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Cablegate: Taiwan Economy: Sunny with Polychrome Clouds

VZCZCXRO1962
RR RUEHGH
DE RUEHIN #3051/01 2490621
ZNR UUUUU ZZH
R 060621Z SEP 06
FM AIT TAIPEI
TO RUEHC/SECSTATE WASHDC 1953
INFO RUCPDOC/USDOC WASHDC
RUEHBK/AMEMBASSY BANGKOK 3394
RUEHBJ/AMEMBASSY BEIJING 5621
RUEHUL/AMEMBASSY SEOUL 8068
RUEHGP/AMEMBASSY SINGAPORE 6592
RUEHKO/AMEMBASSY TOKYO 7997
RUEHML/AMEMBASSY MANILA 9791
RUEHJA/AMEMBASSY JAKARTA 3915
RUEHKL/AMEMBASSY KUALA LUMPUR 3554
RUEHHI/AMEMBASSY HANOI 3121
RUEHBY/AMEMBASSY CANBERRA 4301
RUEHWL/AMEMBASSY WELLINGTON 1549
RUEHHK/AMCONSUL HONG KONG 6828
RUEHGH/AMCONSUL SHANGHAI 0354
RUEHGZ/AMCONSUL GUANGZHOU 9532
RUEHRC/USDA FAS WASHDC 2560
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 05 TAIPEI 003051

SIPDIS

SIPDIS, SENSITIVE BUT UNCLASSIFIED

STATE PLEASE PASS AIT/W AND USTR
STATE FOR EAP/TC, EAP/EP
DOE FOR EIA/OOG/KVAGTS
FAS FOR ITP/ADD/SHIEKH, MIRELES, AND SMITHUS
USTR FOR ALTBACH
USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT
TREASURY FOR OASIA/LMOGHTADER
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 PINR TW
SUBJECT: Taiwan Economy: Sunny With Polychrome Clouds

Ref: (A) Taipei 2695

(B) Taipei 2574
(C) Taipei 1549
(D) 05 Taipei 4647

SUMMARY
-------

1. (SBU) Summary: Local think tanks forecast rising exports will
keep Taiwan's economic growth rate at around 4% in 2006 and 2007 and
bring Taiwan's unemployment rate below the current 3.9%. Private
consumption and investment (75% of GDP) are recovering from high
card debt and inventories, and net capital outflows mitigate excess
liquidity in Taiwan. This sunny forecast contrasts sharply with
media reports and widespread perceptions of gloomy economic
prospects. End summary.

Taiwan Media Reports Paint Bleak Picture
----------------------------------------

2. (SBU) The Taiwan media seems to thrive on doom and gloom stories
of unemployment, suicide, crime, and corruption. Articles on
economic issues commonly include data presented to make Taiwan's
economic situation appear bleak. Recent articles, even in
economic-focus newspapers, have reported that foreign investment is
continually declining, that Taiwan families are worse off than five
years ago, and that Taiwan's level of unemployment and poverty
threaten its social stability, etc. Most economists looking at
Taiwan's economy, along with its crowded restaurants, stores, and
streets would not draw these conclusions.

Forecasts by Four Major Think Tanks
-----------------------------------

3. (U) During July and August four major Taiwan think tanks
published updated economic forecasts for 2006, and two released 2007
forecasts. The Directorate General of Budget, Accounting and
Statistics (DGBAS), Taiwan's official statistics agency, predicted
on August 18 that economic growth will increase from 4% in 2005 to
4.3% in 2006 and will remain above 4% in 2007. The independent
think tanks Chunghua Institution for Economic Research (CIER),
Taiwan Institute of Economic Research (TIER), and Academia Sinica
produced similar estimates with economic growth for 2006 and 2007
projected at around 4%.

Exports Drive Economic Growth
-----------------------------

4. (U) Taiwan Customs data show y-o-y export growth increased from
8.8% in 2005 to 14% in the first seven months of 2006, with the
monthly growth rate accelerating from 10% in May to 16.5% in June
and 21% in July. Growth in export orders in Q2, the basis for
actual shipments in Q3, increased to 21.6% from 21.2% in Q1 of 2006,
both higher than 15.1% in Q2 of 2005. The four Taiwan think tanks
believe that export expansion will continue to propel Taiwan's
economic growth in 2006 and 2007, despite the dampening effects on
foreign demand of higher interest rates and higher energy costs.
Taiwan relies heavily on export-led growth from exports to China
(including Hong Kong), which takes more of Taiwan's exports than the
United States, Japan, and the EU combined. This provides some
insulation to Taiwan from the widely anticipated slowing demand in
developed markets.

