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Taiwan: Tsai’s victory fuels tensions between China and Taiwan, but full escalation unlikely

Country Report

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Tsai Ing-wen’s and her DPP’s victory will increase tensions with China, though an escalation to crisis levels seems not very likely. Growth took a hit in 2015 and is likely to recover in 2016, but external factors create substantial uncertainties.

Strengths (+) and weaknesses (-)

(+) Highly competitive export sector

Taiwan has a good business environment, efficient markets, sound economic infrastructure and sophisticated education system, which benefit its export sector.

(+) Very strong external position

Taiwan’s has persistent current account surpluses, a vast amount of FX reserves (USD 426bn in December 2015) and an acceptable external debt burden.

(-) Vulnerability to external demand shocks

Taiwan’s economy is very open and driven by the export sector.

(-) Tense relationship with mainland China

Mainland China considers Taiwan as one of its provinces. The relation with China is tense and Taiwan has only limited access to multilateral institutions and international organisations as a result.

Key developments

1. Landslide victory for Tsai Ing-wen and her pro-independence DPP

Pro-independence candidate Tsai Ing-wen and her Democratic Progressive Party (DPP) convincingly won the elections that took place on 16 January 2016. The Kuomintang (KMT), traditionally Taiwan’s dominant party, suffered a big defeat, which prompted losing candidate Chu to resign his KMT chairmanship. Tsai will now be inaugurated on 20 May 2016 as Taiwan’s first female president. For the first time in its history, the DPP also gained an outright majority in the Legislative Yuan (parliament), which means that it does not have to form a coalition. The victory may raise tensions with China, given that the DPP is traditionally a pro-independence party, though achieving independence seemed to have gradually lost importance for the DPP. The victory partly reflects the rise of a distinct Taiwanese identity, as the percentage of citizens that regard themselves Taiwanese (instead of Chinese) went up from 18% in 1992 to 61% in 2014, according to a poll released by National Chengchi University.

However, according to the same poll support for independence has remained limited at 24%. Comforting is also that Tsai’s team had already frequent contacts with Beijing before the election. Nevertheless, to date, Tsai has never adhered to the so-called 1992 One China consensus, according to which both Taiwan and China agreed there is only one China, but disagreed what this practically meant. However, immediately after winning the election Tsai emphasized the importance of maintaining the current status quo in an attempt to reassure Beijing. In response, Beijing stated that it insisted on adhering to the 1992 consensus and opposed any independence activities. Beijing could also increase pressure on the remaining 22 (small) countries that do have diplomatic relations with Taiwan, which could lead to further international isolation of Taiwan. While relations with China may thus get more difficult, an outright crisis does not seem to be the most likely scenario right now. However, particularly if Tsai’s presidency proved to be weak or ineffective, there is a risk that the (more radical) pro-independence faction of the DPP would push the party towards more confrontational China policies.

It will be difficult for Tsai to deliver soon on her election promises. First, it will take some time before important decisions will be made. While the new parliament will be sworn in on 1 February 2016, Tsai will be inaugurated on 20 May 2016, which means that not much policy making will happen in the intervening period. In the near term, Tsai’s top domestic goal will be appointing a key ally as speaker of parliament. Second, Tsai wants to Taiwan re-strengthen Taiwan’s position as a high tech innovative economy and has promised to boost innovation and research in several sectors. She also aims to deregulate the service industry, including opening up the financial sector to more foreign investment. However, while the majority of the DPP in the Legislative Yuan augurs well for implementation, it is likely to take time before such measures will have discernible impact. While Tsai is unlikely to disrupt Taiwan’s deep economic relations with China, she could aim for Trans-Pacific Partnership membership in an attempt to achieve more economic diversification. Third, Tsai has pledged to increase spending on infrastructure and housing, but also to shrink the (already relatively small) fiscal deficit. Given the DPP’s tradition of fiscal conservatism and regulations that prohibit the government from taking on debt in excess of 40% of GDP, Taiwan’s fiscal position is likely to remain favourable.

Figure 1: Weak growth in 2015
Figure 1: Weak growth in 2015Source: EIU
Figure 2: Industry may recover
Figure 2: Industry may recoverSource: Macrobond

2. Growth takes a hit in 2015. Recovery likely in 2016, though uncertainties are substantial

The Taiwanese economy contracted by 1% y-o-y in 2015Q3, following growth of 0.5% y-o-y in the preceding quarter. It was the first q-o-q-contraction since the global financial crisis. Economic growth was affected by weaker demand from China and also by less global demand for tech products, with exports contracting by 2.9% y-o-y in Q3. Given the high share of exports in GDP, this had a strong impact on overall growth. In the year as a whole, not only net exports, but also investment and government consumption growth are estimated to have been low, resulting in private consumption, which accounts for about 50% of GDP, being the sole important driver of growth. As a result, growth is likely to have been only about 1% in 2015.

Growth is likely to recover somewhat in 2016, but uncertainties are substantial. The manufacturing PMI has been strengthening in recent months and increased in December 2015 to an above 50 level (51.7) for the first time since March 2015. Furthermore, the 2016 budget is likely to be somewhat more expansionary than the 2015 one (though the fiscal deficit is expected to remain small), thanks to an increase of expenditure on public infrastructure, technology development, education and social welfare. However, external factors add to uncertainty, as is not surprising giving the high level of openness and Taiwan’s export driven growth model. In particular a further slowdown of growth in China would have a negative on growth. Furthermore, an increase of tensions with China could result in China reducing the number of tourists it allows to travel to Taiwan, which could have some impact, given that tourism accounts for about 5% of GDP.

Factsheet Taiwan
Factsheet TaiwanSource: EIU, CIA World Factbook, World Economic Forum, Transparency International, Reporters Without Borders.

Background information

Taiwan, officially named the Republic of China, is a country comprising of several islands, located to the east of the People’s Republic of China. The largest island, the island of Taiwan, makes up 99% of Taiwan’s total land area and is the home of 99.6% of the population. The prosperity of this services-based, capitalist economy stems from its dynamic and entrepreneurial private sector, which employs over 90% of the working population. Taiwan’s business environment is good. The country scores very well on factors such as ease of doing business and is highly competitive internationally, particularly due to its efficient goods and labour markets and developed financial markets, as well as the country’s sophisticated education and healthcare systems and sound infrastructure. Taiwan is home to some of the world’s leading multinationals in the information technology (IT) sector and the country is an important supplier of intermediate IT goods worldwide. However, Taiwan’s high degree of openness, with total exports and imports of goods and services amounting to 116% of GDP (2015), is also the economy’s main weakness. It makes the economy overly dependent on external demand, especially from its main trading partners China, Japan and the US.

After the communist victory in mainland China in 1949, about 2 million Nationalists fled to Taiwan, established a government and incorporated the locals in the governing structure. Mainland China, however, still considers Taiwan part of its territory. Although tensions have eased in recent years, China will still consider any unilateral proclamation of independence by Taiwan an act of war.

Economics indicators of Taiwan
Economics indicators of TaiwanSource: EIU
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