Taiwan's third-quarter GDP growth has shrunk by 1.02 percent year-on-year, after registering a 4.56 percent year-on-year increase in the second. This is worse than the market consensus of a 0.8 percent year-on-year growth decline.

Taiwan's domestic demand contracted again by 2.2 percent year-on-year, following a 2.6 percent contraction in the second quarter. We see a notable slowdown in private consumption and investments, while exports also declined sharply by 0.6 percent year-on-year, after growing by 9.9 percent year-on-year in the second quarter.

October's exports fell sharply by 8.3 percent year-on-year, following an 8.1 percent year-on-year gain in the third quarter.

Historically, Taiwan's domestic investment cycle is intertwined with the export cycle. On the other hand, construction activities have already been slowing, as positive sentiments in the property market after the "presidential" election faded.

That is why we also expect construction investments to offer little buffer to the domestic investment cycle. As for domestic consumption, with the weaker export and domestic capital spending cycle ahead, we do not see any major catalysts in lifting the labor market and the domestic consumption cycle either.

The government has revised the official GDP growth forecasts to 1.87 percent and 2.12 percent for 2008 and 2009 respectively, from 4.3 percent and 5.08 percent.

Although Taiwan does not report seasonally adjusted numbers, which are required to define a technical recession, growth in the fourth quarter will be even worse than the third. It is quite clear that Taiwan is already in a recession.

We believe Taiwan can afford to ease its monetary policy, when faced with intensifying global cyclical headwinds. This largely owes to the moderating domestic inflation pressure. Therefore, we expect another 0.25 percent rate cut in its upcoming policy meeting in December.

Going into 2009, we expect another 1 percent rate reduction by the central bank, bringing the policy rate to 1.50 percent. Amid the rapid economic slowdown, the Taiwan authorities do have the flexibility to pursue a more expansionary fiscal policy.

We also expect more affirmative progress on the cross-Straits relationship and policies. Taiwan's Straits Exchange Foundation (SEF) and the mainland's Association for Relations across the Taiwan Straits (ARATS) have signed agreements on a number of cross-Straits economic policies this year.

We believe greater economic ties with the mainland should help support Taiwan's growth in the longer term.

However, we expect the economic impact from these positive cross-Straits economic policies to come to fruition in late-2009 the earliest, meaning they are unlikely to offer much immediate help to the island against strong global cyclical headwinds in the near future.

Polaris Securities (Hong Kong) Ltd provides the article.

(HK Edition 11/27/2008 page3)