TAIWAN CURRENCY APPRECIATION

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 003738

SIPDIS

STATE PLEASE PASS AIT/W AND USTR
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USTR FOR SCOTT KI
USDOC FOR 4420/USFCS/OEEA/EAP/LDROKER
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AND SAN FRANCISCO FRB/TERESA CURRAN

E.O. 12958: DECL: 11/11/2024
TAGS: EFIN EINV ECON TW
SUBJECT: TAIWAN CURRENCY APPRECIATION

Classified By: AIT Director Douglas Paal, Reason 1.4 (B/D)


1. (C) Summary: On November 22, Taiwan's Central Bank of
China (CBC) intervened in foreign exchange markets to slow
the ongoing appreciation of the New Taiwan Dollar (NTD) after
the currency reached its highest levels in almost four years.
Speculators are moving additional foreign capital to Taiwan
in anticipation of further declines in the USD. A CBC
official told AIT that despite the weak USD, Taiwan would
continue to keep most of its foreign exchange reserves in USD
denominated assets, placing safety and liquidity ahead of
profit. End summary.

Cause and Effect of the Rising NTD
--------------


2. (C) Taiwan CBC officials have confirmed to AIT that they
intervened in currency markets on November 22 to slow the
rise of the NTD. They claim the intervention was slight,
less than one percent of market volume. The NTD opened on
November 23 at NTD 32.495 per USD after CBC intervention,
slightly down from its 44-month high close of NTD 32.420 per
USD on November 18. The value of the New Taiwan Dollar (NTD)
in USD terms has risen sharply in recent weeks, gaining more
than 4 percent on the USD since late September. However,
the Korean Won has gained more against the USD in recent
weeks than has the NTD, and the Japanese Yen has also gained
about four percent.


3. (C) The ongoing appreciation of Asian currencies and an
announcement by Morgan Stanley that it will increase the
weighting of Taiwan share prices in its international capital
index have attracted foreign capital to Taiwan. Foreign net
purchases of Taiwan's traded stocks have already reached NTD
200 billion this year. The widening U.S. trade and Federal
fiscal deficits, and widespread anticipation of a loosened
trading band for China's Renminbi has fueled speculation of
continued declines in the value of the USD. The impact on
the competitiveness of Taiwan companies will be closely
linked to exchange rates in Japan and South Korea, where
Taiwan's main commercial rivals are located.


4. (C) Until November 22, CBC claimed it had made no
significant effort to check the NTD appreciation. However,
CBC officials admitted to AIT that they routinely "manage"
foreign exchange reserves to avoid losses. In an indication
of some tolerance for NTD appreciation, CBC officials noted
to AIT that currency appreciation is an effective way to
fight import-led inflation and Taiwan was among the first
Asian economies to follow the U.S. Federal Reserve in raising
interest rates (CBC raised Taiwan's discount rate by 0.25
percent on September 30).

The Middle Way
--------------


5. (C) The criteria used by CBC to manage the NTD exchange
rates are closely guarded. However, some AIT financial
sector contacts believe that changes in the value of the NTD
closely follow fluctuations in the USD-Yen exchange rate, and
that the NTD keeps to an average value between the two
currencies; i.e., the NTD usually gains or loses value in
concert with the Yen's gains or losses against the USD. In
addition, many Taiwan companies involved in international
trade have reportedly already taken action to hedge against
this risk, as they have been urged to do by Taiwan's Minister
of Economics. On November 8, when the NTD reached a six
month high of 32.89 per USD, Minister Ho tried to reassure
the business community by saying the NTD appreciation thus
far would not have a significant negative impact on Taiwan's
external trade. The relative stability of the NTD exchange
rate against the USD is viewed as a positive factor by the
business community.


