TAIWAN'S ECONOMIC OUTLOOK DARKENS, BUT FINANCIAL

C O N F I D E N T I A L AIT TAIPEI 001638


STATE FOR EAP/TC
STATE PASS USTR FOR STRATFORD AND WINELAND, TREASURY FOR
OASIA/WINSHIP AND PISA,
NSC FOR LOI, COMMERCE FOR 4431/ITA/MAC/AP/OPB/TAIWAN

E.O. 12958: DECL: 11/20/2018
TAGS: ECON EFIN ETRD EINV PGOV PREL TW
SUBJECT: TAIWAN'S ECONOMIC OUTLOOK DARKENS, BUT FINANCIAL
SECTOR LOOKS SOUND

REF: TAIPEI 1630

Classified By: AIT Director Stephen M. Young for reasons 1.4 (b) and (d).


1. (C) SUMMARY. On November 20, official GDP figures showed
the Taiwan economy contracted by 1.02% year-on-year (yoy) in
the third quarter, a sharply lower figure than had been
predicted just weeks earlier. The government's 2008 GDP
growth forecast is now 1.87%, and the official estimate for
2009 GDP growth has declined to 2.12%, from 5.08% in August.
Taiwan's increasingly gloomy economic outlook stems primarily
from a decline in exports, which accounted for 73.7% of GDP
in 2007. To help counter the slowdown, the administration on
November 20 approved a plan to offer NT$ 3,600 (approximately
US$ 108) consumption vouchers to all Taiwan citizens, a
roughly US$ 2.5 billion program slated to add 0.64% to
overall 2009 GDP growth. Despite weak exports and tightening
credit, however, our financial sector contacts are confident
Taiwan banks will weather the ongoing financial crisis and
economic downturn. In general, our contacts do not expect the
downturn to bottom out until the second quarter of 2009. END
SUMMARY.

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Economy shows fresh signs of weakness
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2. (C) Over the past week, our contacts with financial sector
officials, bank regulators, business executives,
administration officials, and private economists have
indicated growing pessimism about Taiwan's immediate economic
prospects, tempered with underlying confidence in the
viability of the financial system and faith in the economy's
ability to ride out the global downturn, which most are
predicting will last at least through the second quarter of

2009. The third quarter GDP figure, which showed a 1.02%
year-on-year decline, was sharply at variance from
predictions made only a few weeks ago by Premier Liu, who
appeared to be expecting a figure in the 3-4% range.


3. (SBU) Even before the release of yesterday's GDP figures,
however, there has been a widespread sense among many of our
contacts that the Taiwan economy is decelerating more quickly
than predicted only two months ago, when the global financial
crisis first began to bite. At a November 18 lunch hosted by
the Director, and in other meetings, Taiwan bankers and
economists acknowledged that collapsing domestic demand and
falling exports, which posted an 8% year-on-year decline in
October, are translating into real hardship for many of their
customers.


4. (C) President Chen Tsu-pei of Cathay United Bank, the
banking portion of Taiwan's largest financial holding
company, told us he expects the Taiwan economy to deteriorate
for at least another year. He said January would be
particularly telling, because that is when Taiwan firms close
for New Year celebrations and distribute annual bonuses. He
said "good companies" would distribute small or even no
bonuses, but a number of other companies would simply fold
and not re-open. Chen also anticipated closures of Taiwan
factories in China during this time. Faced with declining
orders and rising costs, many are struggling, he said,
particularly small and medium-sized enterprises. As the
financial crisis continued, liquidity remains a problem for
many of these firms. He noted that many SMEs have had their
payment terms cut from 120-150 days to 90 days, which
essentially dries up two months of liquidity. This causes a
serious crimp in the cash flow for Taiwan firms, which often
operate with razor-thin margins.


5. (C) Looking at larger firms, Chen said firms in all
sectors are cutting investment and trying to find ways to
lower labor costs. A number of firms, he noted, are putting
workers on unpaid leave for two or three days a week. Other
firms, he predicted, will close down for annual maintenance
and the Chinese New Year holiday, but will delay reopening.
Corning, the largest U.S. investor in Taiwan, told us it is
shuttering its Taichung plant through early 2009 due to weak
demand for its flat glass panels (reftel). The DRAM
industry, in particular, is in trouble, faced with collapsing
prices and falling demand. In the face of these
deteriorating market conditions, Chen, and other bankers,
noted that their banks were tightening credit for companies
as well as for their credit card customers.


