Taiwan’s credit metrics have been bolstered relative to peers due to a robust economic performance and swift recovery from the Covid-19 pandemic shock, which have contributed to a further strengthening of its external buffers and minimized the need for large-scale fiscal stimulus seen elsewhere, says Fitch Ratings.
Growth has been stronger than we assumed when we affirmed Taiwan’s rating at ‘AA-’ in September 2020, with a Stable Outlook. Preliminary data indicate the economy expanded by 8.2% yoy in 1Q21, its fastest pace in over a decade.
This has created considerable upside risks to our 2021 growth forecast of 4.5%, and builds on performance which was already strong at 3.1% in 2020, when it was one of few economies around the world to expand at all.
Growth momentum is underpinned by Taiwan’s continued success in containing the pandemic and global demand for its electronics exports, particularly of semiconductors where its firms are global leaders. Total merchandise exports grew by 24.6% yoy in 1Q21, up from 8.9% yoy in 2H20 (US dollar values). Our baseline forecasts assume exports of electronics and other information and communications equipment will remain strong in both 2021 and 2022, given global supply shortages.
Strong exports have also contributed to a further reinforcement of Taiwan’s external buffers, with foreign-exchange reserves rising to USD541 billion by end-April 2021, up by 12.3% yoy. We wrote in September that Taiwan’s external finances were already among the strongest across Fitch-rated sovereigns, and that a stronger net external credit position could potentially lead to positive rating action.
Surging global demand for high-tech components should also have a positive spill-over effect on domestic activity this year, as major semiconductor and high-tech manufacturers have announced significant capacity expansion plans in response to ongoing global supply shortages. This will provide a boost to private investment spending and the labour market.
We do not believe that the island’s recent drought is likely to have a material impact on semiconductor production or planned investment, limiting its macroeconomic effects. Rationing and recycling measures have helped support semiconductor output, albeit with higher production costs. However, other sectors such as agriculture have been hit, and tech firms may feel a larger impact if the “plum rains” in May-June fail to alleviate the water shortage.
Another supportive trend for the economy has been the reshoring of Taiwanese manufacturing, amid US-China friction. The authorities’ latest figures suggest a total of 871 local companies have plans to invest about NTD1.2 trillion (USD43.5 billion) under three government schemes launched in 2019. Of this, NTD799.7 billion (USD28.6 billion) has been committed by Taiwanese companies returning from mainland China.
Taiwan’s pandemic resilience and rapid economic recovery have also given the authorities latitude for a more measured fiscal policy approach than global peers. The general government deficit was just 2% of GDP in 2020 as Fitch estimates, well below the ‘AA’and global medians of 6.5% and 7.0%, respectively. This trend appears likely to continue in 2021, as stronger-than-expected growth means Taiwan’s deficit could end up below the 1.5% of GDP we currently forecast.
Taiwan’s rating continues to be weighed down by complex and tense relations with mainland China, reflected in a negative rating notch. Heightened tensions have recently been underscored by China’s increased military activity in the Taiwan Strait and targeted economic measures.
Trade actions stemming from US-China geopolitical friction could also pose challenges to Taiwan’s technology exports. However, Fitch currently believes this risk is mitigated by the important role that Taiwan’s high-tech supply chain plays across both economies.