TAIPEI 00003051 002 OF 005

Relocation to China Boosts Taiwan's Economy
-------------------------------------------

5. (U) Taiwan's political parties, media and economic actors have
been endlessly debating whether or not industrial relocation to
China will "hollow out" the economy. However, statistics clearly
show that relocation to China is a major contributor to Taiwan's
export expansion and has enabled firms to increase sales to
developed markets. Taiwan production bases in China import inputs
from Taiwan, including machinery, equipment, components, and
semi-finished goods. Taiwan's exports to China (including Hong
Kong) have grown faster than its exports to other markets,
increasing as a percent of total exports from below 20% prior to
2000 to nearly 40% in July 2006.

... Trade Surplus,
------------------

6. (U) According to Taiwan Customs data, the trade surplus with
China in 2005 reached US$50 billion; double its 2001 level of US$24
billion, and grew another 17%, to US$34.7 billion, in the first
seven months of 2006. Since the year 2000, Taiwan's trade surplus
with China has totaled US$221.7 billion, far more than its global
trade surplus of US$7.4 billion over the same period. Trade with
China is the main source of Taiwan's huge and growing trade
surpluses.

... Increased ForEx Reserves,
-----------------------------

7. (U) Industrial relocation requires investments to flow from
Taiwan to China, but also creates inflows of capital in the form of
trade surpluses. Trade surpluses have increased Taiwan's forex
reserves and money supply (liquidity). Taiwan's trade surplus with
China since 2000 dwarfs Taiwan's cumulative direct investment in
China (US$51 billion according to official statistics or US$70-100
billion, according to private estimates). The US$221.7 billion
cumulative trade surplus with China since 2000 has contributed to
boosting Taiwan's forex reserves by US$153.6 billion, to US$260.4
billion, over the same period.

... And Increased Employment
----------------------------

8. (U) Taiwan's unemployment rate declined to below 4% in November
of 2005 from a historical high of 5.3% in August 2001. A recent
commentary in the Economic Daily News (EDN) explained that exports
to China over the past six year have created 810,000 jobs, far more
than the number of layoffs due to industrial relocation. The
unemployment rate fell to 3.78% in April, and has remained below 4%
since then.

Economic Evolution Towards Increased Value-Added
--------------------------------------------- ---

9. (U) Taiwan firms are still expanding high technology
manufacturing in Taiwan. The excess inventory that contributed to
reduced private investment in H2 of 2005 has been largely
eliminated. Imports of capital goods (for production) grew y-o-y at
a rate of 6.3% in June and 15% in July. New semiconductor and flat
panel projects have turned Taiwan into the world's largest buyer of

TAIPEI 00003051 003 OF 005


Applied Materials' high tech production equipment; outpacing Japan
and South Korea.

Increased Foreign Investment
----------------------------

10. (U) Approved foreign investment (FDI) in Taiwan in the first
seven months of 2006 totaled US$8.3 billion, nearly five times the
level in 2005, and approved FDI in electronic industries surged to
US$4.4 billion, 16 times the level a year ago. Taiwan's
accomplishments in financial consolidation and strong consumer
purchasing power attract foreign investment into its financial and
commercial sectors. Approved FDI in Taiwan's financial sector in
the first seven months of this year totaled US$2.2 billion, nine
times the same period of 2005. Meanwhile, approved FDI in
wholesale/retail firms surged 63% to US$454 million. Financial
institutions and wholesale/retail firms contributed 40% of GDP in H1
of 2006, up from 33% ten years ago. Despite a 0.2% decline in
domestic private investment, approved FDI increased in 2005 by 7%.


11. (U) Foreign investment in Taiwan financial institutions in the
first few months of 2006 includes:

--GE Consumer Finance (Cosmos Bank) NT$2.75 billion;
--Newbridge Asia (Taishin Financial Holdings) NT$27 billion;
--Normura Securities (Taishin Financial Holdings) NT$4 billion;
--AIG (Central (Non-life) Insurance with NT$6 billion;
--Citicorp (Fubon, partially withdrawn);
--Prudential Life (E. Sun Bank);
--New York Life (Bank of Overseas Chinese);
--Temasek Holding (E. Sun Financial Holdings);
--BNP Paribas (Cooperative Bank of Taiwan);
--Shinsei Bank (Jihsun International Commercial Bank);
--Newbridge (Kuo Hua Life);

Consumption Recovers from Card Debt
-----------------------------------

11. (U) A sharp increase in delinquent credit/cash card debt
earlier this year prompted banks to temporarily tighten lending to
consumers, dampening private consumption growth to 1.4% in Q2 of
2006 from 3% a year earlier (refs B&C). However, this problem has
been effectively addressed through debt rescheduling and debt
write-offs. Several private banks recently again launched credit
card promotion campaigns. DGBAS forecasts private consumption will
grow 2.2% in Q4 this year and 2.9% in 2007 while CIER predicts 2007
growth will exceed 3%. Both predictions are higher than the average
annual growth of 2.5% over the past four years.

