Taiwan maintained resilient economic performance in 2022, despite the multiple challenges from the Russia-Ukraine war, Fed tightening, China lockdown, and cross-Strait tensions. According to the IMF, Taiwan’s per capita GDP will reach USD35,510 this year, surpassing South Korea's for the first time since 2003 and Japan's for the first time in history. 

Structural trends

Tech sector staying competitive

2022 has been a good year for Taiwan’s tech sector. Total revenue of the IC industry grew by 22.3% YoY to TWD3.6tn in the first three quarters. TSMC overtook Samsung to become the world’s largest semiconductor company by sales revenue in 3Q, according to IC Insights.

The leading Taiwanese chip foundries continue to focus on the home market for production expansion. For the next five years, TSMC has retained its new factory projects for the most advanced 2nm and 1nm technology nodes in the major local industrial zones, including Hsinchu, Taichung, and Taoyuan.

Meanwhile, foreign tech companies are still keen to invest in Taiwan to leverage the strong industrial ecosystem and vast talent pool. The Dutch semiconductor equipment maker ASML is reportedly to launch its largest-ever investment project in Taiwan next year, spending TWD30bn to build production and R&D facilities in the New Taipei City.

Furthermore, the government will provide more financial incentives to spur the advanced semiconductor investment and sustain the competitiveness of the tech sector. The cabinet recently approved a proposal to increase the tax deduction on semiconductor R&D costs to 25% from 15% and offer a 5% tax break for spending on advanced equipment procurement, effective for the 2023-29 period.

In the short term, the tech sector will enter a cyclical downturn in 2023, due to lower demand, supply glut and pressure of destocking. The WSTS forecasted in November that global semiconductor market will contract 4.1% in 2023, reversing the 4.4% growth this year. Gartner also predicted a 3.6% decline in global semiconductor revenue next year, compared to the 4% growth this year. Note that Taiwan’s semiconductor exports persistently outperformed global semiconductor sales in the past three years. Given the established strong competitiveness, the downturn in Taiwan’s tech sector should not be much worse than that in the global cycle next year.

A typical inventory correction in the tech sector does not last for more than four quarters. This means that a cyclical rebound could emerge by 4Q 2023. The outlook is complicated by the further escalation in China-US tech tensions. The US announced new semiconductor restrictions on China in October, imposing licensing requirements on the sales of advanced chips, software, and semiconductor equipment used to produce advanced chips. Falling sales to the Chinese market could lead to a delay in global tech recovery by a few months/quarters into 2024. In the longer term, global semiconductor demand is likely to stay buoyant in the next 5-10 years, thanks to rising adoption of AI, IoT, EVs and other new technologies, amid the structural transition towards digitalisation and net carbon zero.

Strengthening supply chain resilience

The outbreak of the Covid pandemic and the increase in geopolitical risks have underscored the importance of strengthening the resilience of manufacturing supply chains. Taiwanese companies have been actively diversifying the geographic locations of their production and sourcing bases in the past five years.

Investment into Southeast Asia is surging strongly. Taiwan’s FDI in the ASEAN-6 countries amounted to USD4.0bn in the first ten months of this year, accounting for 32% of its total outward FDI. This share has risen sharply compared to the 14% before the outbreak of the China-US trade war in 2017. Foxconn and Pegatron expanded investments in Vietnam and India, to assemble smartphones, PCs, tablets, and other electronics products for international customers including Apple. UMC added USD5bn investment in Singapore this year, to build a new 22/28nm wafer fab.

The US is also emerging as a major investment destination of Taiwanese companies. Taiwan’s FDI in the US exceeded USD8bn during the 2018-22 period, nearly a fourfold increase compared to the USD2.2bn in 2013-17. This was largely driven by investment in the semiconductor sector. TSMC’s first foundry in Arizona, which is currently under construction, will begin the production of 4nm chips in 2024. The company recently said that it will also produce 3nm chips at the Arizona fab by 2026.

In addition, the onshore investment and production in Taiwan are also on the rise. The overseas production ratio of all export orders received by Taiwanese manufacturers, as reported by the Ministry of Economic Affairs, fell to an average of 49.7% in the first ten months of this year. In other words, the onshore production ratio has risen above the 50% mark, for the first time since 2009.

