Tech sector downturn 

We observe more signs of a downturn in Taiwan’s tech and overall manufacturing sectors. Manufacturing PMIs (both S&P and Chung-Hua Institution for Economic Research) have fallen below 50 since July. Now the hard data have also started to deteriorate. Export orders contracted -1.9% YoY in July. Industrial production slowed to 1.1% YoY, notably down from 3.6% in 2Q and 6.5% in 1Q. Customs exports remained strong at 14.2% YoY as of July. But given the tight correlation with export orders and industrial production, exports growth may also fall to a low single digit rate within the next three months.

As far as the tech sector is concerned, the downturn is largely driven by the downstream consumer electronics segment, and to a less extent, by the upstream semiconductors. Export orders for information and communication products contracted by -0.8% in July. Orders for electronic components continued to grow 8.8%, but the pace has also slowed compared to 10.9% in 2Q and 25.0% in 1Q. On a relative basis, Taiwan’s semiconductor exports continued to outperform South Korea’s. This should be attributed to the strong competitiveness of Taiwanese foundries and the diversification of their chip products.

The ongoing tech downturn is a reflective of the deterioration in global macroeconomic conditions. In July, Gartner revised down its 2022 global semiconductor revenue forecast to 7.4% from 13.6%, and lowered the 2023 forecast to -2.5% from 3.6%. Gartner warned of weakness in downstream consumer electronics areas like PCs and smartphones, citing the deterioration in global consumer disposable incomes as a result of rising inflation and interest rates. It expects the data center and automotive chip segments to remain resilient, driven by the demand from cloud infrastructure investment and transition to electric/autonomous vehicles.

The ongoing tech downturn is also a typical, cyclical adjustment within this sector. Global semiconductor sales have maintained a growing trend for three consecutive years since 2020. Global fab spending has also been in an expansionary mode for three years in a row. The last time when these happened was 2016-2018. Typically, supply-demand conditions in the semiconductor sector will undergo a rebalancing in every 2-3 years, as new fab facilities are constructed and new production capacity is released.

Destocking looks likely to continue through 2H22 and into 1H23. The inventory-to-shipment ratio in Taiwan’s electronic components sector is currently close to the levels seen in early-2019. Based on the 2019 experience, it will take 2-3 quarters for the destocking process to be completed. Leading foundries including TSMC and Vanguard also said recently that inventory correction may continue for several quarters into 1H23.

Low growth, no recession

What are the implications for Taiwan’s overall economy? We think GDP growth will fall below the potential rate but still avoid a contraction. The magnitude of the current manufacturing downturn is similar to 2015 (China slowdown), 2019 (tech downturn) and 2020 (Covid outbreak). In 2015 and 2020, the economy slipped into a technical recession with 2-3 quarters of negative QoQ growth. In 2019, the economy managed to avert a technical recession, maintaining a stable growth rate of around 3%. The key difference was that domestic demand expanded strongly in 2019 to offset the deterioration in exports. Gross fixed capital formation surged 11.1% in 2019, thanks to the investment repatriation from the Taiwanese manufacturers based on the mainland after the China-US trade war.

Compared to 2019, investment may not be strong enough to offset the deterioration in exports this time. The current expansion in domestic investment is largely driven by spending in the tech sector, i.e., construction of new chip fabs and purchases of the semiconductor equipment used in chip fabrication. As the tech sector enters into a downcycle, capital spending is also likely to cool down. TSMC said recently that it would postpone some of the 2022 capex plans into 2023. Vanguard announced to cut its 2022 capex by 4%. DRAM producer Nanya also said that it would cut the 2022 capex by 10%.

Compared to 2015 and 2020, consumption and services will likely provide a better cushion to the economy this time. Consumption and services sectors are currently recovering from the slump caused by domestic Omicron outbreak in 2Q. Mobility data for retail and recreation activities have risen about 50% from the trough in May, but remained 15% below the normal levels as of August; suggesting the room for a further recovery ahead. Thanks to the improvement in Taiwan’s Covid-resilience, the authorities are also mulling plans to further reopen borders around October this year, such as raising the arrival quota, loosening the quarantine requirements, and allowing the entry of foreign tourists. This should help to facilitate the recovery in consumption and services sectors in the quarters ahead.

Forecast revisions

Considering all, we are revising our GDP growth forecast to 2.9% for 2022, from 3.4% previously. The 2023 growth forecast is also lowered to 2.3% from 2.8%. On the quarterly basis, GDP growth is expected to fall notably to 0-1% YoY in 4Q22-1Q23, before returning to 2-3% in the subsequent quarters. 

On monetary policy, two 12.5bps rate hikes are still expected for the September and December central bank meetings. Despite growth slowdown, the central bank will continue to face tightening pressures in the near term, because 1) inflation will likely stay close to 3% in 3Q-4Q due to the supply-side constraints and high energy prices, 2) the Fed will likely stay hawkish and continue to lift rates at the Sep-Dec FOMC meetings. We no longer look for rate hikes in 2Q-4Q23. The CBC may shift to a more balanced policy stance by then, after seeing an easing in domestic inflation to 1-2%, as well as a peaking in global interest rates.

Fiscal stimulus is expected ahead as economic conditions weaken and the November local elections approach. Possible measures include special financing/job support for the SMEs impacted by export slowdown, subsidies on the farmers suffering from China’s recent export bans, consumption vouchers to expedite the post-Covid recovery in domestic demand, among others. The government has proposed an expansionary general budget for 2023, lifting the deficit-to-GDP ratio to -0.7%, from 0.1% in 2022. The 2023 budget will emphasize public spending on the longer-term economic development projects, such as infrastructures, net-zero transition, and social safety net.

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