Taiwan: Reassessing growth, inflation, and financial stability
- Taiwan is slipping into a technical recession, dragged by the severe semiconductor downturn
- Longer-term investment plans remain on track, consumption remains stable, …
- …and services exports have begun to pick up
- Inflation is sticky and widely felt by consumers
- Financial sector is relatively insulated from the banking crisis in US/Europe
Technical recession underway
In recent months, the dismal trade and manufacturing data point to a technical recession in Taiwan in 1Q. Exports and industrial production fell -19.2% YoY and -14.8% respectively in Jan-Feb, deeper declines compared to -8.6% and -5.9% in Oct-Dec22. S&P manufacturing PMI rose to 48.6 in March from the bottom of 41.5 in Oct22 but still stayed in the contraction zone.
Semiconductor exports are facing a severe downturn due to the ending of the pandemic-related demand, rise in interest rates, and escalation of US-China tech tensions. Export orders and exports of electronic components fell sharply by about -20% YoY as of February. The inventory-to-shipment ratio in the electronic component sector spiked to the levels last seen during the 2008 global financial crisis and the 2001 tech bubble burst. Inferred from historical experiences, it would take at least three quarters for the ongoing destocking process to be completed, which means 3Q23 at the soonest.
China's reopening demand is far from broad-based, providing no central support for Taiwan’s exports in the near term. Export orders from China (including Hong Kong SAR) and exports to China extended the massive declines into February, at -30~40% YoY. Historical data analysis shows that Taiwan’s exports to China are more correlated with China’s exports than with its retail sales and fixed asset investment. Compared to electronics, non-electronics exports are correlated relatively with China's domestic indicators. A broader recovery in China’s domestic economy in 2H23 may help to lift Taiwan's non-electronics exports. But a substantial revival in electronics exports, which account for 2/3 of Taiwan’s total exports to China, would still require a turnaround in global end-demand.
Thankfully, the negative spillovers of the ongoing trade recession to Taiwan’s domestic sectors appear limited. In general, semiconductor companies still expect a constructive sectoral outlook in 2024 and beyond, underpinned by demand in the high-performance computing and automotive segments. Large foundries have continued to invest in cutting-edge technologies during the current downturn to consolidate their leading positions. TSMC has set the 2023 capex plan at USD32-36bn, modestly lower than the record USD36bn last year. The company has commenced the construction of its first 2nm chip plant in the Hsinchu headquarter and plans to deploy Nvidia’s new AI acceleration technology by mid-2023 to speed up the manufacturing process of advanced chips.
The consumption outlook remains largely stable. Despite the decline in real wages as a result of higher inflation, consumers could deploy their “excess” deposits accumulated in the past three years during the pandemic. Taiwanese households’ savings rate increased sharply between 2019 and 2021, from 21.8% to 25.2%. A 1% pullback in the savings rate is estimated to unleash spending worth TWD100bn, equivalent to 0.4% of GDP. At the beginning of this year, the government also announced a cash handout of TWD6,000 for each citizen to aid their disposable incomes. Additional fiscal stimulus is expected to bolster consumption and lift GDP growth by about 0.3ppt this year.
Furthermore, services exports have begun to pick up on the back of the border reopening. Foreign visitor arrivals surged from 70k in Sep22 to 370k in Feb23, reverting to 30% of the pre-Covid levels within five months. Notwithstanding China’s tourism bans, rising visitors from Southeast Asia provided a solid uplift for Taiwan’s tourism sector. We estimate a 70-80% recovery in inbound tourism this year implies inbound spending of USD10-11bn or 1.3-1.5% of GDP.
Inflation remains sticky
While the economy is slipping into a technical recession, inflation remains sticky on the other hand. Headline CPI continued to rise 2.7% YoY in Jan-Feb, a pace similar to 4Q22 and well above the 10-year average of 1%. Notably, core CPI has stayed above the 2% mark for 12 months, the first time seen since 2008.
Sticky inflation could be explained by tight labor market conditions, increased price expectations, and the reopening-related services demand. The unemployment rate dropped to a two-decade low of 3.6% (sa) in Jan-Feb, on the back of the still-resilient labor demand and shrinking of the working age population. Under the latest consumer confidence survey, confidence about the price level in the next six months has fallen to the lowest since 2008. Meanwhile, services inflation has stayed above the 2% mark for 12 consecutive months, an unprecedented phenomenon in the recent two decades.
