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Taiwan's Slowdown: Blame Business Cycle

State Can Do Little to Speed Upturn

By Philip Bowring - International Herald Tribune


President Chen Shui-bian is getting much of the blame for the double-digit decline in the Taiwan stock market since his inauguration in May.

The uncertain touch of inexperienced ministers has undermined confidence, hopes of a breakthrough on cross-straits relations have faded, and fears of tax increases lurk in the background. To shore up this politically sensitive, retail-dominated market, the government has again resorted to using public money as well as exhortation.

But this may all be in vain. The main villain in the piece is the business cycle. Add in some legacies of slack Kuomintang government management, notably a huge government deficit and lingering banking problems, and the Chen administration's failings to date seem well down the list of problems.

Official intervention is unlikely to have more than short-term effects. By the standards of almost every other economy, Taiwan's problems are modest. How many can boast persistent growth close to 6 percent, a current-account surplus, inflation of under 2 percent and a key role as hardware supplier to the global information-technology revolution?

Exports, the most crucial factor, rose 20 percent in the first half of this year, and double-digit expansion for the whole year seems assured.

But the best of the current cycle is now in the past. Economists, who spent the first half of the year repeatedly upgrading their growth forecasts, are now moving into reverse. The peak in growth of gross domestic product year-on-year has just about arrived, at probably better than 7 percent. The index of leading indicators has been slipping slowly since February. By the fourth quarter, growth will be down to 6 percent, and, even if global conditions remain favorable, 2001 promises no more than 5.5 percent.

That remains impressive for an economy with minimal labor-force growth. But Taiwan has high expectations, and high stock-market valuations by Asian standards - though only a small fraction of Nasdaq levels, despite Taiwan's huge high-tech sector. So it needs a combination of optimistic sentiment, easy liquidity and strong earnings if its stock-market index is to push back up to its high for this year of more than 10,000 points reached in April. It closed at 8,114.92 on Monday.

Export growth here, as elsewhere in Asia, has stunned most forecasters. But the explosive Asian recovery is slowing down. European demand is strong but not spectacular. And few now want to bet on how much longer the U.S. expansion or the information-technology boom will last. Exports apart, Taiwan's GDP growth this year also has been helped by a surge in private investment as the information industry in particular adds to and upgrades capacity.

But what has benefited the GDP numbers has been bad for liquidity. The surge in capital-goods demand has caused imports to rise even faster than exports so that the current-account surplus has shrunk and money supply growth has been at the low end of the central bank's target range. Despite booming profits in most of the information-technology sector, investment spending is draining corporate liquidity and leading to cash calls from shareholders. There has also been a surge in investment in mainland China to meet global electronics demand as well as improved prospects in China.

Private investment spending is expected to begin to ease by early 2001 as the expansion cycle wanes. That might help the stock market but not the economy, as government spending, long expansionist, could fall. Reconstruction outlays after the 1999 earthquake have already peaked, and, to try to rein in its huge budget deficit, the government has taken an axe to infrastructure projects.

So growth is going to be increasingly dependent on consumers' willingness to spend. After a sharp jump early in the year, consumption growth has slowed as unemployment remains high by local standards and the stock market is down, affecting wealth perceptions. Nominal interest rates are below U.S. levels, but with inflation, low real rates are not much of an encouragement to borrow. Meanwhile, banks are under pressure to clean up their loan portfolios, so they are not rushing to lend, despite the central bank's inducements. Some overstretched Kuomintang-linked companies have been selling shares to raise cash and reduce debts.

The government must try to cut a huge budget deficit while meeting at least some of its election promises, particularly its plan for basic pensions, medical care for children and help for first-time home buyers.

A decade of deficits has brought total government debt to 2.4 trillion Taiwan dollars ($7.75 billion). Though still only 30 percent of GDP, it is up from almost zero a decade ago. Over the past two years it has been increased by counterrecession measures in 1998 and by earthquake reconstruction. Now is the time to retrench.

Fiscal problems have resulted as much from erosion of the tax base as from spending excesses. Business has many tax concessions intended to encourage investment. Customs revenue has fallen as tariffs have come down in readiness for WTO membership. Tax revenue has fallen from 18 percent to 14 percent of GDP over the past five years.

Mr. Chen is eager not to do anything more to displease either the stock market or the business community, which has been upset by a legislated reduction in the workweek; so public-sector investment is headed for a steep fall.