6. (C) While local economists predict some impact on
Taiwan's exports to the United States, appreciation in the
current 4 percent range is seen as tolerable. However,
several Taiwan industry associations have openly called for
CBC to intervene to slow the NTD's "too rapid" rise, and with
legislative elections scheduled for December 11, the NTD
appreciation is a sensitive political issue. On November 20,
the Vice Minister of Economic Affairs urged Taiwan
manufacturers to speed up the globalization of their business
operations to reduce the impact of currency fluctuations.
There will be additional upward pressure on the NTD at the
end of the month, when exporters often sell off their USD
receipts.

U.S. Election Profitable for Central Bank
-------------- --------------


7. (C) CBC Foreign Exchange Department Director General
George Chou told AIT that CBC's Foreign Exchange Trading team
monitors global foreign exchange markets well beyond regular
office hours. In spite of the 13-hour time difference some
team members are assigned to monitor trading activity in New
York. Chou receives updates on U.S. market trends, farm
reports, payroll figures, and other financial reports well
into the night. Chou mentioned that on the night of the U.S.
presidential election, his foreign exchange trading team
earned USD 300,000 from management of CBC's assets in foreign
markets and capitalizing on USD fluctuations during the
ballot counting.

CBC Will Continue to Hold USG Bonds
-------------- --------------


8. (C) In general, Chou said, Taiwan's CBC follows three
principles in managing its foreign exchange reserves: safety,
liquidity, and profitability, with safety and liquidity the
priorities. When international situations pose a threat to
the safety of Taiwan's foreign exchange reserves, CBC will
take defensive action, including moving assets out of a
region. To illustrate this point, Chou mentioned that CBC
stopped including Hong Kong dollars in its foreign exchange
portfolio after Hong Kong's retrocession to China, since this
made Hong Kong less secure, from Taiwan's point of view. It
is with safety foremost in mind that CBC will continue to
hold a large percentage of its assets in U.S. Government
bonds, and to keep large bank deposits in the United States.
While the exact ratios of foreign currencies in Taiwan's
portfolio of USD 235 billion (as of September 2004) in
foreign exchange reserves is considered confidential
information, local economists believe it is roughly USD 65%,
Euro 20%, and Japanese Yen 15%.

Other Factors Influencing the NTD
--------------


9. (C) Chou mentioned that another factor affecting the
composition of CBC's foreign exchange reserves is interest
rates. The U.S. Fed's raising interest rates reinforces
CBC's intent to keep its deposits in U.S. banking
institutions. However, it is also widely believed that over
the past two years CBC has increased its holdings of Euros to
take advantage of their appreciation trend. The PRC's
recent raising of interest rates for the first time in nine
years and new lending restrictions designed to cool economic
growth are expected to result in an increased outflow of
capital from Taiwan to China Mainland as PRC-based Taiwan
companies turn to Taiwan financial institutions for cheaper
working capital. The capital inflow into Taiwan precipitated
by the Morgan Stanley weighting increase is seen as short
term. As the net inflow of capital lessens in coming months,
this source of pressure on the NTD to appreciate will also
lessen. However, Taiwan's relatively high growth rates
compared with other Asian economies, and close economic
relations with China still make the NTD an attractive target
for speculators.

Contradictory Goals
--------------


10. (C) Comment: There will always be tradeoffs among CBC
goals of safety, liquidity, and profitability for Taiwan's
foreign exchange reserves. Even a small percentage decline
in the value of Taiwan's USD 235 billion foreign exchange
reserve translates into an enormous loss. In spite of Chou's
assurances that Taiwan will keep the bulk of its foreign
exchange reserves in USD denominated assets, as a banker
conditioned to minimize risk and maximize profit, he will
surely face strong pressure to protect against the loss of
value that would result from further declines in the USD.
From a purely economic point of view the NTD appreciation
thus far will have only a minor impact on Taiwan's external
trade, especially given the even greater appreciation in the
currencies of other economies. Under the additional pressure
of loud opposition from local businesses to the rapid NTD
appreciation, CBC has opted to slow the NTD's rise prior to
the December 11 elections. There is likely to be continued
upward pressure on the NTD in coming weeks. End comment.
PAAL