TAIPEI Nov 1 The threat of military conflict between Taipei and Beijing has faded, raising the appeal of Taiwan for foreign investors, but sudden policy shifts and new upsets over China could cool the investment climate.
Following is a summary of key risks to watch in Taiwan:
INTEREST RATE POLICY AND CAPITAL CONTROLS
Taiwan's central bank raised interest rates in September for the second time since February 2009 [ID:nTOE68T09L] and is expected to hike them 12.5 to 25 basis points each quarter through the end of 2011.
However, some analysts say a severe enough slowdown in the United States, Taiwan's second biggest single-country export market after China, could force a pause in those hikes for a quarter or two. The previous interest rate, a record low 1.25 percent, was an emergency measure to fight the economic downturn.
The rate hikes signal that Taiwan authorities believe their $414 billion export-reliant economy is gathering steam despite sluggish CPI [ID:nTOE69405Z] and stubborn unemployment that remains at an unusually high 5.08 percent. [ID:nTPV002084]
Recent rate hikes also seek to stop fast-rising property prices in Taipei from becoming an asset bubble.
The central bank remains wary of "hot money" inflows, especially as the Taiwan dollar TWD= and other Asian asset prices have risen sharply since Sept. 27 on expectations of quantitative easing in the United States.
Some hot money departed earlier in the year due to risk aversion driven by the euro zone debt crisis and fears of a double-dip recession in the United States. But in October, central bank governor Perng Fai-nan said about T$120 billion ($3.9 billion) in foreign funds in Taiwan were not invested in securities [ID:nTPV002070], a hint that those funds may be invested in the currency market against his wishes.
Dealers in Taipei believe the interventionist central bank takes steps almost daily to stop speculation in the forex market. It bought roughly $5 billion in U.S. dollars during the month to Oct. 25, according to a survey of traders by IFR Markets.
Earlier this year, the monetary authority warned banks to follow regulations when trading foreign exchange forward contracts, another move to discourage hot money. [ID:nTOE60L08O].
Economists say the Taiwan dollar stands to gain in tandem with the Chinese yuan CNY=CFXS if Beijing allows its nonconvertible unit to appreciate. The island's currency is an ideal proxy for the yuan due to Taiwan's fast-growing trade ties with China.
What to watch:
-- Economists expect the central bank to raise rates again by 12.5 to 25 basis points at its December quarterly policy meeting. [ID:nTOE65O026]
-- Capital controls could be tightened if hot money pours into Taiwan as the United States eases monetary policy. Easing would boost currencies in emerging markets such as Taiwan's, where investors are expected to seek higher returns than they can get in developed markets.
-- The central bank's response to any appreciation of the Taiwan dollar due to a firmer yuan.
Taiwan President Ma Ying-jeou's promotion of closer economic ties with China after decades of hostility culminated on June 29 in a landmark free-trade deal that cuts import tariffs on about 800 items and helps the island's financial sector. [ID:nECFA]
That economic cooperation framework agreement (ECFA) handily cleared the island's parliament in August and is expected to take full effect on Jan. 1, setting the stage for talks with China on potentially thousands more tariff cuts.
The deal positions Taipei to sign free trade deals with its other major trading partners [ID:nTOE67805H] as China is seen muting its usual opposition to such agreements. Beijing normally forbids its diplomatic allies, including the world's most powerful nations, from official deals with Taiwan as it sees the island as part of its territory rather than a sovereign nation. But Taiwan and Singapore, the island's No.6 trade partner, said on Aug. 5 they would begin FTA talks [ID:nTOE67400Q] and China voiced no objections.
Taiwan says China will allow the island to sign FTAs with its major partners under the World Trade Organisation framework, advancing Taiwan's long-term competitiveness. Other Asian nations have toyed with how to approach Taiwan about FTAs, but domestic concerns on both sides such as agricultural tariffs may prove a tough nut to crack. [ID:nTOE68202K]
In further signs of improved China-Taiwan ties, the island's stock market opened this year to qualified Chinese investors, while trade and shipping links established since 2008 will help boost trade and reduce the risk of military conflict.
But the issue of ties with China remains highly divisive in Taiwan and there is always the risk of new controversies, especially as voters in the island's major cities elect local leaders on Nov. 27 with the winning party having a strong shot at the 2012 presidential race. China, for its part, is gradually ramping up pressure on Ma's government to discuss tough political issues, analysts say.
What to watch:
-- Washington is weighing Taiwan's request for F-16 fighter jets, a sale described as a "red line" for Sino-U.S. relations, and other arms packages, but any decision is not expected until at least 2011 as U.S. officials seek better China ties [ID:nTOE66M04U]. If a sale threatens ties with China, the impact on Taiwan asset prices will be negative, with stocks of firms that have benefited from greater access to China hit the hardest.
-- Results of the local elections covering about 60 percent of the electorate. If the ruling party wins resoundingly, it would signal support for more trade dialogue with China. If the opposition gains, China relations could sour.
-- Talks on further tariff reductions that could help Taiwan's biggest industries such as electronics, PVC plastics and machine tools. Beijing may resist making concessions on these as it wants to develop its own industries.
-- Firm statements from Beijing, insisting that Taiwan begin negotiating military and political issues with China.
Ma has a strong mandate to govern, as the ruling Nationalists (KMT) control parliament and the presidency. This has bolstered government effectiveness and helped to avoid political deadlock.
But widespread criticism of the response to Typhoon Morakot last year dented government popularity and led to a cabinet reshuffle. That storm, the worst in 50 years, triggered mudslides that killed about 700 people.
A sudden deal in October to allow U.S. beef imports despite mad cow disease fears also backfired, prompting Taiwan's parliament to scrap part of the agreement and irritating Washington. But the president, coached by party insiders on public relations, has avoided major flaps since early 2010 and stayed clear of any mass criticism over damage following two typhoons this year.
Still, the China-friendly KMT faces what analysts see as a mounting threat from the anti-China opposition Democratic Progressive Party (DPP). If the DPP retakes the presidency in 2012, that shift of power would likely freeze economic ties with Beijing pending new dialogue.
What to watch:
-- Markets are unlikely to react to domestic political controversies unless they significantly weaken the KMT's hold on power, the strength of which will become clearer after the Nov. 27 local elections. If that happens, the risk of policy deadlock and frostier ties with China would be a drag on markets.
Taiwan limits foreign portfolio investment and restricts foreign direct investment in some sectors. As the economy recovers, investors will start to focus again on whether economic reform may relax some restrictions. In a sign of growing focus on competitiveness, the government has cut the corporate income tax rate from 20 to 17 percent. [ID:nTOE64S005]
What to watch:
-- Any announcement from the government on economic reform and specific measures to boost foreign investment. This would be broadly positive for the stock market.
(Editing by Daniel Magnowski)