COUNTRY REPORT | TAIWAN
Taiwan’s bright fundamentals are underpinned by a revival in both export and import demand, but could a housing bubble be on the horizon?
Tony Phoo, chief Taiwan analyst at Standard Chartered, has watched the false dawns—the months during which Taiwan’s key economic indicators rose, then weakened. He believes the current recovery, though, is the real thing. Underpinned by better fundamentals, it has, he says, more staying power.
Taiwan has taken some time to return to equilibrium. GDP growth was on an uptick in the first half of 2013. Then came the US Federal Reserve’s announcement that it might soon begin tapering its quantitative easing program, which caused a mini-shock for Asia’s exporters. Third-quarter growth sputtered to 1.3%. Following a pattern, the figure revived in the fourth quarter to 2.9%, arriving at 2.1% growth for 2013 overall.
Domestic demand, which has remained stable throughout this year, is the key reason for the revival and for Taiwan’s brightened medium-term prospects. With estimates putting full-year projections at a respectable 3.1%, it looks like the country’s slow recovery is now in full swing.
“What we see now is more-reasonable growth,” notes Phoo. “Underlying the numbers is a story of steady domestic demand supported by a good appetite for [Taiwanese] exports from the US and, increasingly, from Europe. We’re seeing a more sustainable growth path.”
Exports are generally seen as a leading indicator of the health of Taiwan’s economy. Export orders in June reached their highest percentage growth level in 17 months, largely owing to a rise in shipments of electronics to China—as components—and to the US and Europe.
It is the rise in imports, though, that economists see as an index of the better environment. The acceleration of import growth in the quarter ending June, according to Moody’s Analytics economist Katrina Ell, “overwhelmed the rise in exports.” She says rising imports are a good indicator of future demand, “given the high proportion used as inputs [for goods that will] ultimately [leave the country] as exports.”
Imports of capital goods, such as machinery to make gadgets in Taiwan’s tech clusters, have been a major contributor to the higher figures. Taiwan’s electronics firms, with their focus on making mobile phones for the likes of Apple, are having a strong year. But imports of consumer goods have been on the rise as well, a sign that the jobs market is improving and people are buying.
“The trend has been persistent in terms of imports of capital goods,” says Phoo, “indicating improving manufacturing confidence.” But he adds, “It’s not just capital goods imports that’s a sign of business confidence. If you look at where banks have been lending, there’s been a rise in loans to small-to-medium-size enterprises over the last 12 months, showing that local businesses are making expansion plans, and this is driving the job market as well.” Phoo says that the unemployment rate in Taiwan had dropped below 4% by July.
Phoo also reads higher imports as a sign that exports will rise. One reason Phoo is confident of sustained export growth is the improvement in the global tech sector, where demand for mobile phones—Taiwan’s specialty—is still in full swing. Taiwan Semiconductor’s second-quarter sales were about $6 billion, exceeding analysts’ expectations. TSMC and rivals GlobalFoundries and Semiconductor Manufacturing International Corp are all gearing up to provide Apple’s suppliers in China with the next generation of iPhones with larger screens.
Amid this atmosphere of plenty, Taiwan’s banks are still experiencing headwinds. As Ginger Kao, Taiwan banking analyst for Moody’s, says, “The banking environment is highly competitive. The banks are awash in liquidity. Normally, this wouldn’t be a bad thing, but they need to find a better way to utilize the liquidity than highly aggressive pricing.”
The banks are in no immediate danger, Kao notes. Despite the aggressive pricing and its impact on profitability, they can easily go to the local bond markets to raise funding, should it become necessary. She notes that a certain inertia has crept into the banking market because “many banks are sharing the same customer base; it is hard for them to differentiate because the profiles are the same.”
EXPOSURE TO THE PANDA
Taiwan’s exposure to changes in China’s economy is reflected in a rising risk profile for the nation’s banks. China is the key trading partner and direct investment market for Taiwan’s businesses, with about 40% of Taiwan’s total exports being shipped to China, including Hong Kong, and 60% of total outward investments going to the mainland.
Taiwan banks’ exposure to China is rising, too. According to Kao, total Chinese exposures rose rapidly to 65% of banks’ total shareholder equity in the second quarter of 2014, versus 50% at September 30 last year. If China’s economy slows faster than expected, a rise in nonperforming loans from the mainland will pinch Taiwanese banks’ capital reserves. Taiwan banks are not alone, however. The same issue applies to banks from other Asian nations, including Singapore, that have expanded even more rapidly into Taiwan in recent years.
|Export boom: Visual Inspection of CPT display (Liquid Crystal Display touch technology) at a plant owned by manufacturer EDT in Kaohsiung, Taiwan.|
The biggest risk to Taiwan’s economy—and to its banks—lies at home. Gareth Leather, Asia economist for London-based consultancy Capital Economics, says “property prices, which have risen over the past couple of years, now look to be in the bubble territory.”
Taiwan’s central bank, he says, is aware of the issue and has been introducing macroprudential measures—short of raising interest rates—that include tighter requirements on mortgages. So far, the tactic hasn’t worked. “A sharp fall in house prices could dampen consumer sentiment, cause problems with the banking sector and slow overall economic growth,” notes Leather.
Kao agrees that a housing bubble could be developing and that governmental measures have fallen short. But she has confidence in the backstop of Taiwan’s high household savings rate. “If there was a shock, there could be some cushion in that people have financial assets that could be quickly liquidated.”
In any case, Kao concludes, Taiwan is well practiced at bouncing back.
TAIWAN BANKS IN CHINA: GOOD TO GO?
Cathay United Bank in July became the first Taiwanese financial institution to open an office in the Shanghai Free Trade Zone (FTZ), a move that represented a milestone in the entry of Taiwanese banks to China.
Cathay United will take advantage of the FTZ in the same way Citigroup, HSBC and Standard Chartered have done. Banks in the FTZ do not face any limits on lending to finance cross-border trade activity conducted inside the zone and will be allowed to exchange Chinese renminbi with foreign currencies freely.
The Taiwanese banking presence in mainland China has grown steadily in the four years since 2010, when three of the nation’s banks were handed licenses to operate on the mainland. Today, pre-tax profit contributions from mainland branches of the 10 largest Taiwanese banks with a presence in China stand at 1% to 9%, according to Moody’s. The figure for Cathay United is about 2.5%, while Taipei Fubon Commercial Bank has the largest exposure—at 8.5%.
Expansion on the mainland remains a key strategy for many banks, but regulatory restrictions in Taiwan have put limits on their ability to grow there. Regulators in Taiwan will allow local banks to open sub-offices across the Taiwan Strait only if their mainland exposure stays below the bank’s total shareholders’ equity. As a consequence, loan exposure has remained relatively low, at about 6% of total loans at the end of 2013, according to Moody’s (Fitch puts the figure at $90 billion, or about 7% of all Taiwan bank assets).
All foreign banks in China share the same risk scenario as the Taiwanese institutions: a rebalancing economy and threat of a deterioration of loan quality as economic growth slows. Moody’s Taiwan banking analyst Ginger Kao says that she sees the banks’ “growth in China remaining modest owing to the ongoing restrictions from both Chinese and Taiwanese regulators.” Growth will be limited enough over the next 12 to 18 months for any negative impact from a China unit to be “nonmaterial.”
Fitch’s Jonathan Lee is a little less sanguine, worrying that “most Taiwanese banks have no proven track record of sustaining profitable offshore operations” and that weakness of governance and transparency in China credits may prove too “challenging” to manage successfully.