6. (C) Not all firms in Taiwan's vital technology sector are
having serious problems, however. A senior executive at tech
sector bellwether Taiwan Semiconductor Manufacturing
Corporation (TSMC),for example, told us his company will be
able to survive the downturn due to its strong cash reserves,
despite a dramatic drop in orders from the U.S. At a recent
luncheon hosted by the Director for young business
entrepreneurs, participants representing the technology,
design, bicycle manufacturing, consulting, and publishing
sectors were all positive about their own business prospects,
even if they were downbeat about the immediate fortunes of
the overall economy.

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Financial sector can weather the storm
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7. (C) During the November 18 luncheon, a group of leading
Taiwan bankers told the Director that, even in the face of
the economic slowdown, Taiwan banks can easily weather the
storm. Although they expect non-performing loans (NPLs) to
increase and have noted some deterioration in consumer credit
quality, their mortgage portfolios and large corporate loans
are doing fine, except for some weakness in the SME sector.
The bankers agreed that Taiwan's SMEs are especially
vulnerable during the downturn. Until a few months ago, banks
were counting on rising income from their rapidly-growing
wealth management businesses, but this sector has largely
collapsed in recent weeks.


8. (C) Yen Ching-Chang, Chairman of Yuanta Financial
Holdings, said Taiwan's financial sector is in a much better
position than a few years ago, in the wake of an overhang
from excessive consumer credit. After an initial round of
bank consolidation and injections of equity by the
authorities, NPL ratios have dropped significantly. The
banking system is flush with liquidity, noted Yen, although
authorities recently had to step in and offer blanket deposit
guarantees to stop the flow of funds from private banks,
which are perceived as riskier, to state-owned institutions.
One bank officer told us that in September and October, over
NT$150 billion (about US$4.5 billion) in deposits flowed out
of private banks into the state-owned Bank of Taiwan.


9. (C) Separately, the Director General of the Banking
Bureau, Chang Ming-dao, told us to expect a rise in NPLs and
a fall in bank fee income, but that the exposure of Taiwan
banks to the global financial crisis is much less that in
other economies. The economic downturn, however is having an
effect on Taiwan's real sector. For example, Taiwan's DRAM
firms now have outstanding loans totaling around NT$ 250
billion (around US$ 7.5 billion). He believes the banking
sector is strong enough to absorb any related losses in this
and other weakening sectors, and predicts the Executive Yuan
will craft a separate rescue plan to infuse liquidity into
the troubled DRAM industry.


10. (C) Although the Director General of the Banking Bureau
told us he expects financial sector reform to continue and
that the Bureau will "encourage" banking sector
consolidation, our private sector banking contacts are
generally more pessimistic. State-owned or state-controlled
banks still hold half of all assets in the market, and
privatizing those institutions is politically sensitive due
in part to strong opposition from unionized workforces.
Victor Kung, President of Fubon Financial, observes that
during the presidential election campaign, then-candidate Ma
told the unions that no further privatization would happen
during his administration. Public opinion, Kung added, does
not necessarily support selling state-owned banks to private
sector counterparts, many of which are controlled by wealthy
families. In a separate conversation, however, SinoPac
Holdings President Sean Chen told us the financial crisis
will ultimately encourage mergers and financial sector
consolidation as weaker players are forced out of the market.


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Comment: No Panic
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11. While the bankers and regulators that we spoke with
expect tough times ahead, no one is showing signs of panic.
Banks are prepared to deal with lower profits, but are not
expecting to see significant deterioration of their balance
sheets. The situation of Citibank, whose Taiwan head joined
the Director's lunch, was telling. A few hours before, his
New York headquarters announced massive job cuts, but he
expected few if any redundancies in Taiwan. Banks aren't all
that worried about their Taiwan operations.


SYOUNG