Executive Summary

[TOP]

Mounting Risks In 2007
Taiwan’s real GDP growth slowed to 4.02% y-o-y in Q406, from 5.02% in July-September, in line with our expectations that the rebound in Q3 was only temporary. The expansion was the slowest in one-and-ahalf years, mainly due to weaker export growth, which we had been anticipating as a result of lower US demand for many of the technology products in which Taiwan specialises. The Q4 reading took full-year growth to 4.62% in 2006, just exceeding our forecast of 4.5%, and improving on the 4.03% recorded in 2005. The better-than-expected Q4 figure also prompted the government to raise its forecast for growth in 2007 to 4.30% from an earlier projection of 4.14% made in November 2006. However, we see persistent downside risks, to both the external and domestic sectors, and forecast slower growth of 4.0% in 2007. We are projecting average annual real GDP growth just exceeding 4% for the remainder of our forecast period, to 2011.

Exports in Recovery
Taiwan’s March exports recovered from a sharper than expected slump in February, rising by 10.4% year-on-year (y-o-y), after declining for the first time in two years by 3.6% y-o-y in February, which was largely attributed to the week-long Lunar New Year holiday. Taiwan’s export growth has been in decline since Q406, due to large inventories of hi-tech goods (Taiwan’s biggest export earner by sector) and easing demand from the US. Indeed, Taiwan’s exports to the US fell by 6.1% y-o-y in March, offset by 13.8% y-o-y growth in the island’s overseas shipments to China.

The Commercial Banking Sector
Taiwan’s potential to regain the economic power it held prior to the Asian Financial Crisis is highly questionable. It is not at all obvious what the catalyst for strong growth will be. We predict that growth is likely to remain uninspiring, due to a combination of structural and economic factors. Taiwan’s budget has run deficits for the past seven years, and despite some moves to control spending and boost the tax take, we contend that this pattern will continue well into the future.

Taiwan’s commercial banking industry is over-fragmented and consolidation is proceeding slowly. The biggest Taiwanese banks are comparatively small by the standards of other industrialised economies. Also, the industry is being forced to resolve issues of bad consumer loans. The relief scheme offered to consumers may well avoid a credit meltdown but will ultimately reduce the payment flows to banks. Interestingly, the loan/asset and the loan/deposit ratios have been falling. Banks and businesses, it seems, have not been optimistic about growth. For a country that is as rich and sophisticated as Taiwan, the loan/deposit ratio is low. Loans and deposits have been growing significantly slower than assets, and nominal GDP. The result of this is that the loan/asset, loan/deposit and loan/GDP ratios have all fallen over the last year or so even though, by most standards, they were already at moderate, high and very high levels, respectively. Excess deposits indicate that Taiwan is a country in which there is good scope for the banks to distribute insurance and other financial products to their clients.

The Taiwanese banking sector’s slow growth echoed similar results among the more developed Asian banking systems, such as Singapore and Hong Kong, which suffered small losses on some of the key indicators. The fact that Taiwan’s banking system is far less developed indicates the potential for more growth in the market, particularly in light of the high savings rate and the well-capitalised banks. Deposits per capita of US$27,505 highlight this. However, with the current structural and economic issues facing the banking sector in Taiwan, growth is likely to remain moderate.

Press Reports
A survey of recent press articles reveals two key themes. The first is a continued trend towards decreased regulation of the banking sector, and the second is debt. Significantly, press reports have indicated that Taiwan’s chief financial regulator, the Financial Supervisory Commission (FSC), is planning to open Taiwan’s markets further, enabling increased foreign investment in the banking sector.

Turning to the issue of debt, surveyed articles indicate that the FSC will continue its programme of monitoring banks with high overdue loans ratios in an attempt to promote better management of the issue among the banks. Banks have responded, in particular, by tightening their lending standards for homebuyers. Encouragingly, press reports indicate that the ratio of overdue loans dropped at the end of March. Family debts in Taiwan, however, remain the heaviest in all Asian nations, with 95% of usable income going to servicing debts, according to a survey by MasterCard.