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Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : East Asia
Taipei,ChinaThe economy showed robust growth in 2004, marking a recovery from SARS in 2003 and supported by the cyclical rebound in the global high-tech sector, which boosted business investment. Growth will moderate this year before picking up in 2006-2007. Policy makers are grappling with ways to raise revenues in order to strengthen the fiscal position and upgrade technology, so that the economy can stay competitive. Macroeconomic assessment of 2004Growth picked up to 5.7%, its fastest rate since 2000. After reaching a peak of 7.9% in the second quarter, momentum slowed in the second half, largely reflecting the higher second-half base in 2003, when the economy rebounded from the impact of SARS. The slowdown also stemmed from decelerating export growth in the second half of 2004, which was caused by higher global oil prices, an easing in global demand for high-tech products, and the PRC's macroeconomic tightening policy. In contrast to previous years when the external sector lifted economic growth, domestic demand--particularly private consumption and investment--was the driver in 2004. Private consumption rose by 3.1% and contributed 1.9 percentage points to growth. The recovery of the information and communications technology (ICT) industry, which is a significant part of the economy, boosted business investment. Consequently, private fixed investment grew sharply by 28.2% and gross fixed capital formation contributed 2.6 percentage points to GDP growth. The external sector did not contribute to GDP growth, as strong export growth was offset by booming demand for imports (Figure 2.5). 
From the production perspective, industry and services contributed fairly equally to GDP growth, with around 3 percentage points each. Growth in services of 4.8% was helped by the rebound from the 2003 SARS outbreak, which boosted tourism, travel, and retail trading. Industrial growth was led by manufacturing, which grew by 9.4%, supported by the ICT subsector. Construction, though, grew by a marginal 1.1%. Overall industry sector growth accelerated to 8.3%. Agricultural production, in contrast, dropped by 7.1% as a typhoon and floods damaged output, though this hardly affected GDP because the sector's share of the economy is only 1.7%. The recovery, combined with the Public Services Program to hire the unemployed, increased the number of people employed by 213,000, or 2.2%, in 2004. The average unemployment rate fell to 4.4% from 5.0% in 2003. Average earnings rose by just 0.1%. The general government fiscal deficit, including the deficit of the central and local governments, has exceeded 3.0% of GDP since 2000, although the gap narrowed to an estimated 2.9% in 2004 from 3.6% in 2003. A major cause of the deficit is weak revenue mobilization. Various tax reductions and incentives over the years, as well as low economic growth rates in 2001-2003, eroded fiscal revenues to about 13.5% of GDP in 2004 from 20.6% in 1990. Government borrowing has increased instead, pushing up public debt to the equivalent of an estimated 38% of GDP in 2004, from 23% in 1998. Inflation returned, after more than 2 years of deflation, to average 1.6% in 2004. Food prices rose in the third quarter because of the damage to food production by the typhoon and floods. The impact of higher global oil prices was limited because fuel makes up only 2.3% of the CPI and because the regulated transport and power industries did not pass on the higher costs to consumers. However, the wholesale price index rose by 7.1% on average, pushed by rising international oil and commodity prices. Money supply (M2) growth picked up to 7.4%, reflecting the economic recovery. The New Taiwan dollar appreciated by nearly 3% against the US dollar to NT$33.4 on average for the year as the latter weakened. However, the domestic currency depreciated against the yen, to NT$0.309/¥1 from NT$0.297/¥1 in 2003. On the external side, merchandise exports climbed steeply by 20.7% in 2004, with exports to Asian nations up by about 25% and accounting for more than half of total exports. A large portion of this export volume to Asian economies is reexported to the US and Europe. Imports shot up by 32.2%. Sharp increases in imports of capital and consumption goods, reflecting strong domestic demand, were largely responsible. The burst of imports caused the trade surplus to shrink to US$16.5 billion in 2004 from US$24.9 billion in 2003, and the current account surplus narrowed to 6.2% of GDP from 10.2%. Foreign reserves rose by a further US$35.1 billion to US$241.7 billion at end-2004, for two main reasons: increased portfolio investment, driven by the opening of the capital market in October 2003 that allowed foreign investors to trade on the stock market; and an appreciation against the US dollar of the reserves denominated in euros and yen. Macroeconomic policy developmentsThe fiscal deficit and rising government debt are among areas receiving attention from policy makers. The tax system has become distorted by concessions and incentives that have seriously eroded the tax base. The authorities have stated that it could take 5-10 years to balance the budget, and they plan to do this by reducing government employment, enlarging the tax base,
Privatization of SOEs has fallen behind schedule because of resistance within Parliament, from labor unions, and sometimes from the companies themselves. The authorities own large stakes in many companies, including those in the airline, banking, petroleum, and telecommunications industries. In an effort to facilitate privatization, it is planned to group 43 of the companies under one (or more) holding company. However, for unprofitable enterprises such as the power monopoly Taipower, the authorities also need to allow market pricing of power before the company is likely to be attractive to investors. In 2005, the authorities intend to issue up to NT$500 billion of bonds, among other things to cover a budget deficit of nearly NT$300 billion. Some of the bonds will be exchangeable into shares of SOEs. Although international rating agencies have expressed concern over the fiscal position and rising public debt, running into serious debt problems in the medium term is unlikely. In the area of monetary policy, the Central Bank of China