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p. 20 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Taipei,China

The economy rebounded in the second half of 2003, largely due to surging exports. Prospects are promising, as a continued rise in exports will likely be joined by a pickup in domestic demand. A weak economy, relocation of firms offshore, and moves to higher-skilled industries have contributed to relatively high unemployment in recent years, but labor market conditions have started to improve. Areas for policy consideration include widening income inequalities and vulnerability to swings in global information technology demand.

Economic Assessment

The economy’s performance in recent years has been significantly affected by the bursting of the information technology (IT) bubble and the global economic downturn. The slump in demand for IT products worldwide was a particularly severe blow given IT’s important role in the economy. However, nascent signs of recovery emerged in the first quarter of 2003, only to be disrupted by the outbreak of SARS in the second. Subsequently, though, the pickup in external demand for IT products and the declaration in July that Taipei,China was free of SARS sparked a sharp upturn in the economy, which was further underpinned by expansionary macroeconomic policies. GDP grew by 4.2% and 5.2% in the third and fourth quarters, respectively, and by 3.2% for the year as a whole.

The strong export momentum in the fourth quarter, reflected in the surge in shipments of electronics products, played an important role in lifting GDP growth (Figure 2.5). Domestic demand was subdued for most of 2003, so that imports continued to lag well behind exports. Consequently, net export expansion contributed 2.4 percentage points of GDP growth in 2003, and domestic demand just over 0.8 percentage point. However, signs were evident of improving domestic demand in the fourth quarter. Private consumption grew moderately, helped by rises in stock market prices and employment. Investment, which was hit hard by the reduced demand for IT products and had contracted since 2001, rose by 6.7% in the fourth quarter. Capacity utilization rates of firms rose as exports strengthened, spurring investment.

The labor market has changed substantially since the mid-1990s. The unemployment rate climbed from 1.8% in 1995 to a peak of 5.3% in October 2002, partly as a result of the Asian financial crisis, the end of the IT boom, and the global downturn. Structural factors also played a role because the economy moved into higher-technology industries, which require fewer low-skilled workers. Some labor-intensive industries relocated to economies with lower labor costs, especially the PRC, further reducing demand for blue-collar workers. The unemployment rate was 5.2% in August 2003, just after the SARS outbreak ended, then declined to 4.6% by year-end as the economy recovered and the authorities aggressively pushed forward their Expansion of Employment through Public Services Plan. Average monthly real earnings in the nonagriculture sector rose by 1.7% in 2003, after declining by 1.0% in 2002 and staying flat in 2001.

The authorities attempted to implement an expansionary fiscal policy in early 2003, but since the budget was not passed until June, most spending was made in the second half of the year. Also in the second half, public investment picked up, having declined for several years. The weak first-half economic performance and expansionary fiscal policies pushed the central government budget deficit to over 3.0% of GDP and public debt to more than 30% of GDP.

As a result of subdued domestic demand in recent years, plus lower import prices and intense competition in local markets, the economy has faced deflationary pressures. The CPI remained unchanged in 2001, declined by 0.2% in 2002, and fell by a further 0.3% in 2003. In the second half of that year, deflationary pressures abated as the economy strengthened and import prices of raw materials rose. Monetary policy, eased since 2000, remained accommodative: the official discount rate and money market rates fell to historical lows. The M2 monetary aggregate grew moderately in 2003, in line with the economy’s performance. Stock market prices rallied in the second half, with the Taiwan Stock Exchange Weighted Price Index gaining 20.3%.

The trade surplus widened in 2003, reflecting a near 14% rise in exports in the second half. This and the expansion of net income receipts led to a marked improvement in the current account surplus. Direct investment recorded a net outflow, but the inflow of portfolio investment posted record figures in 2003, reflecting the large-scale portfolio allocation of international funds into Asia. Large current account surpluses, as well as the net inflow on the financial account, resulted in continued accumulation of substantial foreign exchange reserves, totaling US$206.6 billion by year-end, or the third largest in the world after Japan and the PRC.

Policy Developments

The authorities raised public spending moderately as a result of SARS. In April and May, they announced spending of NT$50 billion (US$1.4 billion) to help cover business losses and bonuses to doctors and nurses required to take care of SARS patients. In addition to the Expansion of Employment Plan, the authorities launched an Infrastructure Expansion and Economic Revitalization Program to boost domestic demand and employment; the combined budget was US$2 billion. By December 2003, 104,000 jobs had been created through the plan and 100 public projects had been selected for implementation under the program.

Various tax reductions and incentives have been introduced in recent years in an effort to stimulate output. However, these reductions and the slow economy have eroded tax revenues, which amount to less than 9% of gross national product (GNP), as against central government expenditures of about 16% of GNP. Furthermore, about 70% of the expenditures are stipulated by law, which leaves little room for reductions. As a result, the ratio of the central government deficit to GDP widened from 2.5% in 2002 to 3.1% in 2003; over a longer perspective, the ratio of public debt to GDP has risen from 14.8% in 1994 to 31.7% in 2003. Although the debt ratio is still moderate by international standards, the upward trend has caused some concern to policy makers.

The Central Bank of China (CBC) cut the discount rate on 15 occasions between December 2000 and June 2003 for a total of 337.5 basis points, to a historical low of 1.375% in an effort to boost domestic demand and alleviate deflationary pressures. Commercial bank lending rates, however, remained inflexible for some time as banks took advantage of higher interest rate spreads. To make the monetary transmission mechanism more responsive, CBC introduced adjustable rate mortgages and a base rate system, which move in line with market rates and have made the rates system more flexible. Interest rates are likely to remain low for some time, even though the economy has rebounded. In December, CBC left key interest rates unchanged, but the money supply target for 2004 has been increased in response to firmer economic conditions.

