Taiwan: GDP grows on a rebound in exports Asia Pacific Economic Outlook, Q4 2016

A revival of overseas demand, especially from China and Hong Kong, as well as an increase in exports to Europe, helped Taiwan’s GDP grow in the second quarter, after three consecutive quarters of decline. However, what to expect in the longer term is of greater importance, and the good news is that the signs are positive.


Special Topic: ASEAN Economic Community

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After declining for three consecutive quarters, Taiwan’s real GDP finally grew in the second quarter of 2016. Growth was largely attributable to a rebound in exports. That, in turn, followed a long period in which the value of the currency declined, thereby improving export competitiveness. Moreover, second quarter export growth benefitted from a revival of overseas demand, especially in China and Hong Kong. Exports to Europe revived as well. On the other hand, consumer spending grew only modestly and business investment continued to decline in the second quarter. Of greater importance than second quarter performance, however, is what to expect in the third quarter and beyond. The good news is that there are a number of positive signs.

First, exports grew in both July and August in dollar terms, boding well for further export growth in the third quarter. Moreover, the rebound in exports is likely to spur a recovery in business investment in order to meet rising overseas demand. Plus, expected strong demand for the next generation of consumer electronics is likely to boost both investment and exports in Taiwan, a country that produces many of the electronic inputs used in smartphones and other products. On the domestic side, employment has begun to increase after decelerating significantly in 2015 and early 2016. This should help to boost the consumer side of the economy.

Second, improving economic strength has likely been fueled by an easier monetary policy. The central bank has cut its benchmark interest rate four times since late 2015. This was made possible by the fact that inflation remains quite low. Prices actually fell significantly in 2015 as the drop in oil prices took a toll. Yet inflation made a comeback in 2016, running currently at about 1.0 percent per year. In addition, the currency, having fallen sharply from 2013 to 2015, has risen since early in 2016, putting downward pressure on inflation. This provided room for the central bank to cut rates with impunity. However, it is likely that the Taiwanese currency will fall again if and when the US Federal Reserve tightens monetary policy.

The bottom line is that the Taiwanese economy should continue to grow modestly in the second half of 2016 and accelerate modestly in 2017. Inflation is expected to remain low and monetary policy can be expected to remain accommodating. Much, of course, will depend on China, Taiwan’s most important trading partner. If the Chinese economy stabilizes, as seems likely at the moment, this will be to the benefit of Taiwan.

In terms of risks to the Taiwanese economy, they are minimal. Taiwan benefits from the fact that it has a modest government budget surplus, thus providing sufficient wiggle room to stimulate the economy in the event of a downturn. In addition, Taiwan has a very large external surplus, more than 13.0 percent of GDP, thus significantly reducing the risk that a downturn in trade or cross-border capital flows might lead to significant currency movements, capital flight, or inadequate liquidity for the financial system. An external surplus actually means that a country is exporting capital, often to support its own exports of goods and services. It reflects an excess of saving over domestic investment. Another positive factor for Taiwan is the fact that both unemployment and inflation are low, thus enabling the central bank to focus on the currency and on the country’s competitiveness. Thus, from a policy perspective, Taiwan is well positioned to absorb future shocks.

On the downside, Taiwan’s demographics, like those of other affluent countries, are worsening due to a low birth rate and a paucity of immigration. The working age population has already begun to decline, thus ensuring slower economic growth in the absence of accelerated productivity growth. Moreover, Taiwan faces increased competition from China. The latter is moving up the value chain, investing in processes that used to be done in places like Taiwan. Now, there is increasing vertical integration in China. Thus, Taiwan will have to focus more on final markets in the future (such as Europe, the United States, and Southeast Asia), rather than relying on providing inputs to final producers in China. Taiwan’s competitiveness, therefore, will depend on having high-quality human capital at a reasonable cost. It will also depend on developing more competitive service industries and not simply relying on manufacturing. Indeed the future development of world-class service industries is likely to be the best path toward faster productivity growth.