Economic Analysis - Domestic Factors To Support Growth - MAY 2017

BMI View: The surge in exports and gross fixed capital formation growth resulted in Taiwan ' s 2016 real GDP expanding by 1.4%, slightly above our forecast of 1.1%.We expect export growth to slow over the coming quarters amid external uncertainties and the ongoing slowdown in China. However, the 2017 Universiade games and the gradual diversification of tourist arrivals will lend support to the economy. The government's infrastructure development plans will also be positive for growth. We therefore maintain our 2017 real GDP forecast at 2.0%.

In seasonally adjusted annualised q-o-q terms, Taiwan's economy grew by 1.9% in Q416, slowing from the 3.9% in the previous quarter. This brought full-year 2016 growth to 1.4%, slightly above our forecast of 1.1%. The uptick in growth was largely due to a surge in both exports and gross fixed capital formation, with exports benefitting from the rise in global demand in Q416. We expect export growth to slow over the coming quarters amid growing external uncertainties pertaining to the Trump administration's trade policies as well as the ongoing economic slowdown in China, Taiwan's main trade partner. However, we see signs that Taiwan's Southbound policy is starting to gain traction, with tourist arrivals from Southeast Asia picking up. This, in addition to the 2017 Universiade games, will lend support to the economy. The government's infrastructure development plans will also be positive for growth and lead to the improvement of the economy's transport network. We therefore maintain our forecast for real GDP growth to accelerate to 2.0% in 2017 on the back of stronger gross fixed capital formation and growth in the various tourism-related domestic sectors.

Surging Growth On The Back Of Strong Exports
Taiwan - Real GDP By Expenditure Breakdown, % chg y-o-y
Source: BMI, DGBAS

Figures from both the production and expenditure accounting methods showed that manufacturing and exports expanded in Q416. Manufacturing grew by 6.1% y-o-y in Q416 (compared to 5.2% y-o-y in Q316) and was the main driver of growth. This was due to an expansion in the production of semiconductor, basic metal and chemical material products. Electricity and gas supply also remained in expansion, coming in at 2.5% y-o-y (versus 3.5% in the previous quarter). On the expenditure side, exports surged by 8.2% y-o-y in Q416 from 3.6% y-o-y in Q316, while gross fixed capital formation expanded by 8.2% y-o-y in the same period (compared to 3.1% in Q316).

Export Recovery To Slow In H117

We believe that the strong recovery in Taiwan's exports is unlikely to last and we expect exports to grow at a slower rate in H117. The strong performance in Q416 was likely due to a sharp increase in global demand due to the pick up in the global tech cycle. As such, we believe that export growth will slow as the tech cycle enters a period of lower demand in H117. Indeed, we are already seeing signs of slowing export demand, with export orders (a leading indicator of exports) starting to grow at a slower rate in December 2016 (6.3% y-o-y compared to 7.0% in November). In addition, we forecast Chinese growth to continue slowing due to inefficient SOEs, significant industrial overcapacity and a corporate debt overhang. These dynamics will put downside pressure on growth, and we forecast China's 2017 real GDP to slow to 6.3% compared to 6.7% in 2016. Given that China is Taiwan's main trade partner (accounting for approximately 40.0% of Taiwan's total exports), a slowdown in the mainland will accordingly weigh on demand for Taiwan's exports.

Strong Export Demand Will Not Last
Taiwan - Exports To China & Total Exports (LHS) & Export Orders & Industrial Production, % chg y-o-y
Source: BMI, Bloomberg

The export-oriented nature of Taiwan's economy has also led to a sharp increase in external uncertainty following a possible rise in trade protectionism on the part of the Trump administration. An increase in trade barriers would present further headwinds to Taiwanese exports due to the economy's lack of free trade agreements (FTAs). Lastly, the winding down of the global tech cycle will result in slower export growth, with electronics being one of Taiwan's key exports (approximately 30% of total).

Diversification Of Tourist Arrivals Will Continue To Gain Traction

Tourist figures in November and December suggest that the government's Southbound policy appears to be gaining traction, and we expect the continued rise in tourists from Southeast Asia to offset the fall in mainland tourist arrivals. The diversification away from Taiwan's traditional source of visitor arrivals will be positive for the economy. Visitor arrivals from Southeast Asia have been on a steady uptrend in recent months, growing by 27.9% y-o-y in December 2016 (from 24.0% y-o-y in November) amid the easing of visa requirements for visitors from the region.

Considering that tourists from Southeast Asia account for approximately 15.5% of total tourist arrivals in 2016, we believe that the relaxing of visa requirements and increased campaigns aimed at attracting tourists from the region are likely to lead to a gradual increase in Southeast Asian visitors. This will be supportive of growth as the tourism sector accounts for approximately 5.5% of GDP. Furthermore, the increase in overseas visitors will likely have positive spillover effects on other sectors such as retail, restaurants, and the broader service industry.

Starting To Diversify Sources Of Tourism
Taiwan - Tourist Arrivals, % Of Total
BMI, Tourism Bureau

In addition, we believe that the 2017 Universiade games that will be held in August will lend further support for Taiwan's tourist sector and other industries. The Universiade is an international sporting and cultural festival which is staged every two years in a different city. It is second only to the Olympic Games. The Summer Universiade consists of 11 compulsory sports with 14 compulsory disciplines and up to three optional sports chosen by the host country. With more than 9,000 students and officials from over 170 countries expected to enter the country for the 12 days of the event, Taiwan's services sector is likely to reap considerable economic benefits from the games.

Infrastructure Investment To Provide Support

We expect that investment in the infrastructure sector will provide additional tailwinds to growth, with the government having stated that it will speed up the unveiling of projects related to a four-year TWD2.0trn (USD62.7bn) public construction plan. According to the government, these projects will comprise rail construction (including mass rapid transit, railway and light rail), water and water resource development, sewerage systems, and green energy, as well as digital technology such as smart wideband. In 2017, the government plans to spend TWD363.4bn (USD11.6bn) on public infrastructure and we believe that these investments will be supportive of growth. Indeed, our infrastructure team forecasts the infrastructure industry to grow by 3.2% y-o-y in 2017 and the transport infrastructure industry value to expand by 3.7% y-o-y.

In addition, these projects will be positive for growth over the longer term as Taiwan continues to improve the connectivity of its transport system. One of the government's projects involves spending TWD20.1bn over four years to improve the road-based public transport. The government will also spend TWD3.2bn over the next four years building the infrastructure for a smart transportation system.

Deteriorating Cross-Strait Ties Present Risks

That said, we note that the increasingly challenging state of cross-Strait ties presents downside risks to our outlook. We expect cross-Strait relations to become increasingly challenging in 2017 as Beijing seeks to adopt a harder line against Taipei in the run up to the 19th Party Congress (see ' Cross-Strait Ties To Face Increasing Challenges ' , January 18). Although not our core view, this could see China impose non-tariff barriers against Taiwan's exports and further restrict the number of tourist visas to Taiwan, weighing on growth.