Taiwan outlook ‘sluggish’, yet downgrade risk limited
Taiwanese assets have performed well this year. Strong fundamentals and a stabilizing mainland economy should continue to underpin Taiwan’s outlook.
The Democratic Progressive Party handily won the 2016 elections. President Tsai become the first woman to lead Taiwan, winning 56% of the vote vs. 31% for KMT candidate Chu. This was the biggest winning margin since the president became elected by the popular vote back in 1996.
The DPP also got a majority in parliament, winning 68 seats out of 113. This was the first time that a party other than the KMT has held a majority. This should allow President Tsai and the DPP greater freedom to pursue its policies. The KMT came in second with 35 seats.
Local elections will be held in 2018 and the next national elections will be held in 2020. The KMT will be led by new head Wu, who took over for Hung, who had in turn replaced Chu after the 2016 defeat. Since the KMT favors stronger ties with China, Wu will face the tricky task of appealing to Taiwanese voters at a time when public support for reunification is at all-time lows.
Yet Tsai’s popularity has plummeted. Recent polls show 33% approving of the way she is leading Taiwan, down from 70% when she first took office. While a lot can happen between now and 2020 (or 2018, for that matter), Tsai’s rapid fall from grace is noteworthy. It remains to be seen if the KMT can capitalize on this. Stay tuned.
The economy is still sluggish. GDP growth is forecast by the IMF to accelerate modestly to 1.7% in 2017 from 1.5% in 2016, and picking up further to 1.9% in 2018. GDP rose 2.6% y/y in Q1, down slightly from 2.8% in Q4, which was the strongest rate since Q1 2015. On the other hand, export orders and leading indicators have been slowing, and support a more cautious outlook for growth.
Price pressures remain low, with CPI rising 0.6% y/y in May vs. 0.1% in April. The central bank does not have an explicit inflation target. However, low inflation supports the case for steady rates. It just left rates unchanged last week, whilst noting that “massive” inflows have led to TWD appreciation, which in turn has limited the need for rate hikes.
Since it last cut 12.5 bp in June 2016, Taiwan’s central bank has kept rates at 1.375%. Next quarterly policy meeting is in September and no change is expected then. Bloomberg consensus sees steady rates through year-end with potential tightening to start by mid-2018.
Fiscal policy has remained prudent despite sluggish growth. The budget deficit came in at an estimated -0.3% of GDP in 2016, little changed from -0.2% 2015. It is expected to widen to around -1% of GDP in both 2017 and 2018.
The external accounts remain solid. Low oil prices have helped limit imports, while the stabilizing mainland economy has helped boost exports. The current account surplus was about 13.5% of GDP in 2016, and is expected by the IMF to widen to around 15% in both 2017 and 2018.
Foreign reserves rose to a record $440 bln in May. They cover almost 20 months of import and are nearly 3 times larger than the stock of short-term external debt.
The Taiwan dollar continues to outperform. In 2016, TWD rose 2% vs. USD and was behind only the best performers BRL (22%), RUB (20%), ZAR (13%), COP (6%), CLP (5.5%), and IDR (2%). So far in 2017, TWD is up 6% YTD and is behind only the top EM performer MXN (15%). Our EM FX model shows the Taiwan dollar to have VERY STRONG fundamentals, so this year’s outperformance is likely to continue.
USD/TWD has traded largely in the 30.00-30.50 range since mid-April. The pair has retraced less than a quarter of this year’s drop. Retracement objectives of that move come in near 30.89 (38%), 31.19 (50%), and 31.49 (62%). The 200-day moving average comes in near 31.06.
Taiwanese equities are underperforming EM slightly after a strong 2016. In 2016, MSCI Taiwan rose 12% vs. 7% for MSCI EM. So far this year, MSCI Taiwan is up 16% YTD and compares to 18% YTD for MSCI EM. This modest underperformance should ebb, as our EM Equity model has Taiwan at an overweight position.
Taiwanese bonds have performed OK recently. The yield on 10-year local currency government bonds is about -18 bp YTD. This is in the middle of the EM pack. The worst performers are Czech Republic (+52 bp), China (+50 bp), and Korea (+5 bp), while the best are Indonesia (-109 bp), Turkey (-92 bp), and Peru (-81 bp). With inflation likely to remain low and the central bank on hold, we think Taiwanese bonds could start outperforming more.
Our own sovereign ratings model shows Taiwan’s implied rating at A+/A1/A+ and is right at the borderline for AA-/Aa3/AA-. As such, actual ratings of AA-/Aa3/AA- are facing very modest downgrade risks.
Win Thin is global head of Emerging Markets Strategy at Brown Brothers Harriman