Capital Outflow Lessens Liquidity
---------------------------------

12. (U) Like Japan, Taiwan has seen excess liquidity build up as a
result of export sales to and through production bases in China, and
to a lesser extend from export sales to developed markets. Taiwan's
Central Bank of China (CBC) has tried to absorb the excess liquidity
by issuing negotiable certificates of deposits (NCD). Outstanding
NCD and savings deposits re-deposited by CBC total NT$5.1 trillion
(US$156 billion), an amount equivalent to the total of currency in
circulation and deposit money. CBC recently began permitting
secured NT dollar (NTD) bank loans to be designated as foreign

TAIPEI 00003051 004 OF 005


direct investment (FDI) in Taiwan as an additional way to absorb
excess liquidity (ref A).

Excess Liquidity Leads to Capital Outflow
-----------------------------------------

13. (U) Excess liquidity depresses interest rates and widens the
difference between interest rates in Taiwan and the United States.
Higher U.S. interest rates along with Taiwan tax exemptions for
overseas earnings encourage capital outflow. Although CBC has
raised interest rates eight times over the past two years, Taiwan
rates remain 2.9 percentage points lower than U.S. rates. Higher
interest rates abroad encourage firms to invest overseas. Net
outbound investment in H1 of 2006 totaled US$15 billion, mitigating
Taiwan's excess liquidity problem.

Other Urban Legends
-------------------

14. (U) Some of the other "common knowledge" about Taiwan's
economic situation that is less than true includes:

-- Reports of a 30% drop in auto sales: While overall auto sales in
H1 fell by 4.6%, sales of luxury cars, motorscooters and motorcycles
increased; Mercedes Benz and Lexus sales increased by over 20%
during this period. Overall passenger car sales through the end of
July were up 2.1% y-o-y.

-- Declining real estate prices: Residential house prices in Q2 this
year registered a 12th consecutive quarterly rise according to an
index compiled by industry and academics. In Taichung, the average
price of high-rise housing units has increased by 47% since 2003.
Overall housing prices increased by 20-30% in this period.

-- Declining consumption: Y-o-Y wholesale and retail sales growth
increased from 5% in Q1 to 6.9% in April, 7.8% in May, and 9.2% in
June. Taiwan hotels reported 4.5% revenue growth in H1. The Sogo
department store's reported decline in sales this year follows a
consumer shift towards other types of retailers, as happened in
Japan.

-- Growing income gap: In fact, the income ratio of the wealthiest
quintile to the poorest quintile was lower in 2004 and 2005 than it
was in 2002 and 2003. Taiwan's income disparity is still one of the
lowest in the world, second in Asia to Japan.

-- Declining disposable income: According to DGBAS statistics,
disposable income has gone up every year since 2001. Disposable
income in 2005 exceeded the high set in 2000 on both a household and
per capita basis.

-- Domestic investment less than outbound investment: Much of
recent FDI has been channeled into high-tech manufacturing and
financial sector consolidation, while outbound FDI is mainly low
tech manufacturing in search of lower production costs.

-- Business criticism: While there are widespread complaints about
current economic policies there are few practical alternatives
suggested. Taiwan's Commercial Times printed two commentaries by
"business leaders" in the past week criticizing current economic
policies, but failed to note that the authors had been indicted in
Taiwan on financial crimes and subsequently fled to China. The

TAIPEI 00003051 005 OF 005


commentaries lauded the superior PRC "understanding" of the needs of
Taiwan businesses, without mention of the vastly different political
contexts.

Clouds are Mainly Political
---------------------------

15. (SBU) Ongoing corruption scandals, campaigns to unseat the
President, the Doha Round suspension, and failed initiatives on
cross-Strait relations have deepened the pessimism of many local
pundits. A Legislator recently told AIT that hopes for a
cross-Strait agreement on banking supervision were dashed by the
political chill caused by Chad's switching diplomatic recognition,
and that pending regional and bilateral trade agreements were bad
news for Taiwan's economy since Taiwan was excluded from these
arrangements. She warned Taiwan may see major firms de-listing from
the Taiwan stock exchange. An AmCham executive recently responded
to the positive economic statistics by noting that Taiwan's economy
could and should be doing much better. The think tank predictions
of good economic prospects conflict sharply with the widespread
pessimism in both public and business perceptions. The economic
numbers look good. The clouds on the horizon are tinged with shades
of the green, blue, orange, purple (tax reform) and red (dump Chen)
of Taiwan political factions.

Young

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