Economic weakness has prompted the intensification of reforms in several Asian economies, and in this context, the authorities in Taipei,China have identified financial reform as a major focus. This is partly to answer the calls for financial reform that were triggered by an increase in NPLs, which stemmed from a period of substantial property-backed lending by banks prior to 1997 and the subsequent downturn of the real estate market.

Various measures were adopted to resolve the NPLs. The Financial Restructuring Fund, established in July 2001 with a capitalization of US$4 billion, has liquidated 44 insolvent community financial institutions. Under the revised statute for this fund, which is being reviewed by the Legislative Yuan, the fund will be replenished so that it can be used to facilitate the acquisition of financially troubled banks and other lending institutions by healthy ones. Asset management companies are encouraged, through incentives such as tax breaks, to help dispose of the NPLs. The financial reforms are indeed yielding results: the average NPL ratio of domestic banks at end-2003 was 4.3%, down from a peak of 8.0% in March 2002.

Financial reforms have been extended to cover corporate governance and prudential regulation. The Financial Institution Merger Act and Financial Holding Company Law were passed in 2000 and 2001, respectively, to provide incentives for financial institutions to consolidate and so reduce the number of banks. A new agency, the Financial Supervisory and Management Committee, will be established on 1 July 2004 to bring the supervision of banks, securities and futures houses, and insurance companies under one roof, although CBC will retain the power to conduct examinations to monitor financial activities relevant to monetary policy. Other financial reform measures include the privatization of SOCBs and moves toward allowing universal banking. These reforms are expected to improve the efficiency and stability of the financial sector.

Reforms have also been spurred by increased competition with the PRC for labor-intensive industries. The relocation of some production to the PRC (and elsewhere) has prompted the authorities and the business community in Taipei,China to encourage the upgrading of technology and generally to make industries more efficient. The economy’s early years of high growth were characterized by a rapid move to industrialize; the latest phase is to develop high-technology and services-oriented industries. A transition like this involves adjustment costs, such as unemployment, as older industries move away. These costs fall unevenly on different industries and members of society, and require official policies to mitigate the social and economic impact.

Outlook for 2004-2005

GDP growth is expected to strengthen to 5.4% in 2004 on the back of surging exports, a continued rise in domestic demand, and structural changes in the economy, though this rate is forecast to then slow to 4.7% in 2005. Buoyant external demand, especially for IT products, will be a boost to economic growth in 2004. Exports of goods and services are likely to strengthen by 8.0% in 2004 and by 7.4% in 2005. Higher levels of exports and capacity utilization have prompted major exporters to increase capital spending, and still further investment is likely. Some major companies, such as Taiwan Semiconductor Manufacturing Co., the world’s largest semiconductor foundry, have indicated that they will raise their investment in 2004. Bank loans to the private sector are increasing to meet this demand. Technological upgrades in the IT industry will also require greater capital investment. Indeed, a surge in investment-by 8.5% in 2004 and 7.5% in 2005-is expected to be a major factor in the robust overall economic performance.

The gains in exports and capital investment, in turn, should revive the labor market. Higher employment and firmer asset prices will likely bolster private consumption, which is expected to expand by 4.0% in 2004 and by 3.8% in 2005. Inflation is projected to rise, but to remain low at 0.8% in 2004 and 1.2% in 2005, reflecting the competitive pressures in the domestic market. Strong economic and revenue expansion will narrow the budget deficit. Public debt, however, is forecast to rise because of the upturn in government borrowing to finance new projects. Interest rates may rise in 2004-2005, but will likely remain moderate, partly because of low domestic inflationary pressures. Strengthening domestic demand will see growth of imports at 8.7% and 7.6% over the forecast period, outpacing that of exports, leading to smaller trade and current account surpluses.

The economy depends heavily on the performance of its key trading partners, so this generally upbeat outlook assumes that the global economy will strengthen in 2004-2005.

While the economy is well on the road to recovery, longer-term policies need to address several challenges, three of which stand out. The first is rising income inequalities. Income per capita in Taipei,China is at a relatively high level of about US$12,000. However, according to official statistics, the ratio between the incomes of the highest and lowest quintiles widened from 5.4 in 1996 to 6.2 in 2002. Whereas the economy grew briskly in the 1970s and 1980s, with low unemployment and relatively even income distribution, since the early 1990s the development of electronics and other high-tech industries has seen incomes of skilled workers increase rapidly, while incomes for the unskilled have crept up more slowly or even declined, widening the income gap. Higher unemployment has also contributed to these income disparities.

The second challenge is how best to manage the relationship between deepening economic integration on the one hand and potential political uncertainties on the other, between Taipei,China and the PRC. The PRC is now Taipei,China’s largest export market and largest investment destination, and economic integration between the two economies benefits both of them in the long run. However, any uncertainties could hamper investment and growth on both sides of the strait.

The significant impact of the bursting of the IT bubble on the economy highlights the increased effect of external shocks. The economy now is more open and the IT industry plays a more significant part, making Taipei,China more vulnerable to a weakening in global demand for IT products. The third challenge is therefore for economic policies to take into consideration such volatility. For example, more prudent fiscal policies are required, so that budgets in good economic years make allowance for periods when the economy turns down and requires policy stimulation.

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