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290854Z Jun 05

UNCLAS SECTION 01 OF 03 TAIPEI 002835 
 
SIPDIS 
 
 
SENSITIVE 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR Audrey Winter and Tim Wineland 
 
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 PINR TW
SUBJECT:  Soft Business Performance Spills to Q2 of 2005 
 
 
Summary 
------- 
 
¶1.  Taiwan's soft economic performance from the first 
quarter of 2005 spilled over into the second quarter.  Weak 
world demand for Taiwan products has driven y-o-y export 
growth in May 2005 to a new low and manufacturing posted its 
most significant contraction since SARS attacked Taiwan in 
early 2003.  Higher petroleum prices and heavy rains 
together pushed up the inflation rate in May to a new 7- 
month high.  Nevertheless, inflationary pressure is not a 
concern in light of low money supply growth and declines in 
price levels for services industries.  The unemployment rate 
in May rose slightly from April, due mainly to new 
graduates' joining the labor market.  Local economists 
differ in their outlook of economic trends for Taiwan in the 
next six months.  Some suggest the government should 
stimulate domestic growth rather than relying on export 
growth.  End Summary 
 
 
Export Expansion Slows, Manufacturing Sector Shrinks 
--------------------------------------------- ------- 
 
¶2.  Taiwan's export sector, contributing two-thirds of the 
island economy's GDP in 2004, continued to experience a 
slowdown in export expansion in Q2.  Taiwan's export growth 
began to decline in the second half of 2004 when world 
demand for Taiwan products (mainly electronic goods) began 
to weaken.  Y-o-y growth in exports dropped steadily from 
28.8% in Q2 of 2004 to 7.8% in Q1 and 7.5% in April and May 
of 2005.  Growth in export orders received by Taiwan also 
declined from 29.1% in Q2 of 2004 to 14.3% in April and May 
this year. 
 
¶3.  However, Taiwan's manufacturing firms did not benefit 
from the 14.3% growth in export orders.  Relatively high 
inventories built up in the second half of 2004 and higher 
rates of offshore production resulted in a 0.8% decline in 
manufacturing in May.  This is the largest contraction of 
manufacturing in the past two years.  Taiwan's manufacturing 
production in May 2004 declined 1.7% as a result of SARS on 
the island. 
 
Offshore Production of Export Orders 
------------------------------------ 
 
¶4.  Many Taiwan business firms have set up production bases 
overseas, mainly in China.  These offshore bases produced 
37.7% of export orders in May 2005, slightly down from 39.7% 
in February but still much higher than 30.7% a year ago. 
For the information & communications industry, the ratio 
reached 73%.  According to the latest survey of the 
Industrial Technology Intelligence Services, Taiwan's 
notebook computer firms, occupying 72% of the global market, 
are receiving export orders in Taiwan, but only producing 
11% of the orders on the island.  The remaining 89% is 
manufactured overseas. 
 
Capital Outflow Cuts Money Supply Growth 
---------------------------------------- 
 
¶5.  Offshore production of export orders is a result of a 
chronic net outflow of direct investment (DI) funds, which 
continued to prevail in 2005.  Outbound DI approved by the 
Ministry of Economic Affairs in the first five months of 
this year totaled US$1,080 million, more than double the 
US$498 million in approved inbound DI.  The net outflow of 
DI totally offset the modest, by Taiwan standards, trade 
surplus of US$549 million.  The trade surplus in the first 
five months of 2005 was 87% less than during the comparable 
period a year ago because import growth of 13.5% greatly 
exceeded the 7.6% rate of export growth. 
 
¶6.  Capital outflow from the direct investment account in 
the first five months of 2005 dampened money supply growth 
and, therefore, helped decrease inflationary pressure.  In 
May 2005, M1b grew at a 5.6% rate, the second lowest in the 
past 16 months.  M2 grew at a 5.9% rate, the lowest in the 
past two years.  M1b is composed of currency held by the 
public plus deposit money.  M2 includes M1b, time deposits, 
time savings deposits, and foreign currency deposits. 
 
