FACTBOX-Key political risks to watch in Taiwan

By Ralph Jennings

TAIPEI, Sept 5 (BestGrowthStock) – The threat of military conflict
between Taipei and Beijing has faded, raising the appeal of
Taiwan for foreign investors, but sudden policy shifts and
fractious local politics could cool the investment climate.

Following is a summary of key Taiwan risks to watch:

* INTEREST RATE POLICY AND CAPITAL CONTROLS

Taiwan’s central bank raised interest rates in June for the
first time since the crisis, and is expected to hike them 12.5
to 25 basis points each quarter through to end-2011
[ID:nSGE65N0D0]. However, some analysts say a severe enough
slowdown in the U.S. economy could pause those hikes for a
quarter or two.

The hikes signal that Taiwan authorities believe the $414
billion export-reliant island economy is gathering steam
despite sluggish CPI [ID:nTOE63602D] and stubborn unemployment
that remains at an unusually high 5.17 percent [ID:nTPV001880].
Forecast-beating GDP growth [ID:nTOE67F07A] gave support to
this view.

The central bank also remains wary of “hot money” inflows
that have buoyed Asian asset prices. Some of this money has
already departed: Foreign funds sold a net $4 billion of Taiwan
stocks (.TWII: ) in May and another net $1.25 billion in August
due to risk aversion driven first by the euro zone debt crisis
and later fears of a double-dip recession in the United States.

The interventionist central bank moves almost daily to stop
speculation in the island’s currency market, dealers in Taipei
believe. Earlier this year it warned local and foreign banks to
follow regulations when trading foreign exchange forward
contracts, another move to discourage hot money
[ID:nTOE60L08O].

But economists say the undervalued Taiwan dollar stands to
catch up with other Asian currencies on any gains in the
Chinese yuan (CNY=CFXS: ), especially following Beijing’s
flexible yuan policy announced in June.

The Taiwan dollar is an ideal proxy for the nonconvertible
Chinese unit due to the island’s fast-growing trade ties with
China, and the central bank is expected to allow some currency
appreciation as a result of China’s policy shift.

What to watch:

— Economists expect the central bank to raise rates again
at a quarterly policy meeting in September by 12.5 to 25 basis
points, and make a similar move in December. [ID:nTOE65O026]

— Capital controls could be tightened further if hot money
resurfaces as an issue. This would push down the Taiwan dollar.
However, analysts do not expect the kind of rigid capital
controls that would cause major outflows. [ID:nHKG263506]

— The central bank’s response to any appreciation of the
Taiwan dollar due to a firmer yuan.

* CHINA-TAIWAN RELATIONS

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, despite
noise from the opposition, and is expected to take full effect
on Jan. 1, setting the stage for talks with China on the next
round of tariff cuts.

The deal also positions Taipei to sign free trade deals
with its other major world 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.

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 2010 is a local election year with the winning
party having a strong shot at the 2012 presidential race.

In local elections last December, seen as a test of Ma’s
policy of engagement with Beijing, his government lost some
ground to the anti-China opposition that Beijing hopes to keep
out of power.

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 Nov. 27 local elections covering about 60
percent of the electorate and Taiwan’s major cities. If the
ruling party wins big, it signals 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.

— China’s blessing for free-trade agreements between
Taiwan and other governments, including the world’s biggest
economies, would advance Taiwan’s long-term competitiveness
strategy and signal improvement in Beijing’s ties with Taipei.

* GOVERNMENT EFFECTIVENESS

Ma has a strong mandate to govern, as the KMT controls
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. Cabinet flaps that saw one minister quit and
another offer his resignation have raised further questions
about ruling party leadership ability [ID:nTOE62B01S], although
the president has avoided major flaps over the past four
months.

The high degree of polarisation between the two major
parties, the China-friendly Nationalists (KMT) and the
anti-China opposition Democratic Progressive Party (DPP), can
undermine policy continuity and increase uncertainty.

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 happened, the risk of policy
deadlock and frostier ties with China would be a drag on
markets.

* ECONOMIC REFORM

Taiwan puts limits on 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 Andrew Marshall)

FACTBOX-Key political risks to watch in Taiwan