Taiwan: Weakening Exports, Resilient Consumption
Andy Xie (Hong Kong)
Morgan Stanley
Aug 17, 2004
I spent three days in Taiwan last week visiting investors and businesses. It appears that consumption and property are holding up well, but exports are beginning to turn down. August is likely the turning point for the export cycle, and the downturn may be sharper than the market expects, in my view.
Taiwan’s exports go disproportionately to the US market, directly or via mainland China’s production base. Taiwanese business sentiment about exports suggests that the US economy is in trouble.
Taiwan’s domestic demand appears quite resilient. The property market is holding up well, which is surprising after the post-election turmoil. Consumption may be moderating after the strong bounce from the SARS crash last year—but it is still growing at a good pace. I believe Taiwan’s domestic demand may show substantial resilience even as exports turn down.
Exports Look Set to Turn Down Significantly
From my conversations with Taiwanese businesses last week, exporters have sensed a sharp downturn in demand over the past few weeks. This sentiment appears to be forward-looking, as the July data still showed strong exports across the region. The combined exports of mainland China, Taiwan, and Korea showed a 33.5% YoY increase in July compared with annual increases of 34.5% in the first half and 25.5% in 2003.
I believe the current situation resembles that in 1995. In mid-1995, the combined exports of mainland China, Taiwan, and Korea were growing at about a 30% annual rate. The growth rate decelerated sharply thereafter, and began to show negative growth in the spring of 1996. The transition occurred after the US Federal Reserve shifted into a tightening mode, which triggered the Mexican peso crisis in 1995.
The peso crisis, which many view as the shock that knocked down Asian exports, was just a manifestation of a liquidity bust after a long period of low Fed funds rates. In this cycle, I think the oil shock, which reflects a long period of negative Fed funds rates, is playing a similar role.
Asian exports turned down significantly in 1995, 18 months after the first Fed hike. Why should exports turn down quicker this time? The main reason, I believe, is that the Fed provided more stimulus and for longer this time. The real Fed funds rate was 0.5% in 1992, 0.1% in 1993, and 1.6% in 1994. In this cycle, it was 1% in 2001, 0.1% in 2002, -1.1% in 2003, and -1.3% in the first half of 2004.
The long period of negative real interest rates has sparked a global property bubble, which, in turn, has created strong demand for Asian exports. The combined exports of mainland China, Taiwan, and Korea experienced 17 months of above 20% annual growth up to the middle of 1995; they have already experienced 25 months of above 20% annual growth in this cycle.
Bubble-induced growth is borrowing from the future. It is very sensitive to any deterioration in liquidity conditions. The expectation of a rising Fed funds rate has been tightening liquidity conditions. The rising oil price is worsening the US trade deficit, further straining US liquidity conditions. US money with zero maturity (MZM) registered growth of 15.8% in 2001, 12.9% in 2002, and 7.3% in 2003. US MZM decelerated to 2.6% annual growth in July 2004. Liquidity conditions are now poor for financial assets and, hence, for Asian exports.
I suspect that the downturn in Asian exports in this cycle will be much quicker than the market is expecting. What Taiwanese businesses are seeing suggests that this month may be the turning point. I suspect that Asian exports could travel from 30% annual growth to low-single-digit or even negative growth within 12 months.
Domestic Demand Is Holding Up
Taiwan’s domestic demand has surprised me on the upside. I thought that the post-election turmoil could thrash the property market, causing consumption to weaken quickly. The property market seems to be holding up surprisingly well. Consumer confidence, though decelerating, remains high.
I believe the main reason for the resilience of Taiwan’s domestic demand is that its fixed investment is already very low. Its gross fixed investment declined to 17.5% of GDP from 23.5% in 2000. The low fixed investment has boosted return on capital in general, and, hence, there is less pressure to retrench labor to boost returns. A stable labor market is bolstering stability in consumption and the property market.
Much of the investment retrenchment has shown up in rising net exports. Taiwan’s net exports increased to 7.2% of GDP in 2003 from 2.3% in 2000. The surplus has caused the real interest rate to decline. The real housing loan rate, for example, has dropped to 0.7% from 3.3% in 2003 and 4.6% in 2002. The low real interest rate has enabled the property market to survive the post-election turmoil.
Further upside in consumption is possible, in my view. A low real interest rate will motivate financial institutions to create new products to boost consumption. Distributors should also come up with new ways to distribute and price products to encourage consumption. I see considerable upside potential for Taiwan’s domestic demand.
Cross-Strait Tension Is Increasing the Risk Premium
Rising cross-strait tension is the major threat to a relatively good domestic economy, in my view. Taiwan’s business community sees a significant probability that some sort of conflict between Taiwan and mainland China will occur in the next few years. When I visited Taiwan just before the election, I did not sense this level of concern over a conflict with the mainland.
The concern appears to be consistent with the evidence in mainland China. According to the mainland press, China may pass a reunification law soon, possibly after the US presidential election, which may stipulate a timetable for reunification with Taiwan. A similar timetable was stipulated before the Sino-British negotiations over Hong Kong’s handover two decades ago.
Anticipation of a worsening cross-strait relationship appears to be a factor affecting business decisions in Taiwan. Because it increases the risk premium, capital spending is unlikely to revive, in my view. This continues to keep the real interest rate low, which supports the property market. However, if cross-strait tension undermines confidence in property, that could trigger serious economic weakness.
morganstanley.com |
