US embassy cable - 05TAIPEI2289

UNCLAS SECTION 01 OF 05 TAIPEI 002289 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR SCOTT KI 
 
USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER 
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT 
 
TREASURY FOR OASIA/ZELIKOW AND WISNER 
 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF 
GOVERNORS, AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EINV, EFIN, ECON, TW 
SUBJECT: Mediocre Growth Returns to Taiwan 
 
 
SUMMARY 
------- 
 
1.  Taiwan's economy in Q1 2005 posted its worst performance 
since the middle of 2003, due mainly to a slowdown in export 
growth and the first decline in manufacturing production in 
the past three years.  Nevertheless, a stronger local 
currency partly offset the impact of higher energy prices 
and kept inflation fairly stable.  Private investment 
increased and unemployment continued to decline.  Business 
circles are optimistic about future prospects.  Local 
economists anticipate both exports and manufacturing 
production to pick up momentum in the second half of this 
year. END SUMMARY. 
 
Poor Performance in Q1 2005 
----------------------------- 
 
2.  Taiwan's business indicators compiled for March 2005 by 
the Council for Economic Planning and Development (CEPD) 
showed that Taiwan's economy continued softening in Q1 of 
2005.  A steady slowdown in export growth and a decline in 
manufacturing production prompted the Directorate General of 
Budget, Accounting and Statistics (DGBAS) to lower Taiwan's 
economic growth in Q1 of 2005 to 2.54% from 4.03% predicted 
in February 2005. 
 
Export Growth Slowing 
--------------------- 
 
3.  The pace of export expansion slowed dramatically in the 
first quarter of 2005.  Y-o-Y export growth dropped from 22% 
in Q1 and 29% in Q2 of 2004 to 7.8% in Q1 of 2005, the 
lowest since the middle of 2003.  The growth rate for March 
2005 was only 6.9%.  Hsu Kuo-chung, Director of the Ministry 
of Finance's Statistical Department (MOFSD), attributed the 
slowdown to three factors:  world economic softening, 
appreciation of the NT dollar (relative to the US dollar) 
blunting the competitiveness of Taiwan's exports, and PRC 
measures to cool down its economy.  Faced with a stronger 
NTD, many manufacturers are choosing to shift production 
from their Taiwan plants to their assembly lines in China. 
As a consequence, increased shipments from China to fill 
export orders are replacing a portion of deliveries from 
Taiwan.  The share of export orders received by Taiwan 
firms, but filled by overseas production bases, hit a new 
high of 40% in February 2005.  Slowing growth in the 
Mainland has also dampened demand for some production inputs 
from Taiwan. 
 
4.  Chang Yao-chung, Director of the Ministry of Economic 
Affairs Statistical Department (MOEASD), cites the same 
fundamental factors as Hsu.  Chang attributed the softening 
export performance to higher oil prices that had dampened 
demand for Taiwan-made products in such developed markets as 
the United States and Europe.  Exports to the United States 
in Q1 of 2005 grew only 7.3% from a year ago, with the 
growth rate for March 2005 still lower at 3.3%.  Exports to 
Europe in Q1 posted a decline of 1.4%, with the rate of 
decline accelerating to 5% in March 2005.  Mr. Chang also 
attributed the poor export performance to a stronger local 
currency.  The NT dollar (NTD) gained 4.6% against the US 
dollar (USD) and strengthened 2.4% against the Euro in Q1 
2005.  Compared to a year ago, the NTD has appreciated ten 
percent against the USD.  The NTD appreciation eroded 
exporters' profits and blunted Taiwan's export competitive 
edge as well, according to Mr. Chang. 
 
Double-digit Import Growth Slashes Trade Surplus 
--------------------------------------------- --- 
 
5.  Although its growth rate also slowed down, the import 
sector continued to post double-digit growth of 12.6% in Q1 
of 2005, much higher than the export growth of 7.8%. 
Consequently, Taiwan's trade surplus in Q1 of 2005 plunged 
85% from a year ago level to US$289 million.  Taiwan's 
foreign trade even ran into a deficit of US$208 billion in 
January and another deficit of US$399 billion in March. 
 
