Mediocre Growth Returns to Taiwan

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E.O. 12958: N/A
TAGS: EINV EFIN ECON TW
SUBJECT: Mediocre Growth Returns to Taiwan


SUMMARY
--------------


1. Taiwan's economy in Q1 2005 posted its worst performance
since the middle of 2003, due mainly to a slowdown in export
growth and the first decline in manufacturing production in
the past three years. Nevertheless, a stronger local
currency partly offset the impact of higher energy prices
and kept inflation fairly stable. Private investment
increased and unemployment continued to decline. Business
circles are optimistic about future prospects. Local
economists anticipate both exports and manufacturing
production to pick up momentum in the second half of this
year. END SUMMARY.

Poor Performance in Q1 2005
--------------


2. Taiwan's business indicators compiled for March 2005 by
the Council for Economic Planning and Development (CEPD)
showed that Taiwan's economy continued softening in Q1 of

2005. A steady slowdown in export growth and a decline in
manufacturing production prompted the Directorate General of
Budget, Accounting and Statistics (DGBAS) to lower Taiwan's
economic growth in Q1 of 2005 to 2.54% from 4.03% predicted
in February 2005.

Export Growth Slowing
--------------


3. The pace of export expansion slowed dramatically in the
first quarter of 2005. Y-o-Y export growth dropped from 22%
in Q1 and 29% in Q2 of 2004 to 7.8% in Q1 of 2005, the
lowest since the middle of 2003. The growth rate for March
2005 was only 6.9%. Hsu Kuo-chung, Director of the Ministry
of Finance's Statistical Department (MOFSD),attributed the
slowdown to three factors: world economic softening,
appreciation of the NT dollar (relative to the US dollar)
blunting the competitiveness of Taiwan's exports, and PRC
measures to cool down its economy. Faced with a stronger
NTD, many manufacturers are choosing to shift production
from their Taiwan plants to their assembly lines in China.
As a consequence, increased shipments from China to fill
export orders are replacing a portion of deliveries from
Taiwan. The share of export orders received by Taiwan
firms, but filled by overseas production bases, hit a new
high of 40% in February 2005. Slowing growth in the
Mainland has also dampened demand for some production inputs
from Taiwan.


4. Chang Yao-chung, Director of the Ministry of Economic
Affairs Statistical Department (MOEASD),cites the same
fundamental factors as Hsu. Chang attributed the softening
export performance to higher oil prices that had dampened
demand for Taiwan-made products in such developed markets as
the United States and Europe. Exports to the United States
in Q1 of 2005 grew only 7.3% from a year ago, with the
growth rate for March 2005 still lower at 3.3%. Exports to
Europe in Q1 posted a decline of 1.4%, with the rate of
decline accelerating to 5% in March 2005. Mr. Chang also
attributed the poor export performance to a stronger local
currency. The NT dollar (NTD) gained 4.6% against the US
dollar (USD) and strengthened 2.4% against the Euro in Q1

2005. Compared to a year ago, the NTD has appreciated ten
percent against the USD. The NTD appreciation eroded
exporters' profits and blunted Taiwan's export competitive
edge as well, according to Mr. Chang.

Double-digit Import Growth Slashes Trade Surplus
-------------- ---


5. Although its growth rate also slowed down, the import
sector continued to post double-digit growth of 12.6% in Q1
of 2005, much higher than the export growth of 7.8%.
Consequently, Taiwan's trade surplus in Q1 of 2005 plunged
85% from a year ago level to US$289 million. Taiwan's
foreign trade even ran into a deficit of US$208 billion in
January and another deficit of US$399 billion in March.

Culprits: Higher Oil Prices, Railway Cars and Aircraft
-------------- --------------


6. Hsu told AIT/T that higher oil prices were the most
important factor cutting into Taiwan's trade surplus.
According to Hsu, the average price of crude oil imported in
March was 47.6% higher than a year ago, sending the import
value of crude oil to shoot up 132%. As a result, crude oil
as a percentage share of Taiwan's total imports in March
2005 doubled to 10% from 5.0% a year earlier. Higher oil
prices and a substantial increase in import volume to build
up the island's safety stock in energy also contributed to
significant growth in imports from oil exporting countries,
i.e., up 169% in imports from Kuwait and up another 51.5% in
imports from Saudi Arabia. In Q1 of 2005, imports of crude
oil posted a significant growth of 43.5% from the same
period of 2004.


7. Hsu said that imports of transport equipment also
lowered the trade surplus. Railway cars (for Taiwan's high-
speed railway scheduled to start commercial operation in
late 2005) began to arrive in Taiwan from Japan late last
year. In addition, civilian aircraft procured in 2002 and
2003 by Taiwan's two largest airlines (China Airlines and
EVA Airways) from Boeing and Airbus also arrived early this
year. Consequently, imports of transport equipment in Q1
2005 rose 66% from a year ago to US$1.69 billion. The
growth rate accelerated to 72% in March and 86% in April

2005.

