising budget deficit, the ratio of outstanding public debt to GDP rose from 12.0% in 1993 to 28.5% in 2001, and to 29.8% in 2002.

Further stimulus through additional public spending has been hindered by the sluggish economy, while the president's promise not to raise taxes in the next 2 years has made the widening of the tax base difficult. Instead of tax cuts, reform of the tax system has been directed to rationalizing the tax system, such as reducing some of the tax breaks that used to be enjoyed by high-tech companies, and improving the overall efficiency of the tax system. The Legislative Yuan is still reviewing the proposal to eliminate tax exemptions for teachers in the primary and secondary school system and for military personnel.

The war in Iraq has created uncertainty regarding external demand. To sustain the economic recovery, but after much debate due to the levels of spending involved, the Legislative Yuan passed two laws in 2002 to expand domestic demand in case there is a shortfall in external markets. One was to allow the authorities to have a supplementary budget of NT$50 billion to increase infrastructure construction in 2003, and the other was to allow them to make supplementary budget appropriations of NT$20 billion to create short-term jobs for the unemployed in 2003. In 2002, the authorities also launched a medium- to long-term program, Challenge 2008, aimed at upgrading the structure of the economy; the Legislative Yuan passed the first year's budget (2003) of the initiative, for NT$150 billion.

Outlook for 2003-2004

The slow but steady recovery in 2002 is expected to continue in 2003 and to improve in 2004 as the global economy strengthens further. Given that the PRC, through Hong Kong, China, has become the largest export market for Taipei,China, and that the rapid growth of the PRC economy is expected to continue, exports are expected to be buoyant, remaining the driving force in sustaining economic recovery. In addition, the laws passed by the Legislative Yuan could inject a substantial amount of funding into the economy. This would support the anticipated pickup of private investment and consumption in 2003-2004. The implementation of Challenge 2008 would also help adjust Taipei,China's economic structure, so as to accelerate economic recovery.

Monetary policy is likely to remain accommodative over the next 2 years. The threat of deflation in 2003 should be minimal due to higher industrial raw material prices in the global market and continuing recovery in the domestic economy. Nevertheless, consumer price inflation will remain subdued in 2003 as structural and cyclical unemployment restrains wage growth and as deregulation of the economy increases competitive pressure.

However, these forecasts must be considered against the backdrop of the recent outbreak of SARS. In light of the close links between the PRC; Hong Kong, China; and Taipei,China—especially in tourism—GDP growth in Taipei,China may be affected if the epidemic is prolonged.

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