Taiwan is facing a challenging year, according to participants in a Global Finance roundtable in Taipei. But sound regulation has made banks resilient, and the mood is still upbeat.
Global Finance: What are your views on growth prospects for the nation in 2016?
T.-Y. Lin: Taiwan had a bumpy economic performance last year. This year it is expected to do better, [but] there is downside risk. A pickup in global economic growth is likely to provide momentum, but the downside risk from the external environment remains high. First, will China’s economy experience a sharper-than-expected slowdown? Second, turbulence in the global financial markets has become worse due to monetary policy divergence among major economies, namely the United States, Europe and Japan. Third, persistent lower commodity prices are having an effect. Yet perhaps the most important trend this year for Taiwan is the loss of purchasing power in the emerging economies because of the depreciation of currencies.
In terms of domestic demand, the high correlation between investments and exports would suggest that improvement in exports will help boost private investment. Another factor is whether the labor market remains favorable. The unemployment rate remained around 3.7% in 2015, and even though wages grew a limited amount during the year, there still could be a lift in private spending and consumer confidence.
In the meantime, it is expected that expansionary fiscal policy will also continue and that public spending will, in turn, increase. All will help shore up domestic demand. And major research institutions, both international and domestic, predict that gross domestic product growth in 2016 will range between 1.5% and 2%.
Regarding inflation, right now in Taiwan we are less worried about inflation. We expect inflation to rise to about 1%, higher than last year’s negative 0.3%.
Oliver Hsieh: We can’t forget the problem in exports. Taiwan’s exports dropped sharply in 2015. Some people argue [that] maybe the structure of exports has changed. We have to really create value within the supply chain, encouraging innovation wherever and whenever we can. We have to create new demand. Changes in economic trends will of course affect Taiwan’s exports—both good and bad. But if we don’t make this change, even if all the economic conditions are a benefit to Taiwan, then we won’t see a dramatic increase in our exports.
We are trying to make the changes that will improve the export scenario. But the procedure is quite difficult. Small and medium businesses play a large role in Taiwan’s economy, yet most of these companies play a small role in the supply chain. If we are to change, we need to have them add value in the supply chain. In this, the government may have to help. President Ma Ying-jeou already had this kind of idea, so in some sense the thinking is already under way. [Also] we can no longer always focus on the markets in Southeast Asia and China, but [rather] on new markets in the US, Europe and Japan. Because they are changing, we have to change as well.
Rick Lo: The outlook is not very promising this year. Global trade decreased significantly last year. And we think it will be the same this year. Domestic demand in Taiwan also weakened because of stock market swings and a housing market downturn. Put all this together, and Taiwan’s economy seems to have lost its steam.
We expect Taiwan’s economy to expand 2.1% in 2016. However, if China’s economic growth continues to slow down and oil prices stay low, in a worst-case scenario, Taiwan’s growth rate will fall below 1%.
In terms of a “black swan” event, we think that the number-one [potential risk] is China. If China’s growth rates keep slowing, then many surrounding countries will suffer. The second is oil price: If the price stays below $30 per barrel, then the US energy sector will have to lay off lots of workers and cut back capital spending, and we think it will affect US growth. A third “swan” could be the Brexit, if Britain votes to leave Europe. If this happens, Europe’s economy will slow quickly. The last is Donald Trump. [The participants laugh.] If he is elected president, then we cannot predict what he will do next.
Jack Wang: In my daily activities, we look at the market only. Consider three of the top five [companies] by market cap of Taiwan: TSMC, Hon Hai Precision and Chunghwa Telecom. And all these three are related to Apple. Here you have Mr. [Tim] Cook [chief executive of Apple] saying that he is having trouble sleeping due to declining iPhone sales. And this, gentlemen, is a problem for Taiwan’s economy. The other two in the top five according to market cap are petrochemical firms, both linked to oil. Oil is posing uncertainty across the global economy. It’s almost certain we don’t know what lies ahead. Many investment bank research divisions are still predicting oil at US$60 to $70 a barrel throughout 2016. If you look at it today, it’s below US$30. And we don’t really know how Apple or other giants of the digital economy—such as Facebook and Amazon—can sustain the drive and growth that have marked their recent history.
Another major uncertainty is how slowing growth and volatility in China will affect Taiwan’s economy. Since the stock market crash and devaluation of the renminbi in August 2015, China has introduced several policy factors, such as the basket index. When they announced the basket in December, the market was still very nervous. But today the basket index is relatively stable. The message delivered by this is that the renminbi is a stable, strong currency against other currencies.
The main number that the market is looking at now is China’s level of reserves. Today that’s a comfortable US$3 trillion. If the number falls below this, people will be very nervous. But we have to ask: Are we, the market, too nervous, too China-bearish?
GF: What’s the case for rate cuts in the first half of this year?
T.-Y. Lin: If you are interested in how the central bank designs its policy, you can look back to last year, when the central bank raised rates twice, in September and December. The rate change was based on the consideration at that time that the global economy was experiencing a slow recovery. Second, we thought that domestic growth momentum had weakened. Third, the negative output gap had widened, and at that time the inflation expectation was very mild. The major goal of any monetary policy stance is to be accommodative and to sustain adequate liquidity in the market. This is our basic stance.