Offshore Operations Cut into Local Industrial Production
-------------- --------------


8. Taiwan's manufacturing production in Q1 of 2005 declined
1.2% for the first time in the past three years although
export sales still posted a growth of 7.8%. Also on the
plus side, export orders for Taiwan grew 20%. Chang told
AIT/T that many local manufacturing firms have shifted a
significant portion of their production from their local
plants to overseas bases, primarily in the PRC. These
overseas bases filled nearly 40% of export orders in
February 2005. Chang said that as recently as early 2004,
Taiwan firms manufactured 27-28% of their exports overseas.
Even as Taiwan firms have increased PRC-based production
they continue to ship goods back to Taiwan for assembly and
transshipment. This process helps to explain how Taiwan's
manufacturing index declines, while exports continue to
grow, albeit at a modest rate.

Investment: up Domestically, down for Cross-border Projects
-------------- --------------


9. According to statistics published on May 20 by DGBAS,
private investment in Q1 of 2005 grew 15.5%, with momentum
of the growth mainly from huge imports of aircraft and high-
speed railway cars. Private economic think tanks estimated
private investment in Q1 of 2005 would grow 11-12%.
However, foreign direct investment in Taiwan approved by
Taiwan's government in Q1 of 2005 dropped 38% from a year
ago to US$476 million. Meanwhile, approved outbound
investment declined 10% to US$1,725 million. Taiwan's new
investment in China in Q1 of 2005 fell 6.6% to US$1,207
million, compared to the same period last year.

Relatively Stable Prices
--------------


10. The inflation rate measured by the consumer price index
(CPI) in Q1 of 2005 declined to 1.6% from 2.9% in Q3 of

2004. During the same period, the growth rate in the
wholesale price index (WPI) also dropped from 10.4% to 2.9%.
Wu Chao-ming, a section chief of DGBAS, attributed the
decline in inflation partially to a strong local currency
and partially to declines in prices of non-energy products
and services. According to Wu, the NTD in March 2005 was
ten percent stronger against the USD than a year earlier,
making prices of imported products (including energy)
cheaper both in retail and wholesale markets. Rental rates,
another component of the CPI, in Q1 declined 0.3% from a
year ago, offsetting a significant part of the 8.5% rise in
gasoline price. Rental rates carry a weight of 21% in the
CPI, far more than gasoline's weight of 2.3%. In the WPI,
prices of machinery, computers, communication equipment,
electronic parts and components, and electrical equipment
all reported declines in prices due to keen competition.
These products account for 36% of the weighting in the WPI.
Energy, in the form of crude oil and coal, accounts for 4.5%
of the weighting in the WPI. Prices for crude oil and coal
rose 19% in NTD terms in Q1 of 2005.

(Notes on Composition of CPI and WPI.) The difference in
inflation rates measured by the CPI and the WPI is due to
differences in the composition of these two indices. Price
hikes in petroleum and basic metals have been directly and
quickly reflected in prices of relevant products, which,
coupled with petroleum and basic metals, account for over
20% of weighting in the WPI. Petroleum and basic metals are
not included in calculating the CPI. Gasoline, electricity,
and transportation services, which account for 6% of
weighting in the CPI, serve as the energy components of the
CPI. The state-owned Chinese Petroleum Corporation has
absorbed a large portion of the petroleum price hike. When
the NTD oil price rose 19%, gasoline prices increased only
8.5%. The state-owned Taiwan Power Company has not raised
power charges this past year, and the transportation
authorities have not changed transportation fares in the
past two years.)

Employment Increases
--------------


11. Taiwan's employment population in March 2005 rose 1.7%
from a year ago to 9.9 million persons. Meanwhile,
unemployment declined 5.35% to 428,000 persons.
Consequently, the unemployment rate in March 2005 fell to
4.15% from 4.45% a year earlier. The average unemployment
rate in Q1 of 2005 also declined to 4.16% from 4.55% in the
same period of 2004.

Prospects
--------------


12. With the slowdown in export growth and a decline in
manufacturing production, most businesses are neutral on
future economic performance. According to a recent survey
conducted by the CEPD, 19% of firms are optimistic about
business prospects, compared to 7% of firms expecting
declining performance. The remaining 74% of firms are
expecting no change in the economy.


13. Local economists are optimistic about Taiwan's economy
in the near future. Both MOFSD's Hsu and TIER's Chen Miao
believe Taiwan will not suffer chronic trade deficits in the
future. Chen indicated that as an export-oriented economy
with poor natural resources, Taiwan should be able to post
trade surplus with value added in the production process.
According to Hsu and Chen, aircraft and railway cars are
major capital goods that will not reappear on the import
rolls each month. Meanwhile, higher energy costs will
ultimately be reflected in the value of products exported
from Taiwan.


14. MOEASD's Chang believes that export growth will turn up
in the near future. He indicated that export growth in
April was nearly 12%, much higher than 6.9% in March 2005.
He told AIT/T that the proportion of export orders filled by
offshore plants would not go higher than the 39.7% in
February 2005 because assembly lines that could be relocated
overseas (particularly to China) have already done so. In
particular, Taiwan manufacturing firms would increase
shipments from their Taiwan facilities to fill export orders
and reduce their China-based assembly lines' production once
the renminbi revalues (against the USD) as expected by most
observers. According to Chang, the manufacturing
environment in China is not yet capable of taking over
production for hi-tech industries still in Taiwan, such as
flat panel displays. Chang indicated that the proportion in
March 2005 of Taiwan export orders filled in overseas plants
has already declined to 37%. He believes the proportion
will continue to fall in months ahead.
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PAAL