October 12, 2016 / 11:01 AM / a year ago

Fitch Upgrades Taiwan to 'AA-'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, October 12 (Fitch) Fitch Ratings has upgraded Taiwan's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'AA-' from 'A+'. The Outlook is Stable. The issue ratings on Taiwan's senior unsecured local-currency bonds are also upgraded to 'AA-' from 'A+'. The Country Ceiling is revised to 'AA+' from 'AA'. The Short-Term Local-and Foreign-Currency IDRs have been affirmed at 'F1+'. KEY RATING DRIVERS The upgrade of the IDRs reflects the following key rating drivers: Taiwan's fiscal profile has continued to steadily improve despite the challenges presented by lower economic growth. Real GDP growth slowed to a mere 0.65% in 2015, yet the general government balance showed a surplus of 0.1% of GDP for the year, the first surplus in nearly two decades. Fitch expects the budget balance to remain stronger than official targets in 2016, driven by strong tax revenue collection and prudent expenditure management. The agency forecasts a 2016 budget deficit of 0.7% of GDP, below our prior forecast of 1.2%, and sufficient to keep public debt dynamics on a modest downward trajectory. The new government, which took office in May 2016, has maintained fiscal deficit targets broadly consistent with the prior administration. The proposed 2017 central government budget has set revenue growth at 1.3%, expenditure growth at 1.1%, and a deficit target of 0.9% of GDP. Fitch forecasts a 2017 general government deficit of 1.0%, which incorporates a central government deficit of 0.6% of GDP (0.3pp below budget) and a small deficit at the local government level. Our forecast reflects the view that expenditure outturns will be kept below budget, a track record that Taiwan has maintained every year since at least 1975. Gross general government debt (GGGD) fell to 42.8% of GDP in 2015, below the 'A' median of 51.3%, and broadly consistent with the 'AA' category median of 39.4%. GGGD has fallen by nearly 5pp relative to its 2012 peak of 47.6%, facilitated by a multi-year fiscal consolidation strategy called the "Sound Finance Program". Fitch expects GGGD to remain on a downward trajectory over the 2016-2018 forecast horizon, but the rate of decline will slow as the economy faces weak global trade volumes and lacklustre domestic demand. The agency views fiscal financing risk as low, reflecting an average debt maturity of 11.2 years, average borrowing costs of 1.9%, and a debt stock denominated entirely in local currency. The IDRs also reflect the following key rating drivers: Taiwan's robust external finances remain its core credit strength. The current-account balance rose to 14.5% of GDP in 2015, the highest recorded in recent history, and the agency expects a broadly similar outturn in 2016. A structural current-account surplus has facilitated continued reserve accumulation and strengthened the sovereign balance sheet. Fitch expects sovereign net foreign assets to grow to 84% of GDP in 2016, well above the 'AA' median of 38.2%. The agency also forecasts foreign reserve coverage will grow to 17.7x current-account payments in 2016, higher than medians for both 'AA' and 'A' rated peers of 4.3x and 4.2x, respectively. Recent GDP growth has been weak, and the medium-term growth outlook is challenged by adverse demographics and threats to Taiwan's export competitiveness from ongoing enhancements to mainland China's domestic supply chain. Real GDP grew by 0.7% year-on-year in 2Q16, after contracting during the three previous quarters. Net exports contributed positively to growth for the first time since 1Q15, but domestic demand remains lacklustre. Fitch's 2016 growth forecast of 1% incorporates a modest acceleration during the second half of the year, but remains below the official growth forecast of 1.22%. The agency expects a moderate acceleration of growth to 1.5% in 2017 and 2% in 2018. Policy rates were lowered on four occasions since September 2015, but the central bank left rates unchanged in its most recent board meeting, citing renewed momentum for the domestic economy and a mild inflation outlook. The reduction in funding costs has opened up some room to increase expenditures in other areas of the budget, including on education and infrastructure. Fitch expects that policy will remain accommodative over the rating horizon, as inflationary pressures remain low and the economy continues to perform below potential. Fitch views Taiwan's large banking system and leveraged private sector as a potential risk to its sovereign balance sheet, although asset quality and capitalisation remain strong. Impaired loans were 1.2% of total loans at end-July 2016 and adequately provisioned. The weighted average capital adequacy ratio of 13.0% at end-2Q16 is already in excess of the 10.5% regulatory minimum required by end-2018 under the Basel III standards. Fitch estimates that financial-sector exposures to mainland China fell to 6.2% of banking sector assets at end-1H16 (from 6.7% at end-2015), and continue to be below those of other regional banking systems, including Hong Kong (28%), Macao (26%), and Singapore (13%). Cross-strait relations have cooled since President Tsai Ing-wen of the Democratic Progressive Party (DPP) took office in May 2016, but have not altered Taiwan's sovereign creditworthiness. Since the change in government, there has been a suspension in official communications by Beijing's Taiwan Affairs Office and a reduction in mainland Chinese tourist arrivals. Fitch believes that further rapprochement over the rating horizon is unlikely, but existing economic and trade linkages will continue to operate uninterrupted. 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 and/or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could lead to negative rating action, individually or collectively, 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 swift deterioration in the banking sector's asset quality, in light of the macro-prudential risks stemming from high private-sector leverage and mainland China exposure. 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 - No disruptive escalation in regional geopolitical tensions. 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: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1012985 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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