Analyst
Jing Chen
cherrychen@Dagongcredit.com

                                                    
Sovereign Credit Rating
 
Local currency/outlook AA-/stable
Foreign currency/outlook AA-/stable
Rating time October 2010

Rationale

Dagong assigns “AA-” on both local and foreign currency credit ratings for Taiwan Province of China (hereinafter referred to as “Taiwan”) based on a comprehensive analysis of Taiwan’s current financing requirements and its debt repayment risks.

The fiscal position of the authorities in Taiwan has been deteriorated since 2000, resulting in a rapid expansion of debt scale and naturally an increasing debt burden. In 2008, the debt outstanding of its authorities is 2.9 times as much as that in 1999. In response to the economic crisis, Taiwan authorities adopted corresponding counter-cyclical policies, which have led to a further significant increase in its debt size. As of the end of August 2010, the outstanding debt of Taiwan authorities has reached New Taiwan Dollar (“NTD”) 4.3 trillion, equivalent to 32.3% of the island's GDP. Despite the fast growth of its debt, it is nearly the same compared with the emerging markets average level of 32.5% and its debt scale is still reasonable. Meanwhile, the debt structure of Taiwan authorities is relatively good. Currently, its debt is entirely composed of domestic debt, and the short-term debt only accounts for a small proportion, naturally a moderate debt pressures in a short term. According to the 2010 and 2011 fiscal budgets, its debt size will keep an upward trend in the future.  The debt ratio will reach 37.8% in 2011 and after that will be stable at a level a little bit lower than 40%.

As a whole, though the unreasonable tax arrangement has resulted in a lasting fiscal deficit for many years, yet based on the gradual easing in the relations across the Taiwan Straits, the good economic growth capability and the ample foreign exchange reserves, we believe that Taiwan authorities hold relatively high local and foreign currency solvency.  The basic reasons are as follows：

There is a significant improvement in the relations across the Taiwan Straits since 2008. The “three direct links across the Taiwan straits” and the ECFA agreement could bring two benefits to its economy. On the one hand, it could reduce the uncertainty of Taiwan's economic environment to some extent. On the other, it also helps to stop the marginalizing trend of Taiwan in the international economy, removing development obstacles for its export-oriented economy;

The narrow tax base has led to a lasting fiscal deficit in Taiwan. Despite the ease of deficit rate in recent years, the counter-cyclical policies against the international financial crisis has resulted in a dramatic increase in the deficit, amounting to 3.9% of its GDP, causing its outstanding debt to expand rapidly;

The high international competitiveness of Taiwan’s electronic information industry keeps its current account surplus for a long time. Pushed by the strong demand in the international market and the good economic development of mainland China, Taiwan's exports have increased significantly since 2010, which has driven the related industries to recover first and  its economy showed a strong growth tendency;

The ample foreign exchange reserves and its net international investment position provide support for the stability of its currency and the finance of the authorities.

Outlook

Driven by the better recovery prospects in mainland China, Hong Kong and other major trading partners, Taiwan's export-oriented economy will continue its growth tendency in 2011, but the growth rate is a little bit lower than the pre-crisis average level of 5.2%. Meanwhile, the current program of tax reform could increase the fiscal revenue of Taiwan authorities to some extent in the future, but the social aging tendency limits the space for tax base to expand, which is not conducive to the improvement of future fiscal deficits. The lasting deficit will make the authorities’ debt continue to grow, but the size of the highest authorities’ and general authorities’ debt will be stable at a level less than 40% and 48% of its GDP respectively. Therefore, Dagong keeps a stable outlook for both local and foreign currency debt ratings of Taiwan in the next 1-2 years.