RMB Appreciation No Help for Taiwan

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TAGS: EINV EFIN ECON PINR TW
SUBJECT: RMB Appreciation No Help for Taiwan

Summary
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1. (U) Because of Taiwan's massive investment in the PRC,
the two economies cooperate more than compete in world
export markets. Thus export orders to Taiwan firms will not
benefit from a revaluation of the Renminbi (RMB). Although
a revaluation could affect some investment decisions by
Taiwan firms, high levels of Taiwan investment in the PRC
are likely to continue. On balance, a revaluation of the
RMB would not benefit Taiwan's exports to the PRC because
most of them are inputs used to assemble consumer goods that
are re-exported from the PRC. Overall the effect for Taiwan
will probably be negligible. End summary.

Collaborators Not Competitors
--------------


2. (U) While many of the world's exporting economies stand
to benefit from the anticipated revaluation of the PRC's
Renminbi (RMB),which would make China's exports more
expensive, Taiwan's situation is different from most.
Taiwan and China are not competitors in international
markets so much as collaborators. The cross-Strait economic
dynamic is mainly one of cooperation with China serving as
the factory for Taiwan's exporters. The predominant pattern
is for Taiwan firms to move labor-intensive manufacturing
processes to the Mainland, while maintaining technology and
capital-intensive production of inputs in Taiwan. Taiwan-
owned factories in the Mainland fill export orders received
by headquarters in Taiwan using Taiwan-made components. In
2004, more than 70 percent of information technology
products produced by Taiwan firms were manufactured in the
PRC.


3. (U) Appreciation of the RMB would generally increase
prices for exports of Taiwan firms. Even though many
production inputs come from Taiwan and would become cheaper
with the RMB appreciation, exports manufactured by Taiwan
firms in China would still be more expensive because the RMB
appreciation would increase the cost of locally sourced
inputs, especially the labor component. As a result, export
orders for Taiwan firms manufacturing their goods in the
Mainland could fall. However, some observers point out that
although Taiwan firms with operations in the Mainland will
face higher production costs, they will also see the value
of their Mainland investments rise. Most estimates put
total Taiwan investment in the Mainland at USD 100 billion
or more.

Marginal Change in Investment Strategies
--------------


4. (U) Because appreciation of the RMB will increase
production costs in the Mainland and make it more expensive
to invest there, some Taiwan firms may change their
investment patterns. In the short run, some Taiwan
manufacturers may shift some production from China back to
Taiwan or to other locations. Some firms may reconsider or
postpone relocation of production lines to China if
production costs rise to levels comparable to costs in
Taiwan. They may also choose to relocate to places other
than China. However, many analysts expect any such reaction
to be temporary with cost-cutting measures quickly restoring
the full advantage of production in the Mainland.


5. (SBU) In the long run, RMB appreciation may not have much
impact on Taiwan investment at all if past experience is an
indicator. As Morgan Stanley (Taiwan) President Ho Chi-wen
pointed out, the RMB gained 20% against the NTD from 1997 to
2002, but its appreciation never dampened the relocation of
Taiwan's production lines to China. Taiwan approved USD 3.9
billion in PRC investment in 2002, more than double the USD
1.61 billion approved in 1997. Approved Taiwan investment
in China continued to rise to USD 4.6 billion in 2003 and
US$6.9 billion in 2004.

Trade Balance - Trends Continue
--------------


6. (U) The RMB appreciation will make imports cheaper in
China and, therefore, could benefit foreign suppliers.
However, Taiwan's exports to China are rarely consumer goods
for local markets. Some estimates indicate that over 85
percent of Taiwan's exports to China are production inputs
that are re-exported after further processing. The RMB
appreciation will make the final products more expensive and
could thus slow the pace or reduce Taiwan exports of inputs
to the PRC.


7. (U) Theoretically, the RMB appreciation will make Taiwan
imports from China more expensive and slow down the flow of
imports from China. However, products from China could
remain far cheaper than their Taiwan-made counterparts. It
is likely that imports from China will continue increasing.
The RMB appreciation of 20% against the NTD from 1997 to
2002 did not lead to any reduction in Taiwan's imports from
China. Market liberalization required by Taiwan's and
China's WTO accession prompted a sharp increase in Taiwan's
imports. Taiwan imported USD 7.95 billion from the PRC in
2002, nearly double the USD 3.9 billion worth of PRC imports
in 1997.

More Hot Money?
--------------


8. (SBU) Investor expectations that the RMB will revalue
have already produced a large inflow of speculative capital
(hot money) to China from all over the world. That flow
will increase substantially if the PRC adopts gradual upward
adjustment of the currency value. Such speculative money
has begun to spill over to Taiwan with the expectation that
currencies in the region will follow the RMB. For Taiwan,
AIT/T contacts report an increase in advance payment for
exports and a delay in payment for imports. Some additional
hot money has flowed into Taiwan in the form of portfolio
investment. However, the flows into Taiwan have not been
enough to increase the money supply to a degree that would
increase inflationary pressure. The capital inflow could
well reverse once the RMB stabilizes after revaluation takes
place.

Comment - Negligible Impact for Taiwan Economy
-------------- -


9. (SBU) The net effect of an RMB appreciation for the
Taiwan economy is likely to be negligible. A revaluation of
the RMB would increase the price of PRC-produced goods.
The dominant link between the two economies is Taiwan firms
manufacturing products in the Mainland. Thus, increased
production costs for the PRC would inevitably mean increased
costs for Taiwan manufacturers. However, most analysts
expect a fairly modest revaluation of the RMB, something on
the order of ten percent. Financial markets have already
adjusted prices with the expectation of this modest
revaluation, as have Taiwan firms. Should the RMB revalue
substantially more than what the market anticipates, then
the impact on Taiwan will be greater and could dampen
economic growth.

PAAL