raised the official discount rate by 25 basis points to 1.625% in September 2004, the first increase since mid-2000, and lifted the rate further to 1.75% in December. The rises were prompted by concerns about inflation, a widening spread between domestic and US rates, and the desire to maintain positive real domestic rates. Consolidation in the banking industry is progressing slowly; the economy still has about 50 banks and a large number of small lenders. Fourteen financial holding companies were formed in 2001 to amalgamate banking, insurance, and securities operations. A number of financial-sector mergers and acquisitions were finalized in 2004, though the authorities hope to reduce further the number of financial institutions and increase the size and market share of several key domestic players. In addition, the resolution of problems that emerged during the Asian financial crisis continued in 2004. Some weak financial institutions were liquidated or acquired, and NPLs at domestic banks fell to 2.8% at end-2004 from 7.5% in 2001. The improvement in the soundness of the institutions helped spur lending to businesses. The Financial Supervisory Commission was established in July 2004 to consolidate multiple layers of financial supervision for insurance, securities, and banking. This move is expected to lead to more transparency and accountability in the financial sector. Of broader concern to policy makers is the decline in Taipei,China's economic growth rate to an average of 2.7% in the past 4 years, from 6.3% in the 1990s and 8.1% in the 1980s. Slow population growth and an outflow of FDI, partly caused by manufacturers relocating to lower-cost economies, are two of the main causes. The authorities consider that upgrading technology and a general increase in productivity is the way to achieve longer-term sustainable growth. To spur the development of a knowledge-based economy, they initiated the Challenge 2008: National Development Plan, which involves mobilizing around US$15 billion of government investment and encouraging the private sector to invest US$6 billion by 2008. Other goals for 2008 include achieving economic growth of more than 5% a year, raising spending on research and development, making the economy the world leader in 15 products or technologies, and connecting more than 6 million households to broadband telecommunications. Outlook for 2005-2007 and medium-term trendsThe GDP growth rate is expected to moderate to 4.2% in 2005 as external demand eases. Supporting this forecast, the composite index of leading economic indicators--a gauge of economic activity 3-6 months ahead--fell for several months in a row in late 2004 and its rate of decline accelerated in January. Private consumption will continue to grow, by around 3% annually in the forecast period. Private fixed investment growth will remain relatively strong and government investment in infrastructure is likely to increase. Growth in exports of goods and services will slow to 10.2% in 2005 because of softening global demand, and will decelerate to below 8% in 2006-2007. Imports of goods and services are expected to grow by 8.4% in 2005. Per capita gross national product (GNP) is set to rise to US$15,600 this year from US$14,717 in 2004, reflecting the appreciation of the local currency against the US dollar, moderate growth in GDP, and net factor foreign income flows. This milestone could be significant because the experience of other economies suggests that technology upgrades are facilitated when per capita GNP exceeds US$15,000. It has taken Taipei,China 8 years to increase its per capita GNP from US$13,500 to above US$15,000 because of slow economic growth and a weakening of the currency during the period. GDP growth is forecast to edge higher to 4.5% in 2006 and to 4.6% in 2007, based on expectations of an upturn in the global technology cycle, a greater focus on economic issues by the new cabinet, and reasonably smooth relations with the PRC. If plans to increase tax revenues gain legislative approval and further progress is made in strengthening the domestic financial system, investment and growth could be greater than forecast. CPI inflation is expected to rise to 1.7% in 2005. Regulated transport services and public utilities could well receive approval to raise prices following increases in their costs, though this should be largely offset because the appreciating currency will limit imported inflation. The CPI rose by 1.2% in the first 2 months of 2005 from the year-earlier period and the wholesale price index rose by 3.3%. Inflation is expected to be below 2% in 2006-2007, depending in large part on movements in international commodities and the exchange rate. This is expected to appreciate to average about NT$31.7 to the US dollar in 2005 and strengthen further in the following 2 years. Interest rates will be on a gradual upward trend from the low levels of recent years. In March 2005, the central bank again raised the official discount rate, to 1.875%, the third increase in 6 months. It pointed to rising inflationary expectations, high capacity utilization in manufacturing (80.3% in January), a stronger labor market (unemployment averaged 4.2% in the first 2 months of the year), and low real interest rates. In this context and with economic growth on track, the central bank said that monetary policy would gradually return to a neutral stance to help maintain price stability and prevent negative real interest rates from hampering fund allocation and long-term financial stability. It added that the rate rise would cause only a small increase in nominal costs for firms, given that the banking sector has ample liquidity to accommodate funding needs. Downside risks to this outlook include a larger than expected rise in oil prices; a sharp appreciation in the New Taiwan dollar, reducing the economy's export competitiveness; and any serious heightening of tensions with the PRC. Also, there is a risk that Taipei,China could be left out of closer regional economic integration, which would reduce its economic opportunities.
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raising tax rates, and selling some SOEs. In February 2005, they proposed a new minimum business income tax on local and foreign enterprises. However, no time frame for implementation was presented. 
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