Regarding low interest rates and the effect on household debt levels, the dual ratios of debt and disposable income to GDP in Taiwan stand at around 120% and 80%, respectively. Both are high, yet relatively stable. Mortgage loans are the primary source of household debt, but the nonperforming loan ratio at domestic banks has remained low in recent years. A higher level of household debt probably means a greater vulnerability in the event of a reverse in the national interest rate trend. If the interest rate in the market is going up, probably households will have a greater burden managing their debt. So the central bank is always mindful of the risk stemming from future interest rate changes.
Rick Lo: We predicted the first rate cut (in 2015) correctly, but regarding the second rate cut, everyone was wrong. Taiwan’s real interest rate is still higher than many Asian economies. The CBC [Central Bank of the Republic of China (Taiwan)] might consider another rate cut in the first quarter.
Jack Wang: On the interest rate cut. We’re in the dealing room. Most of the traders were so surprised. Last year, I always asked research guys about the direction of rates, and they predicted that they would rise. How is Taiwan withstanding the volatility? There’s a couple of reasons why we can manage this volatility. One is that our banking system, as a whole, is very well governed. If you compare it to other countries’—India’s or China’s—our numbers are always transparent. Our regulator does smart things, and does them in time. The Financial Services Commission recognized Taiwan’s banks have a large exposure to overseas renminbi. They pushed the so-called credit value adjustment (CVA) reserve measure. Our banks are well capitalized and compliant with global standards. Compare Japan, where the banks are still in, like, Basel 2.5 or Basel 2 stage. We are in Basel 3, moving to Basel 4. We achieved Tier 1 capital requirements and CVA requirements ahead of peer countries.
T.-Y. Lin: You kind of look at the interest rate cut as a surprise, but at that time it only seemed like a surprise because the US Federal Reserve had started to hike its rate. Market sentiment told us it wasn’t necessary to lower Taiwan’s interest rate, because the US had already increased its rate. But at the time the central bank looked at a lot of economic indicators, especially the export numbers. We had very bad export figures. Last year, we were looking at 11 months of negative growth rates in exports at the time of the rate-cut decision. Also some of our concern involved the condition of general market sentiment. We thought we weren’t moving fast enough. We had only done a 12.5-basis-point cut in September. So we thought another minor cut would be suitable in December.
[Editor’s note: At presstime, the CBC cut its discount rate to 1.5%.]
GF: Will there be continuity in economic policy when the administration of president-elect Tsai Ing-wen takes power?
Rick Lo: Most of the economic policies will be continued, especially those related to regional economic integration and strategic industries. In terms of trade policies, the Trans-Pacific Partnership will be the utmost. The “new southbound policy,” brought forward during Tsai’s election campaign, indicates India and the Asean will be the keys to Taiwan’s trade development. The trade negotiations with China will be continued under the Cross-Strait Supervision [and Regulations Bill].
Regarding industrial policies, the new administration will focus on biotech and medicine, green tech, entrepreneurship, smart machine, and defense and aerospace in the hope of finding new drivers of economic growth. The new administration will set up a national investment fund, similar to Temasek Holdings in Singapore, to absorb/reduce costs associated with innovation.
Jack Wang: If you take a look at the Democratic Progressive Party white paper on economic policy, one focus is biotech. Our vice-president-elect Chen Chien-jen is a biotech expert. Taiwan does put a lot of resources in the biotech sector. Still, the sector has been underallocated in terms of public investment and support, and the government needs to invest. It will take a couple of years to show results, but the potential is huge. Taiwan is good at making both high-value-added products and mass market products. Our chemical manufacturing capability and distribution is very strong. Investing in this sector is one simple way the government can achieve good things. One thing is certain, the new government has to deliver something to the voters. Biotech has the talent pool and leadership.
Oliver Hsieh: People always welcome a new government if the previous government didn’t do things well. But it depends on how the new government uses its power. Does it spend time checking on the policy of the previous government to see if it had done something wrong? Or will it look for new opportunity?
GF: Competition in Taiwan’s banking system is fierce. How are banks adapting to competition, via specialization and targeting niche markets in particular?
Rick Lo: There is overbanking in Taiwan and the profit is low. Net interest margin rose slightly from 1.43% in Q2 2015 to 1.46% in Q3 2015, marking a seven-year high. To survive, banks—in particular, the relatively small-scaled regional and local ones—have tried to find their niche. For example, both Taichung Bank and Bank of Kaohsiung focus on SME [small and midsize enterprises] finance. Larger banks, like Taipei Fubon Commercial Bank, instead expand operations into overseas markets via M&A, and make use of high-quality service to gain more market share.
Oliver Hsieh: The previous chairman of FSC [Financial Supervisory Commission] recognized the competition in the banking industry and launched Bank 3.0 to encourage banks to engage in reform. In the meantime, he applied a lot more regulation. The net result of the two-pronged approach is that the financial structure is healthier now. Beneficial policies focused on the increase in capital, knowing your customer, encouraging banks to go overseas, and engagement of fintech. Banks are preparing for future development. To go overseas, we have to adjust ourselves to a different kind of culture—this eventually will make the head office even smarter in Taiwan. The policies of the FSC have been very good.
T.-Y. Lin: Look at the scale of Taiwan’s banks compared to the international banks. If you want to grow outside Taiwan, the scale of our banks are kind of small. Mergers and acquisitions, making the banks bigger, would be one requirement. But size isn’t everything. Remember Japanese banks, which made a push out of Japan by setting up in New York and elsewhere? They wanted to broaden the scope of their business and operation. They never really succeeded.
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