My take on Tsai Ing-wen inaugural speech tomorrow: Getting worse before it gets better

All eyes are now on President-elect Tsai Ing-wen inaugural speech tomorrow. There are two key things to watch: China-Taiwan relations and policy announcements to confront Taiwan’s economic contraction.

China-Taiwan relations

The expectation from China’s side from President Tsai’s speech is crystal clear: President Tsai has to explicitly accept the 1992 consensus with China. The problem lies on the fact that Tsai’s party, the DPP, has long been avoiding this. We find it quite implausible for Tsai to embrace China’s demand as she has basically been elected as a response to Taiwanese disenchantment with their “rapprochement” with China. In fact, Pro-Beijing measures seem to have become increasingly unpopular (the best example being the seizure of the Legislative Yuan, the central government building, by students in March 2014).

However, Taiwan’s economy has never been as dependent on China . The eight years under Tsai’s predecessor, President Ma have seen a dramatic increase in cross-strait economic relations. Since both sides signed the Economic Cooperation Framework Agreement (ECFA) in 2010, bilateral trade has increased by 70% and Taiwan’s surplus has continued to increase (now 3 to 1 in Taiwan's favour). To have an idea of the figures, cross-strait trade in 2015 nearly reached $190 billion in 2015.

In an nutshell, given Taiwan’s massive dependence on China, Tsai cannot afford taking the same position as the previous KMT government nor will her voters accept her to be as accepting of China as President Ma. Tsai will need to opt for the Aristotelian middle course, which however will not be enough for China. We are, thus, expecting some economic retaliation from China right after President’s Tsai inaugural speech but always remaining within acceptable boundaries. This could include barriers on Chinese tourists visiting beautiful Formosa and/or new fito-sanitary regulations limiting food imports from Taiwan. We doubt that President Tsai will react to such economic retaliation and that would of course be the right thing to do so that economic retaliation becomes more a temporary than a structural feature for Xi-Tsai relations.

Economic policy announcements

Taiwan is one of the countries in South East Asia that has been most affected by China’s slowdown to the point that it is the only one finding itself in a recession. In fact, the first quarter of 2016 was the third consecutive one with negative real GDP growth (-0.84% yoy). The reason is very simple. Taiwan is an extremely open economy, with external demand contributing about three quarters of GDP. Within that context, exports have been falling for 15 consecutive months (-6.5% yoy in April with an even larger fall for exports to the Mainland, -7.4%).

Against such a negative background, President Tsai needs to make some economic policy announcement as to calm the Taiwanese. An obvious one should be to diversify the destination of Taiwan’s exports away from China. We, thus, expect her inaugural speech to mention the government’s  intention to negotiate participation in regional or bilateral trade agreements.

The other key issue for such an open economy is to keep its comparative advantage in international trade. In fact, Taiwan’s manufacturers are being outmuscled by Chinese competitors as they struggle to climb up the value chain to compete in new areas. This is particularly true for one of Taiwan’s key sectors, namely the semiconductor industry. We, thus, expect President Tsai to announce measures to foster innovation in sectors such as energyand machinery a central part of her economic policies. This is particularly important as one of the protracted problems of the Taiwanese economy are the lack of high-pay job opportunities, especially for the youth. Productivity needs to increase for wages to move up without creating inflationary pressures.

Finally, so far domestic consumption has been the stronghold of the economy so Tsai may want to hint at how her administration is going to support domestic demand with lax monetary and fiscal policies. Taiwan is one of the least indebted economies in the region (with public debt hovering around 30% and very moderate fiscal deficits) so that there is plenty of room to act. The Central Bank has already cut rates twice since last summer and is bound to continue to further cheapen the Taiwan dollar. We do expect the hardly leveraged Taiwanese economy to react positively to these stimuli so that 2016 should end better than it started. However, China’s short term reaction to President’s Tsai first steps will make things worse temporarily. All in all, the Taiwanese economy will get worse before it gets better but it will, definitively get better.

Alicia Garcia Herrero

Chief Economist Asia Pacific

Natixis