Inflationary Pressure Light 
--------------------------- 
 
¶7.  In May 2005, the consumer price index rose 2.3% from a 
year ago, the highest in the past seven months.  Higher 
inflation resulted partly from higher oil prices and partly 
from heavy rains destroying some vegetable and fruit crops. 
Oil prices rose above US$50 per barrel in May and US$60 in 
June, prompting petroleum-related prices to rise 7.35% for 
gasoline and 10.5% for petroleum and natural gases, 
according to the Directorate General of Budget, Accounting 
and Statistics. 
 
¶8.  In May and June 2005, heavy rains damaged agricultural 
production in southern and central Taiwan.  Agricultural 
losses caused by floods exceeded NT$2 billion during these 
two months.  Consequently, produce prices surged 36% for 
fruits and 21% for vegetables in May. 
 
¶9.  On the other hand, declines of 0.5-1.5% in price levels 
in the services sector (including housing rentals, 
entertainment, and beauty services) in May 2005 offset a 
portion of the increased energy and produce prices.  Housing 
rentals, entertainment, and beauty services constitute 44% 
of CPI, far more than 8% weighting for energy, fruits and 
vegetables. 
 
Unemployment Rate Rises Seasonally 
---------------------------------- 
 
¶10.  Taiwan's unemployment rate in May 2005 rose to 4.1% 
from 4.04% in April.  It was 4.41% a year ago.  The moderate 
rise in unemployment resulted mainly from the seasonal event 
of new graduates joining the labor market. Employment has 
improved, with the number of people employed in May 2005 
rising by 0.2% from April and by 1.6% from a year ago. 
 
Economic Prospects 
------------------ 
 
¶11.  Local observers differ in their expectations for 
Taiwan's economy in the second half of 2005.  Senior 
Economist Wu Chung-shu of Academia Sinica is optimistic.  He 
predicts better economic performance in the next six months. 
Wu says that China, acting as the "factory" for Taiwan 
firms, continued to enjoy handsome export growth of 34% in 
the first four months of 2005.  In addition, economies of 
Taiwan's major export markets will continue to grow at a 
moderate rate.  Wu predicted that Taiwan's export growth 
would return to double-digits in the second half of this 
year, and that its growth rate could reach 20% in the last 
quarter.  Wu noted that to meet higher export demand, 
private investment would post double-digit growth that could 
exceed 20% in Q3 of 2005.  A sign for the expected expansion 
of private investment was a 30% growth in imports of capital 
goods (excluding aircraft) in May 2005.  The growth in 
machinery imports in the month even reached 54.4%.  However, 
Wu indicated that the trend might turn sour if oil prices 
should continue to rise and China's Renminbi should 
significantly appreciate (against the US dollar). 
 
¶12.  Tsai Hung-kun, Deputy Director of the DGBAS' 
Statistical Bureau, on the other hand is relatively 
pessimistic.  He believes that a slowdown in global economic 
growth in 2005 will cap Taiwan's export growth at 8% for the 
rest of this year.  Tsai predicted that private investment 
growth would slow from 15% in Q1 to merely 2.5% in Q4 of 
¶2005. 
 
¶13.  In a recent speech to the Council for Economic Planning 
and Development (CEPD), Schive Chi, President of the Taiwan 
Academy of Banking and Finance and former Vice Chairman of 
CEPD, suggested that the government should stimulate 
Taiwan's domestic demand rather than rely on export growth. 
He indicated that Taiwan's services sector, particularly 
financial services firms, had great potential for further 
development.  He said that the financial service sector has 
been catching up to the manufacturing sector in production, 
with a ratio between these two sectors narrowing from 32:100 
in 1984 to 84:100 in 2004.  According to Schive, taking bank 
offices as an example, the number of bank offices for every 
100,000 persons in Taiwan is 27, less than over 40 in 
Germany, France and Italy.  The number of bank employees 
serving every 100,000 persons in Taiwan is 551, also less 
than 600 - 800 in the United States and Europe. 
 
PAAL