Domestic consumers widely feel the impact of inflation. Under the CPI basket, the items with more than one purchase per month saw the highest inflation of 3.9% in Jan-Feb. Food inflation was particularly high at 5%, led by eggs and edible oil, followed by cereals, meat, and seafood. The supply-side factors pushing up food inflation, such as the rise in feeding costs and the outbreak of bird flu, have continued to linger. Energy inflation, which correlates with the movement in global oil prices, has begun to moderate. But a belated electricity price hike, which aims to mitigate the cumulative losses incurred by the state-owned Taiwan Power Company, is on the way. The 11% electricity price hike scheduled for April is estimated to boost CPI inflation by about 0.2ppt this year.
The financial sector remains stable
Regarding financial stability, Taiwan remains relatively insulated from the recent banking crisis in the US and Europe. Following the investment loss news of the Silicon Valley Bank in early March, the TAIEX fell moderately by -4% between March 8 and March 16, with the financial shares dropping -6%. The TAIEX regained the lost ground, posting a year-to-date rise of more than 10%.
As a whole, Taiwanese banks should benefit from the current rise in global/domestic interest rates and the resultant expansion in interest rate margins. On the balance sheet, loans account for the majority 58% of Taiwanese banks’ total assets, while portfolio investments account for only 10%. On the other hand, 80% of banks' total liabilities are comprised of household and enterprise deposits. As much as 98% of the depositors are covered by deposit insurance under the government-run Central Deposit Insurance Corporation (TWD3mn per depositor per insured institution). Thanks to the higher interest rate environment over the past one year, banks’ averaged ROE and ROA ratios improved modestly, from 8.0% and 0.59%, respectively, in 2021 to 9.2% and 0.64% in 2022.
Credit risk, rather than market risk, is a relatively important concern for the financial soundness of Taiwanese banks. Loan default risk could rise in the coming quarters due to the current cyclical downturn in the property market and the resultant deleveraging in the household sector. The property market appears in a soft-landing mode at present. Sinyi residential property prices in the Taipei area eased modestly to 4.8% YoY in Jan-Feb, down from 8.4% in 4Q22. The median days for property transactions have risen from the bottom but remained far lower than the peak levels seen during the 2015-16 property downturn. Banks’ housing loans and construction loans also slowed gradually, to 5.6% and 10.1%, respectively, in Jan-Feb, compared to 7.1% and 11.5% in 4Q22. The past-due loan ratio in the banking sector remained very low and stable at 0.2% as of January.
After all, Taiwan’s central bank (CBC) has refrained from aggressive monetary policy tightening over the past year. The CBC raised the benchmark discount rate by merely 75bps between Mar22 and Mar23, from 1.125% to 1.875%. The discount rate, 1Y deposit rate, and base lending rate remained more than 100bps lower than their prior peak levels in 2008. The gradual and calibrated approach to monetary policy normalisation has helped to reduce the fluctuations in bond prices and temper the increase in corporate and household debt repayment burdens.
In anticipation of a severe export downturn, we have downgraded the 2023 GDP growth forecast to 1.6% from 2.3% during a January review. This is lower than the central bank and the government’s latest forecasts of 2.2% and 2.1%. We are currently maintaining our full-year growth forecast below consensus at 1.6%. This implies two quarters of negative YoY growth in 4Q22 and 1Q23, matching the definition of a technical recession. The YoY growth is expected to turn positive from 2Q23 onwards but remain subpar at around 2% on the back of a milder degree of export contraction and a stronger pickup in consumption. A notable GDP rebound to 3% is expected to emerge in 4Q23 after export growth turns positive and the semiconductor destocking process is largely completed.
Our CPI inflation forecast for 2023 is revised to 2.0%, up from 1.8%. This reflects the inflationary impact of the upcoming electricity price hike in April. Our inflation forecasts now stand close to the central bank and the government’s estimates of 2.1% and 2.2%. On a quarterly basis, we think that CPI figures have peaked in 1Q23 but will stay close to 2% YoY through 2Q23-4Q23.
In line with the upward inflation forecast revision, we are adding a 12.5bps hike into our interest rate forecast, projecting the benchmark discount rate to peak at 2.00% in 2Q23. Another 12.5bps hike will allow the CBC to further normalise monetary policy and take the inflation-adjusted real rate closer to zero. During its full-year GDP projections, the CBC has factored in negative growth in 1Q23 and a strong rebound in 2Q-4Q23. Technical recession in 1Q23 may not deter the CBC from further policy normalisation at the June meeting. Higher real rates, retreating inflation/inflation expectations, and a weaker-than-expected growth rebound will likely prompt the CBC to pause at the September meeting.
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