Taiwan's 2006 Balance of Payments

UNCLAS SECTION 01 OF 02 TAIPEI 000564

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SIPDIS

STATE PLEASE PASS USTR
STATE FOR EAP/RSP/TC, EAP/EP
USTR FOR ALTBACH AND STRATFORD
USDOC FOR 3132/USFCS/OIO/EAP/WZARIT
TREASURY FOR OASIA/LMOGHTADER
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF
GOVERNORS, NEW YORK FRB/MARA BOLIS AND SAN FRANCISCO FRB/TERESA
CURRAN

E.O. 12958: N/A
TAGS: EINV EFIN ECON PINR TW
SUBJECT: Taiwan's 2006 Balance of Payments



1. SUMMARY: Taiwan's current account surplus in 2006 surged nearly
60% to US$25 billion. The C/A surplus was largely offset by a huge
capital outflow of direct investment and insurance firms' portfolio
investment. Depreciation of the US Dollar (USD) drove up the USD
value of Taiwan's EURO and Yen foreign exchange (FX) reserves.
Taiwan's valuation-adjusted FX reserves in 2006 grew by US$13
billion or 5% to US$266 billion. In 2007, Taiwan's C/A surplus may
be totally offset by net capital outflow due to Taiwan's low
interest rates. END SUMMARY.

Favorable Trade Leads Keeps C/A Positive
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2. Taiwan's current account (C/A) has enjoyed surpluses every year
since 1981. Its C/A surplus in 2006 surged nearly 60% to US$25
billion from US$16 billion in 2005. Over 90% of the C/A surplus or
US$23 billion came from merchandise trade, boosted by double-digit
growth in exports to developed markets as well as shipments of
production inputs to China and Southeast Asia, where many Taiwan
manufacturing firms have located their export manufacturing.

Deep Cut in Service Trade Deficit
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3. Two other sources of the C/A surplus were (1) triangle trade and
(2) interest earned from Taiwan's FX reserves. Triangle trade
(i.e., orders placed in Taiwan and shipped from overseas production
bases) began to play an important role in Taiwan's service trade in
the mid-1990s as a growing number of manufacturing firms began to
relocate their factories overseas, particularly in the PRC. Income
generated from triangle trade in 2006 increased to US$14.9 billion
or 6.7% of total merchandise exports, leading to a 37% cut in
Taiwan's service trade deficit from US$6.6 billion in 2005 to US$4.2
billion in 2006.

TBC Contributes to Factor Income's Inflow
--------------


4. Taiwan's FX reserves, ranking third largest in the world, have
brought huge interest earnings which reversed the factor income
account from a chronic net outflow to a chronic net inflow in 1982.
In 2006, the US Federal Reserve Banks steadily raised interest
rates; together with Taiwan Central Bank's (TCB) effective
management of its FX assets, this contributed to a 20% growth in
interest earned from Taiwan's FX reserves to US$14.7 billion and 20%
growth in the factor income account's inflow to US$20 billion in

2006.

Capital Outflow
--------------


5. Capital outflow caused Taiwan's financial account (F/A) have a
deficit of US$23 billion in 2006, down from a surplus of US$1.7
billion in 2005. Capital left Taiwan mainly in the form of foreign
direct investment (FDI) and portfolio investment (PI). Total
outbound FDI and PI in 2006 increased 26% to US$51.4 billion, which
was US$22 billion more than the inbound total.

China Accounts for Majority of Taiwan FDI
--------------


6. In 2006, outbound FDI increased 21% to US$7.3 billion, a
majority of which went to China. The TCB's FDI statistics are not
organized by country, but approval figures compiled by the Ministry
of Economic Affairs (MOEA) are organized by country. FDI approved
in 2006 totaled US$11.9 billion. Of this amount, 80% went to China,
including 64% directly to China and 16% (according to Investment

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Commission estimates) indirectly to China through such third
territories as Caribbean tax havens. The combined share of approved
FDI going directly and indirectly to China exceeded 85% in 2005.

Low Interest Rate Drives up Outbound PI
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7. While openness of Taiwan's stock market has attracted many
foreign portfolio investors, low interest rates are driving local
funds to seek higher yields in overseas financial markets. Taiwan's
interest rates are among the lowest in the world. The interest rate
gap between Taiwan and the United States broadened from less than
half a percentage point in 2004 to above 3 percentage points in

2006. The interest rate gap has brought heavy pressure on Taiwan
insurance companies which have to meet high-yield commitments made
to policy owners. Consequently, overseas stocks and bonds bought by
Taiwan insurance firms steadily increased from US$22.6 billion in
2004 and US$31 billion in 2005 to US$42.5 billion in 2006. In 2006,
insurance firms accounted for 86% of Taiwan's total outbound PI.

Increase in FX Assets
--------------


8. The FX reserves held by the TCB (before valuation adjustment)
increased US$6.1 billion. However, valuation adjustment of the EURO
and Japanese Yen reserves drove up the increase to US$12.9 billion.
Taiwan's FX reserves grew in 2006 to US$266 billion, about 30% of
which are in the Euro and Japanese yen. In 2006, the EURO and the
Japanese Yen appreciated 11% and 13.6% against the USD,
respectively.

Prospects
--------------


9. Taiwan's current account will continue in surplus in 2007 as
Taiwan remains an export-oriented economy and a production input
supplier to the many Taiwan firms located in China and Southeast
Asian nations. However, Taiwan's FX reserves may level off or even
decline in 2007 and beyond as the current account surplus may be
totally offset by a financial account deficit if the TCB continues
to keep local interest rates far below levels in the United States
and Europe. The interest rate gap will force insurance firms and
other Taiwan portfolio investors to seek portfolio investment
opportunities overseas.

YOUNG