October 11, 2017 / 9:31 AM / a year ago

Fitch Affirms Taiwan at 'AA-'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, October 11 (Fitch) Fitch Ratings has affirmed Taiwan's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA-' with a Stable Outlook. A full list of rating action is at the end of this commentary. KEY RATING DRIVERS Taiwan's ratings are supported by its exceptionally strong external finances, credible policy framework, supportive business environment and high governance standards as measured in international surveys. The ratings are constrained by high GDP volatility, per capita income of USD23,573 that falls below the 'AA' category median of USD41,375 and complex relations with mainland China that raise the potential for economic and political shocks. The strength of Taiwan's external finances is exemplified by its status as the eighth-largest net external creditor among Fitch-rated sovereigns (188% of GDP), large foreign reserve holdings and a more than 30-year track record of current-account surpluses despite numerous external shocks. The current account balance was recorded at 13.6% of GDP in 2016, and we expect a similar outcome in 2017. Foreign-reserve buffers are projected by Fitch to remain sizeable at 15.7x current external payments at end-2017, the fourth highest globally and well above the 'AA' and 'A' category medians of 3.5x and 4.9x, respectively. Fiscal policy has become more expansionary, but Fitch expects budget deficits to remain in line with the 'AA' category median of 1.3% of GDP. The agency projects Taiwan's general government deficit will rise to 1.2% of GDP by 2018, up from 0.7% in 2017, due to higher capital expenditure associated with the government's recently approved TWD420 billion infrastructure stimulus programme. The four-year programme aims to spur domestic demand and promote industrial reform and will increase expenditure by approximately 0.5% of GDP per year through 2021. Other proposed fiscal policy changes, including amendments to individual and corporate tax rates, appear broadly revenue neutral. Fitch forecasts gross general government debt (GGGD) to rise by 0.3pp to 42.4% of GDP in 2017, a level consistent with the 'AA' category median of 42.3%. Our baseline forecasts suggest GGGD/GDP will remain broadly stable through to at least 2020, assuming GDP growth is 2% and the primary deficit remains below 0.7% of GDP. Taiwan's medium-term fiscal discipline is anchored through various policy measures, including a public-debt ceiling of 50% of GDP enshrined in the Public Debt Act and a more recent fiscal rule that limits the growth rate of public debt to the three-year average nominal GDP growth rate. Growth momentum has improved, but remains lower and more volatile than for 'AA' category peers. Fitch forecasts GDP growth to accelerate to 2.1% in 2017, from 1.5% in 2016, as an improvement in global trade volumes and strong growth in mainland China have had a positive spill over on Taiwan's export-oriented industrial sector. Net exports contributed 0.9pp to overall growth in 2Q17, compared with a negative contribution of -0.4pp in 2016; a development also reflected in a notable rebound in export orders this year. Fitch expects growth to average approximately 2% over 2018-19, a view that balances the recent shift towards a more supportive fiscal policy with ongoing headwinds to private consumption from Taiwan's high household debt burden and adverse demographic profile. The central bank left its discount rate unchanged at 1.375% during its late-September 2017 board meeting, citing uncertainties over the global economic outlook, subdued price pressures (CPI has averaged 0.7% year-to-date) and soft domestic demand. Fitch expects monetary policy to remain accommodative through 2018, despite the improved growth momentum, given our benign inflation outlook and the central bank's own assessment that the economy continues to perform below potential. Fitch sees Taiwan's large banking sector as a risk to its sovereign balance sheet, illustrated by the fact that the average stand-alone rating of Fitch-rated banks ('bbb') falls two rating categories below the sovereign. Nevertheless, asset quality and capitalisation remain strong. Impaired loans remained at a low 1.2% of total loans as of end-1H17. The weighted-average capital adequacy ratio of 13.3% at end-2Q17 is below the 'AA' category median of 16.4%, but we expect it will rise ahead of the full phase-in of Basel III requirements at end-2018. The banking sector is also liquid and predominantly deposit-funded. Fitch estimates the mainland China exposure of Taiwanese banks at 6.2% of system assets at end-2016, down from a peak of 8.4% in 2014 and well below other regional banking systems, including Macao (33%), Hong Kong (30%) and Singapore (14%). Cross-strait relations remain frayed since President Tsai Ing-wen took office in May 2016. President Tsai has continued to reiterate the government's desire to maintain peace and stability in cross-strait relations, but her refusal to accept the so-called "1992 Consensus" basis of "one China, with respective interpretations" prompted Beijing to suspend high-level communications between the two governments and has also triggered a 34% decline in mainland Chinese tourists. Critical trade and investment linkages nevertheless remain unaffected, underscored by the 21% rebound in Taiwan exports to mainland China during the first eight months of 2017. Fitch believes a significant deterioration in cross-strait relations over the next two to three years is unlikely, given that status-quo relations are favoured by the majority of Taiwan's population. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Taiwan a score equivalent to a rating of 'AA' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows: - Structural Features: -1 notch to reflect complex relations with mainland China that raise the potential for economic and political shocks. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could lead to negative rating action are: - An adverse macroeconomic or financial shock that weakens medium-term growth prospects and negatively affects public-debt dynamics, such as a hard landing in mainland China. - A deterioration in cross-strait relations sufficient to undermine Taiwan's basic economic stability. The main factor that could lead to positive rating action is: - A return to high economic growth that brings per capita income closer in line with peers. KEY ASSUMPTIONS - The global economy performs broadly in line with Fitch's latest Global Economic Outlook. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F1+' Short-Term Local-Currency IDR affirmed at 'F1+' Country Ceiling affirmed at 'AA+' Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'AA-' Contact: Primary Analyst Andrew Fennell Director +852 2263 9925 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Sagarika Chandra Associate Director +852 2263 9921 Committee Chairperson Jan Friederich Senior Director +852 2263 9910 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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