Looking ahead, ASEAN is likely to overtake China to become Taiwan’s largest FDI destination in 2023. In addition to the external push factors (Covid, geopolitics), catalysts will also come from the domestic pull factors in major ASEAN economies, such as the abundant labor resources, increase in macro resilience, and improvement in the ease of doing business. According to a latest survey conducted by the US’s Center for Strategic and International Studies, nearly 60% of the 500 Taiwanese firms with business on mainland China have moved or were considering moving some of their business operations out of China. Among them, 63% said they were moving to Southeast Asia.

Trade and investment ties with the US are also likely to strengthen further in 2023. The US is currently working with Japan, South Korea, and Taiwan on the so-called Chip 4 alliance, to strengthen collaboration on the semiconductor supply chains. Taiwan has joined the preliminary meeting and will likely continue to participate next year, considering the need to secure the supply of advanced semiconductor equipment and technology from the US.

Meanwhile, Taiwan and the US have commenced negotiations on the Initiative on 21st-Century Trade. The initiative is a bilateral version of the Indo-Pacific Economic Framework. It covers a wide range of areas, from trade facilitation, trade between SMEs, agriculture trade, digital trade, labor standard, to environmental standard. While the initiative does not include commitments to tariff removals, it will likely provide a framework for the future negotiation of a bilateral free trade agreement between Taiwan and the US.

Accelerating green energy transition

Like other major economies in the region, Taiwan has also been actively pushing for the process of green energy transition. This year, electricity supply from renewable energy surged strongly by 36% YoY in the first ten months. As a share of total electricity supply, renewable energy reached a new high of 8%, notably up from the 6% in 2021.

Meanwhile, FDI into the electricity and gas sector increased by more than tenfold to USD1.5bn in Jan-Oct 2022. FDI from European countries soared especially strongly during the same period, by nearly 400% YoY. Denmark’s largest energy group Orsted, for instance, expanded its investment in the Greater Changhua wind farm projects in the west coast.

The government’s decarbonization policies will likely continue to drive green energy growth in the coming years. Taiwan’s per capita CO2 emission is among the highest in the Asia region, standing at 11.5 tons in 2020 (Asia and world average: 4.4-4.5). To tackle the climate change challenges, Taiwan formally announced the 2050 net carbon zero target last year. The government aims to achieve 15% usage of green energy in the manufacturing industry by 2030, electrification of all buses by 2030, and 100% sales rate of electric cars and motorcycles by 2040. In addition to fiscal and regulatory measures, the government also plans to introduce a carbon tax and establish the carbon pricing mechanism by 2024.

Meanwhile, energy security concerns will likely provide a new catalyst for green energy transition in the private sector. The Russia-Ukraine war this year caused a global oil price shock, sharply boosting the costs of oil imports. China’s military exercises in the Taiwan Strait also triggered concerns about a potential trade blockade and disruption of energy imports. These new developments will likely further incentivize Taiwanese companies to reduce the reliance on fossil fuel imports, explore the alternative sources of domestic energy supply, and improve the energy self-sufficiency rate.

Macroeconomic outlook for 2023

GDP growth

In 2023, GDP growth is expected to slow to 2.3%, down from the 2.9% this year. This will be close to the growth rates seen during the 2012 European debt crisis and 2015-16 China slowdown, but better than the contraction seen during the 2001 tech bubble burst and 2008-09 global financial crisis.

On a quarterly basis, GDP growth is expected to fall to virtually 0% YoY in 1Q23 and rebound to around 2-3% in the subsequent three quarters. Goods exports and private investment will likely deteriorate next year, due to growing headwinds from a broader global economic slowdown. Services exports and private consumption will likely recover further, benefiting from the post-Covid border reopening. Government consumption and public investment will also pick up, thanks to the adoption of an expansionary fiscal policy.

