Fitch Ratings said that the Taiwanese economy had become much more open in recent years, and considerably more exposed to economic conditions in China. Industrial production and exports are both on a slowing trend and the agency expects GDP growth rate for Taiwan to be 4.3% this year, down from 5.7% in 2007.

"It appears there is no avoiding a slowdown in emerging Asia, and evidence of weakness in the region's largest economies, China and India, are already showing," said James McCormack, head of Asia Sovereigns, speaking on the sidelines of a Fitch conference in Taiwan earlier today. The short-term outlook for emerging Asian economies is deteriorating, based on synchronised GDP growth downturns in the US, Europe and Japan. Asian inflation rates, many of which continue to move higher, are also worrying. "Real (inflation-adjusted) interest rates remain very low in most countries, particularly in Vietnam, Sri Lanka and Mongolia, suggesting monetary policy is still broadly accommodative."

Taiwanese banks are not immune to the ongoing global economic slowdown either. "The credit cycle in the remaining of 2008 and 2009 will be tougher and banks will probably see their NPLs rise modestly," believes Jonathan Lee, Senior Director of Fitch's Financial Institutions team. For the longer term, structural overhangs will continue to curb the profitability of Taiwanese banking system, which include a still fragmented and over-banked system, pricing dictation by large state-controlled banks and excess liquidity resulting in interest margin compression.

Nevertheless, after a multi-year improvement in asset quality, Taiwanese banks are in a better footing to absorb the likely external shocks brought about by the US-led global economic slowdown. Despite some visible headline corporate defaults in 2008, Taiwanese banks' credit costs continue to trend down. NPLs and gross charge-off ratios fell to their all-time lows at 1.55% and 86bp respectively in H108; loan loss reserves at the same time continued to rise to 67% (of NPLs) at end-H108, up notably from 55% a year ago. Thanks to a generally modest loan growth in 2006-2008 (loans up 1.8% year-to-end June 2008) in the wake of the twin-cards crisis in late 2005, asset quality has been reasonably managed. The previously somewhat bubbling mortgage market was also reined in as many top-tier banks tighten their mortgage lines and demand higher collateral securities.

Turning to the life insurance sector, Fitch notes that the capitalisation and profit performance of Taiwanese life insurance companies have been vulnerable to unfavourable erratic market movements as a sizeable amount of legacy guaranteed-return insurance policies continue to weigh on large insurance companies. Fitch anticipates many insurance companies (including large ones) will need to raise new capital to sustain its credit profile. The agency also expects a new breed of product categories, including participating endowment and investment-linked products, to lead future sales growth amid an environment of low interest rates but high inflation.