Growth outlook for the second half of 2022 faces further downside risks due to the rise in geopolitical tensions in the Taiwan Straits, and more importantly, the rapid weakening of exports demand.
Military exercises around Taiwan
In response to US House Speaker Nancy Pelosi’s visit to Taiwan this week, China has announced to conduct military exercises and organize live-fire drills around Taiwan from 4 to 7 August. It will cover six zones surrounding all sides of Taiwan, including both the sea and air space.
These activities may cause a moderate and temporary disruption in the regional supply chains. Planes and ships will need to reroute during the period of military exercises, not only affecting shipments into/out of Taiwan, but also those going via Taiwan to other parts of the region. The extent and duration of disruptions depend on whether the military exercises will be expanded/extended in the coming days.
Another possible outcome is a bout of risk aversion in the financial markets. The extent and duration also depend on how long the military exercises will last and how intense they will be. The previous Taiwan Strait Crisis in 1995-96 was comprised of a series of military exercises and missile tests. The first phase of the crisis lasted four months from 21 July to 23 November, 1995. The second phase lasted half a month from 8 to 25 March, 1996. The TAIEX fell nearly 10% during the first phase, but rebounded 5.5% during the second one.
Trade restriction measures
In response to Pelosi’s visit to Taiwan, Beijing has also announced new trade restriction measures against Taiwan. On August 3, China’s Customs Administration said that it would suspend the imports of citrus fruits and certain fish products from Taiwan. The Ministry of Commerce also said on the same day that it would ban natural sand exports to Taiwan.
These trade restriction measures are targeted and symbolic, which should have limited impact on Taiwan’s overall economy in the short term. The mainland market accounted for 19% of Taiwan’s agricultural goods exports in 2021. But agricultural goods accounted for merely 0.6% of Taiwan’s total exports.
A 2007 document from China’s Ministry of Commerce showed that 90% of Taiwan’s natural sand imports came from the mainland. But this share has fallen sharply since then, as China tightened environmental standard and curbed natural sand exports to all countries in 2007.
Will Beijing broaden the trade restriction measures to the manufacturing sector especially semiconductors/electronics? Considering the difficulty of sourcing substitutes and the strategic importance of semiconductor supply, the chances for Beijing to curb imports of the Taiwan-made semiconductors should remain low. It might be relatively easy for Beijing to implement import curbs on the Taiwan-made minerals, wood, footwear & headgear, in addition to agricultural and food products.
Rapid weakening of exports demand
The rapid weakening of exports demand especially tech sector demand is a bigger worry in the short term. Taiwan’s exports and manufacturing sectors have been facing the downward pressures since 2Q, due to the US/European economic slowdown, China’s Covid controls, and inventory correction in the tech sector. The July PMI data released this week suggest that the pace of exports slowdown is quickening in 3Q. The S&P manufacturing PMI registered 44.6 in July, below the neutral 50 level for the second consecutive month, and the lowest reading seen since June 2020. The manufacturing PMI compiled by Chung-Hua Institution for Economic Research also recorded a weak 47.8 in July, the lowest over two years. Data breakdown shows a steep decline in new orders, new export orders, and production. Activity in the electronic and optical sector contracted the most, followed by electrical & machinery equipment and basic materials.
We have forecasted a modest GDP growth rebound in 2H (3Q: 4.5%, 4Q: 2.8% YoY), on expectations of a gradual slowdown in exports and a moderate recovery in consumer demand after Covid. The July PMI results suggest that 3Q GDP growth may fall short of expectations by a wide margin as exports lose steam at a faster pace. We will revisit our GDP forecasts after collecting more hard data for the Jul-Aug period (e.g., customs trade, industrial production).
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