Reopening should be an important growth driver in 2023. Taiwan has started to allow the entry of 150,000 foreign visitors per week from October and raised the upper limit to 200,000 per week in December. This means a maximum 10mn visitors a year, almost on par with the pre-Covid levels in 2019. Considering that Chinese tourists may not come back soon, we assume a 70% recovery in visitor arrivals. This will generate services export revenues worth USD10bn, equivalent to 1.3% of Taiwan’s GDP. The services sectors including transportation, accommodation, food catering, recreation and entertainment should benefit the most.

Inflation and monetary policy

CPI inflation is expected to ease to 1.8% in 2023, lower than the 3.0% this year, but still above the long-term trend of 1%. On a quarterly basis, CPI is expected to ease to around 2% YoY in 1Q23 and further to 1.5% in 2Q-4Q23. Prices of imported oil and other commodities are likely to retreat next year, owing to weaker global demand and stabilisation in EM currencies vs USD. Domestic services inflation will likely stay elevated on the other hand, driven by the reopening-related demand.

Lower inflation, together with the prospect of a Fed policy pivot, will likely provide greater flexibility for Taiwan’s central bank on its domestic monetary policy. We expect the central bank to pause tightening after the March policy meeting. This means that the benchmark discount rate will peak at 1.875% in 1Q23, compared to 1.625% currently.

Fiscal policy

Fiscal policy will turn expansionary in 2023. Based on the annual budget proposal, the central government’s total expenditures will increase strongly by 20.8% YoY next year, significantly outpacing revenue growth of 12.8%. Increased spending will focus on the areas with long-term economic benefits, such as public infrastructures, elderly care, counteracting measures on low birth rate, and net carbon zero transition.

There is adequate leeway for the government to implement an expansionary fiscal policy to counter the risk of growth slowdown. The central government’s debt-to-GDP ratio has remained low and stable at 26% as of 2021, thanks to the successful Covid management and resilient economic performance in the last three years. Should recession risks increase sharply in 2023, the government would pursue countercyclical stimulus measures through the extra budgets, such as providing job/wage subsidies to alleviate the labor market pressure and offering special loans to SMEs to reduce their financing burdens.

Macro stability

The risk of a property market correction and its spill-over impact may need to be monitored in 2023. Home affordability has continued to deteriorate this year. The housing price-to-income ratio rose to an all-time high of 9.7 times in 2Q22; the housing loan repayment-to-income ratio also reached a record 40%. Meanwhile, banks’ exposure to the real estate sector is on the rise. The share of housing mortgage loans and construction loans in banks’ total loan portfolios reached 37% as of 3Q22.

Having said that, we don’t expect a drastic income shock or interest rate shock that triggers a sharp property market downturn in 2023. Under our baseline macro scenarios, borrowing costs will continue to rise at a slow pace in 2023; employment and wage conditions will soften modestly. With property demand gradually cooling down, property prices (measured by the Sinyi existing home index) are likely to retreat to a low single-digit growth rate next year, compared to the 10-15% this year. 

Risks

Geopolitics and cross-Strait tensions will likely remain the key risks for 2023. China’s large-scale military exercises around Taiwan in August this year forced many vessels and airlines to divert their routes, resulting in a temporary increase in shipping costs in the Taiwan Strait. Meanwhile, Beijing also imposed some trade restrictions measures against Taiwan this year, such as banning the imports of certain Taiwanese agricultural goods.

While China has concluded its 20th Party Congress, both Taiwan and the US will head towards presidential elections in 2024. Given the busy political calendar ahead, further escalation of cross-Strait tensions cannot be ruled out for the next one year.

On the economic front, there is plenty of room for Beijing to broaden the trade restriction measures from the agricultural sector to non-tech manufacturing sectors – where Taiwan highly relies on China for exports, but China does not rely very much on Taiwan for imports. Beijing could also retain the existing bans on Chinese tourists visiting Taiwan in 2023 and beyond. Thankfully, China is ending its Covid-zero policy and gradually moving towards reopening. The broad Chinese demand is likely to pick up in the later part of next year as consumption and investment activities normalise. This should still lend cyclical support to Taiwan’s overall exports in 2023.

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Ma Tieying 

Senior Economist - Japan, South Korea, & Taiwan 

[email protected]