IS TAIWAN FAVORING EXCHANGE RATE STABILITY OVER

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 002303

SIPDIS

SIPDIS

STATE PASS USTR, STATE FOR EAP/TC,USTR FOR STRATFORD AND
KATZ, TREASURY FOR OASIA/TTYANG AND HAARSAGER

E.O. 12958: DECL: 10/09/2017
TAGS: EFIN ECON ETRD PREL TW
SUBJECT: IS TAIWAN FAVORING EXCHANGE RATE STABILITY OVER
FREE CAPITAL FLOWS?


Classified By: AIT Director Stephen M. Young for reasons 1.5 (b),(c)


1. (C) SUMMARY. In recent years, the New Taiwan Dollar (NT)
has been one of the weakest performers in Asia vis-a-vis the
U.S. dollar, and capital outflows for portfolio investment
have increased dramatically. Taiwan's central bank appears
to have adopted an informal policy to bolster the NT by
discouraging capital outflows and encouraging domestic
investment. Central bank officials insist they are not
swerving from a long term commitment to open fund flows.
Some Taiwan officials, however, acknowledge the bank has been
taking short term measures to discourage capital outflows and
encourage domestic portfolio investment. Contacts in local
and U.S. financial firms also see indications of these
measures. It is not clear how long the current emphasis on
domestic investment will last. END SUMMARY.

Weak NT$ and Surge of Capital Outflows
--------------

2. (U) Unlike many currencies in the region, Taiwan's
currency has failed to appreciate significantly against the
greenback. In the past two years, for example, the New
Taiwan Dollar has appreciated less than two percent against
the US Dollar, while both the Singapore Dollar and the Korean
Won have appreciated more than 14%. China's Renminbi has
appreciated about 8%. (The Japanese Yen, another laggard,
actually depreciated about two percent against the US Dollar.)


3. (U) At the same time, Taiwan has seen a surge in capital
outflows for portfolio investment. From the years 2002 to
2005, annual net capital outflows ranged from a high of
US$8.8 billion in 2002 to a low of US$2.9 billion in 2005.
In 2006, however, these outflows increased dramatically to
US$20 billion, and accelerated to US$11.7 billion in the
first quarter of 2007 alone. The number dropped to US$7.1
billion for the second quarter, but that was still higher
than the same period last year.

Is the Central Bank Trying to Stem the Outflows?
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4. (SBU) In a recent meeting with econoff, a major U.S.
mutual fund company expressed concern that over the past
several months Taiwan authorities appear to have adopted a
policy of discouraging capital outflows through "guidelines"
and other quasi-formal measures. The policy measures seem to
have originated at Taiwan's central bank but have been
relayed through financial regulators and industry groupings.

Smoking Gun or Just Smoke?
--------------

5. (U) In May, Taiwan authorities sent a clear message to
the fund industry and the general public encouraging more
domestic portfolio investment. Senior officials from the
central bank and the Financial Services Commission (FSC) met
with executives from a group of investment trust companies.
In a press release issued after the meeting, the central bank
publicly urged investment firms to fully disclose the risks
involved in foreign investments and quoted a private research
report that Taiwan stocks were significantly undervalued. "It
is not difficult to see that Taiwan's stocks are relatively
cheap and local institutional investors have allotted a
disproportionately small percentage of their portfolios to
domestic equity," stated the press release.


6. (C) Some U.S. asset management firms believe that the
central bank is doing more than just issuing press releases.
They claim that the central bank is devoting an
extraordinarily high level of scrutiny to their fund
applications and business activities. In a recent
conversation with econoff, Terrance Hui, who heads the Taiwan
subsidiary of U.S. investment firm Invesco, stated that the
Taiwan authorities do appear to be delaying overseas mutual
fund approvals as part of a broader strategy to support
domestic investment, but added that the issue has not been a

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major problem for his firm. (Note: The local fund industry
group told econoff that they saw no indication of delays in
fund approvals for domestic or overseas funds. End Note)


7. (C) FSC officials have also alluded to a shift in policy,
if only temporary. In a September 28 meeting with visiting
U.S. Treasury officials, Susan Chang, Vice Chairman of the
Financial Supervisory Commission (FSC),Taiwan's bank
regulator, noted that capital outflows "needed to be watched
closely." A few weeks earlier, in a meeting with AIT/W
Director of Trade and Commercial Programs Rick Ruzicka, FSC
Chairman Dr. Hu Sheng-Cheng was a bit more forward,
explaining that Taiwan's long term policy in support of free
capital flows has not changed, but that Taiwan's central bank
has adopted "short term" measures to encourage domestic
investment and discourage outflows. According to Hu, the
policy is based solely on maintaining exchange rate
stability.


8. (C) A Taipei-based senior U.S. mutual fund company
executive cites conversations with senior financial officials
in asserting that the policy shift is motivated in part by
political concerns. In this analysis, the Chen government is
seeking to encourage domestic investment as a means of
propping up the stock market and showcasing its economic
stewardship.


9. (C) Victor Kung, President of Fubon Financial Holding Co.,
Taiwan's third-largest financial institution, also told us
the authorities appear to be encouraging domestic investment.
Kung expressed underlying confidence in the independence of
the Central Bank, and attributed the policy to a focus on
exchange rate stability, rather than political motivations.
The emphasis on stability jibes with what we heard from
senior central bank officials during a recent case involving
an overseas fund transfer in excess of US$ 500 million by a
U.S. firm's Taiwan subsidiary. Although regulations do not
place restrictions on the amount of overseas fund flows, in
practice the bank asked the firm to stagger the transfer over
a period of days in order to avoid potential exchange rate
disruptions.

Central Bank Denies Policy Shift
--------------

10. (SBU) During informal conversations with AIT staff,
central bank officials have denied any change in underlying
policy on overseas fund transfers, instead stressing that
their role is limited to maintaining exchange rate stability
in the relatively small market for the NT dollar. This
message was reiterated on October 1 in a question and answer
session with legislators, when Bank Governor Peng Fai-nan
affirmed that the bank would not interfere in the foreign
exchange market or obstruct capital flows. He further
offered that the bank's recent rate rise was to address
concerns about inflationary pressures in Taiwan, not to
attract foreign funds and would have no effect on stock
prices.

Rosy Outlook - Problem Solved?
--------------

11. (C) On September 28 George Chou, deputy governor of the
central bank, told visiting U.S. Treasury officials capital
outflows were particularly pronounced from May to August, a
period for which figures have not yet been publicly released.
He speculated, however, that outflows will drop. He pointed
to the bank's September 20 rate hike of 125 basis points and
implied that another rate hike was likely, thus narrowing the
difference between U.S. and Taiwan rates. He also
anticipates an improving domestic stock market, which he
predicted would rise in the run-up to the presidential
election next March. Both narrowing interest rate spreads and
a rising domestic stock market should stem the net outflow,
he said.


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12. (SBU) COMMENT. Evidence that fund flow policy is driven
by political concerns is anecdotal, difficult to prove, and
is flatly denied by senior central bank officials. We
believe, however, that there has been at least a temporary
shift toward discouraging overseas fund outflows. How long
it lasts, or whether it has already ended, is not clear.
Perhaps due to various motivating factors behind the policy,
the new emphasis on domestic investment does not appear to
have been communicated effectively to the financial sector,
and has increased the level of policy uncertainty. We will
continue to encourage our Taiwan counterparts to maintain
regulatory transparency and implement a liberal financial
transfer regime. We will also work closely with Amcham
which, due to industry interest, has established an asset
management committee to follow the issue and lobby for a more
liberal regulatory environment. END COMMENT.
YOUNG