Culprits: Higher Oil Prices, Railway Cars and Aircraft 
--------------------------------------------- --------- 
 
6.  Hsu told AIT/T that higher oil prices were the most 
important factor cutting into Taiwan's trade surplus. 
According to Hsu, the average price of crude oil imported in 
March was 47.6% higher than a year ago, sending the import 
value of crude oil to shoot up 132%.  As a result, crude oil 
as a percentage share of Taiwan's total imports in March 
2005 doubled to 10% from 5.0% a year earlier.  Higher oil 
prices and a substantial increase in import volume to build 
up the island's safety stock in energy also contributed to 
significant growth in imports from oil exporting countries, 
i.e., up 169% in imports from Kuwait and up another 51.5% in 
imports from Saudi Arabia.  In Q1 of 2005, imports of crude 
oil posted a significant growth of 43.5% from the same 
period of 2004. 
 
7.  Hsu said that imports of transport equipment also 
lowered the trade surplus.  Railway cars (for Taiwan's high- 
speed railway scheduled to start commercial operation in 
late 2005) began to arrive in Taiwan from Japan late last 
year.  In addition, civilian aircraft procured in 2002 and 
2003 by Taiwan's two largest airlines (China Airlines and 
EVA Airways) from Boeing and Airbus also arrived early this 
year.  Consequently, imports of transport equipment in Q1 
2005 rose 66% from a year ago to US$1.69 billion.  The 
growth rate accelerated to 72% in March and 86% in April 
2005. 
 
Offshore Operations Cut into Local Industrial Production 
--------------------------------------------- ----------- 
 
8.  Taiwan's manufacturing production in Q1 of 2005 declined 
1.2% for the first time in the past three years although 
export sales still posted a growth of 7.8%.  Also on the 
plus side, export orders for Taiwan grew 20%.  Chang told 
AIT/T that many local manufacturing firms have shifted a 
significant portion of their production from their local 
plants to overseas bases, primarily in the PRC.  These 
overseas bases filled nearly 40% of export orders in 
February 2005.  Chang said that as recently as early 2004, 
Taiwan firms manufactured 27-28% of their exports overseas. 
Even as Taiwan firms have increased PRC-based production 
they continue to ship goods back to Taiwan for assembly and 
transshipment.  This process helps to explain how Taiwan's 
manufacturing index declines, while exports continue to 
grow, albeit at a modest rate. 
 
Investment: up Domestically, down for Cross-border Projects 
--------------------------------------------- -------------- 
 
9.  According to statistics published on May 20 by DGBAS, 
private investment in Q1 of 2005 grew 15.5%, with momentum 
of the growth mainly from huge imports of aircraft and high- 
speed railway cars.  Private economic think tanks estimated 
private investment in Q1 of 2005 would grow 11-12%. 
However, foreign direct investment in Taiwan approved by 
Taiwan's government in Q1 of 2005 dropped 38% from a year 
ago to US$476 million.  Meanwhile, approved outbound 
investment declined 10% to US$1,725 million.  Taiwan's new 
investment in China in Q1 of 2005 fell 6.6% to US$1,207 
million, compared to the same period last year. 
 
Relatively Stable Prices 
------------------------ 
 
10.  The inflation rate measured by the consumer price index 
(CPI) in Q1 of 2005 declined to 1.6% from 2.9% in Q3 of 
2004.  During the same period, the growth rate in the 
wholesale price index (WPI) also dropped from 10.4% to 2.9%. 
Wu Chao-ming, a section chief of DGBAS, attributed the 
decline in inflation partially to a strong local currency 
and partially to declines in prices of non-energy products 
and services.  According to Wu, the NTD in March 2005 was 
ten percent stronger against the USD than a year earlier, 
making prices of imported products (including energy) 
cheaper both in retail and wholesale markets.  Rental rates, 
another component of the CPI, in Q1 declined 0.3% from a 
year ago, offsetting a significant part of the 8.5% rise in 
gasoline price.  Rental rates carry a weight of 21% in the 
CPI, far more than gasoline's weight of 2.3%.  In the WPI, 
prices of machinery, computers, communication equipment, 
electronic parts and components, and electrical equipment 
all reported declines in prices due to keen competition. 
These products account for 36% of the weighting in the WPI. 
Energy, in the form of crude oil and coal, accounts for 4.5% 
of the weighting in the WPI.  Prices for crude oil and coal 
rose 19% in NTD terms in Q1 of 2005. 
 
