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Taiwan Country Risk Report Q1 2016

Taiwan Country Risk Report Q1 2016

Core Views

Taiwan's economy contracted by 1.0% y-o-y in Q315 compared to the 0.5% expansion registered in the previous quarter. Ongoing weakness in the Chinese economy amid increasing uncertainty in the domestic political situation will continue to weigh on Taiwan's economic growth. As such, we have downgraded our 2015 and 2016 real GDP forecasts to 1.0% and 1.9% (respectively) from 1.7% and 2.5% previously.

The replacement of Kuomintang (KMT)'s presidential candidate less than three months before the presidential and legislative elections on January 16 2016 will be insufficient to stem the sharp outflow of support from the KMT and might even backfire as it loses the support of deep-blue and swing voters. As such, the opposition Democratic Progressive Party (DPP) candidate, Tsai Ing-wen, remains the frontrunner in the presidential election, and the gap between the KMT and the DPP for the legislature race continues to widen in favour of the DPP.

The Central Bank of the Republic of China (CBC) cut its discount rate by 12.5 basis points (bps) to 1.75% on September 24 amid concerns over the slowing economy. While we expect the central bank to stand pat on rates for the rest of this year as policy makers assess the impact of the cut, we now forecast two additional rate cuts of 12.5bps each in 2016 in a bid to support growth and keep the Taiwan dollar competitive. We have also downgraded our 2016 real GDP forecast to 1.9%, from 2.5% previously to reflect ongoing export headwinds.

Taiwan's expansionary budget will miss its deficit target in 2016 due to its overly optimistic view of stronger global growth, informing our forecast for the deficit to come in at 1.6% of GDP, higher than the government's projected 0.9%.

The surge in reserves reflects fundamental buying pressure on the Taiwan dollar, with the currency carving out a bottom. Over the long term, an undervalued real effective exchange rate, low inflation, and huge current account surplus will lend support to the currency, allowing gradual appreciation.

Major Forecast Changes

We have downgraded our 2015 and 2016 real GDP growth forecast to 1.0% and 1.9% respectively (from 1.7% and 2.5% previously) to reflect the impact of a challenging external environment, as well as the deleterious toll that policy uncertainty has taken on the domestic economy.

We now forecast the CBC to cut its discount rate by 25bps in 2016 to 1.50% instead of hiking rates to 2.00% as previously forecast.

We have upgraded our end-2015 forecast to TWD32.40/USD from TWD33.00/USD to reflect the slight upside pressure.


Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Political Outlook
SWOT Analysis
BMI Political Risk Index
Short-Term Politics
No Change In Fortunes Despite New KMT Presidential Candidate
The replacement of KMT's presidential candidate less than three months before the presidential and legislative elections on January 16
2016 will be insufficient to stem the sharp outflow of support from the KMT and might even backfire as it loses the support of deep-blue
and swing voters.
TABLE: POLITICAL OVERVIEW
Long-Term Politics
Legal Status Quo To Prevail In 2010s
Taiwan's long-term political prospects are inseparable from its relations with China, and while cross-Strait relations have thawed in
recent years, we believe the status quo will largely prevail. While further economic integration is likely between the two Chinas, we
exclude meaningful political convergence.
Chapter 2: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Downgrading Growth As Headwinds Mount
Taiwan's economy contracted by 1.0% y-o-y in Q315 compared to the 0.5% expansion registered in the previous quarter. Ongoing
weakness in the Chinese economy amid increasing uncertainty in the domestic political situation will continue to weigh on Taiwan's
economic growth.
GDP By Expenditure Outlook
Fiscal Policy And Public Debt Outlook
Budget 2016: Fiscal Deficit Will Remain Modest
Taiwan's expansionary budget will miss its deficit target in 2016 due to its overly optimistic view of stronger global growth, informing our
forecast for the deficit to come in at 1.6% of GDP, higher than the government's projected 0.9%.
TABLE: ECONOMIC ACTIVITY
Structural Fiscal Position
TABLE: FISCAL POLICY
TABLE: MAIN REVENUE AND EXPENDITURE CATEGORIES
Monetary Policy
Rate Cut Signals Start Of Easing Cycle
The CBC cut its discount rate by 12.5 basis points (bps) to 1.75% on September 24 amid concerns over the slowing economy. While we
expect the central bank to stand pat on rates for the rest of this year as policy makers assess the impact of the cut, we now forecast two
additional rate cuts of 12.5bps each in 2016 in a bid to support growth and keep the Taiwan dollar competitive.
Monetary Policy Framework
External Trade And Investment Outlook
TWD: Bottoming Out
The surge in reserves reflects fundamental buying pressure on the TWD, with the currency carving out a bottom. Over the long-term,
an undervalued real effective exchange rate, low inflation, and huge current account surplus will lend support to the currency, allowing
gradual appreciation.
TABLE: MONETARY POLICY
TABLE: BMI CURRENCY FORECAST
Outlook On External Position
TABLE: MAIN IMPORTS AND EXPORTS
TABLE: CURRENT ACCOUNT
TABLE: MAIN IMPORT AND EXPORT PARTNERS
Chapter 3: 10-Year Forecast
The Taiwan Economy To 2024
Multiple Headwinds Against Structural Growth
A strong recovery from the global financial crisis by no means suggests that Taiwan's economy will maintain a robust growth trajectory going forward. We believe the lingering presence of the government within the banking sector, an increasingly uncompetitive technology sector, an overly tech-focused economy and the reluctance to speed up Chinese investment, will impede Taiwan's structural growth prospects. Moreover, a rigid labour market, coupled with fast deteriorating demographics will serve to erode the attractive of Taiwan's business environment. Lastly, we expect the structural shift in China's economy to carry wide-ranging ramifications for Taiwan. We expect real GDP growth to average 3.8% between 2015 and 2024.
TABLE: LONG-TERM MACROECONOMIC FORECASTS
Chapter 4: Operational Risk
SWOT Analysis
Operational Risk Index
Operational Risk
TABLE: OPERATIONAL RISK
Education
TABLE: ASIA - EDUCATION RISK
TABLE: ENROLMENT IN TERTIARY EDUCATION
Government Intervention
TABLE: ASIA -GOVERNMENT INTERVENTION RISK
TABLE: NET TAXABLE INCOME (NTD) AND TAX RATE
Chapter 5: BMI Global Macro Outlook
Global Outlook
Exit The Dragon
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %

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