(Notes on Composition of CPI and WPI.)  The difference in 
inflation rates measured by the CPI and the WPI is due to 
differences in the composition of these two indices.  Price 
hikes in petroleum and basic metals have been directly and 
quickly reflected in prices of relevant products, which, 
coupled with petroleum and basic metals, account for over 
20% of weighting in the WPI.  Petroleum and basic metals are 
not included in calculating the CPI.  Gasoline, electricity, 
and transportation services, which account for 6% of 
weighting in the CPI, serve as the energy components of the 
CPI.  The state-owned Chinese Petroleum Corporation has 
absorbed a large portion of the petroleum price hike.  When 
the NTD oil price rose 19%, gasoline prices increased only 
8.5%.  The state-owned Taiwan Power Company has not raised 
power charges this past year, and the transportation 
authorities have not changed transportation fares in the 
past two years.) 
 
Employment Increases 
-------------------- 
 
11.  Taiwan's employment population in March 2005 rose 1.7% 
from a year ago to 9.9 million persons.  Meanwhile, 
unemployment declined 5.35% to 428,000 persons. 
Consequently, the unemployment rate in March 2005 fell to 
4.15% from 4.45% a year earlier.  The average unemployment 
rate in Q1 of 2005 also declined to 4.16% from 4.55% in the 
same period of 2004. 
 
Prospects 
--------- 
 
12.  With the slowdown in export growth and a decline in 
manufacturing production, most businesses are neutral on 
future economic performance.  According to a recent survey 
conducted by the CEPD, 19% of firms are optimistic about 
business prospects, compared to 7% of firms expecting 
declining performance.  The remaining 74% of firms are 
expecting no change in the economy. 
 
13.  Local economists are optimistic about Taiwan's economy 
in the near future.  Both MOFSD's Hsu and TIER's Chen Miao 
believe Taiwan will not suffer chronic trade deficits in the 
future.  Chen indicated that as an export-oriented economy 
with poor natural resources, Taiwan should be able to post 
trade surplus with value added in the production process. 
According to Hsu and Chen, aircraft and railway cars are 
major capital goods that will not reappear on the import 
rolls each month.  Meanwhile, higher energy costs will 
ultimately be reflected in the value of products exported 
from Taiwan. 
 
14.  MOEASD's Chang believes that export growth will turn up 
in the near future.  He indicated that export growth in 
April was nearly 12%, much higher than 6.9% in March 2005. 
He told AIT/T that the proportion of export orders filled by 
offshore plants would not go higher than the 39.7% in 
February 2005 because assembly lines that could be relocated 
overseas (particularly to China) have already done so.  In 
particular, Taiwan manufacturing firms would increase 
shipments from their Taiwan facilities to fill export orders 
and reduce their China-based assembly lines' production once 
the renminbi revalues (against the USD) as expected by most 
observers.  According to Chang, the manufacturing 
environment in China is not yet capable of taking over 
production for hi-tech industries still in Taiwan, such as 
flat panel displays.  Chang indicated that the proportion in 
March 2005 of Taiwan export orders filled in overseas plants 
has already declined to 37%.  He believes the proportion 
will continue to fall in months ahead. 
(We will post tablular data on both our intranet page 
http://taipei.state.gov/ait_s/econ/econ_web/e condata_main.ht 
m and our SIPRnet page 
http://www.state.sgov.gov/p/eap/tapei/.  Click on the 
"Economic Section" navigation link on the left.) 
PAAL