US embassy cable - 04TAIPEI3738

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 003738 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OMA 
USTR FOR SCOTT KI 
USDOC FOR 4420/USFCS/OEEA/EAP/LDROKER 
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT 
TREASURY FOR OASIA/ZELIKOW AND WISNER 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF GOVERNORS, 
AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: DECL: 11/11/2024 
TAGS: EFIN, EINV, ECON, TW 
SUBJECT: TAIWAN CURRENCY APPRECIATION 
 
Classified By: AIT Director Douglas Paal, Reason 1.4 (B/D) 
 
1. (C) Summary:  On November 22, Taiwan's Central Bank of 
China (CBC) intervened in foreign exchange markets to slow 
the ongoing appreciation of the New Taiwan Dollar (NTD) after 
the currency reached its highest levels in almost four years. 
  Speculators are moving additional foreign capital to Taiwan 
in anticipation of further declines in the USD.  A CBC 
official told AIT that despite the weak USD, Taiwan would 
continue to keep most of its foreign exchange reserves in USD 
denominated assets, placing safety and liquidity ahead of 
profit.  End summary. 
 
Cause and Effect of the Rising NTD 
------------------------------------------- 
 
2.  (C)  Taiwan CBC officials have confirmed to AIT that they 
intervened in currency markets on November 22 to slow the 
rise of the NTD.  They claim the intervention was slight, 
less than one percent of market volume.  The NTD opened on 
November 23 at NTD 32.495 per USD after CBC intervention, 
slightly down from its 44-month high close of NTD 32.420 per 
USD on November 18.  The value of the New Taiwan Dollar (NTD) 
in USD terms has risen sharply in recent weeks, gaining more 
than 4 percent on the USD since late September.   However, 
the Korean Won has gained more against the USD in recent 
weeks than has the NTD, and the Japanese Yen has also gained 
about four percent. 
 
3.  (C) The ongoing appreciation of Asian currencies and an 
announcement by Morgan Stanley that it will increase the 
weighting of Taiwan share prices in its international capital 
index have attracted foreign capital to Taiwan.  Foreign net 
purchases of Taiwan's traded stocks have already reached NTD 
200 billion this year.  The widening U.S. trade and Federal 
fiscal deficits, and widespread anticipation of a loosened 
trading band for China's Renminbi has fueled speculation of 
continued declines in the value of the USD.  The impact on 
the competitiveness of Taiwan companies will be closely 
linked to exchange rates in Japan and South Korea, where 
Taiwan's main commercial rivals are located. 
 
4.  (C) Until November 22, CBC claimed it had made no 
significant effort to check the NTD appreciation.  However, 
CBC officials admitted to AIT that they routinely "manage" 
foreign exchange reserves to avoid losses.   In an indication 
of some tolerance for NTD appreciation, CBC officials noted 
to AIT that currency appreciation is an effective way to 
fight import-led inflation and Taiwan was among the first 
Asian economies to follow the U.S. Federal Reserve in raising 
interest rates (CBC raised Taiwan's discount rate by 0.25 
percent on September 30). 
 
The Middle Way 
-------------------- 
 
5.  (C) The criteria used by CBC to manage the NTD exchange 
rates are closely guarded.  However, some AIT financial 
sector contacts believe that changes in the value of the NTD 
closely follow fluctuations in the USD-Yen exchange rate, and 
that the NTD keeps to an average value between the two 
currencies; i.e., the NTD usually gains or loses value in 
concert with the Yen's gains or losses against the USD.  In 
addition, many Taiwan companies involved in international 
trade have reportedly already taken action to hedge against 
this risk, as they have been urged to do by Taiwan's Minister 
of Economics.  On November 8, when the NTD reached a six 
month high of 32.89 per USD, Minister Ho tried to reassure 
the business community by saying the NTD appreciation thus 
far would not have a significant negative impact on Taiwan's 
external trade.  The relative stability of the NTD exchange 
rate against the USD is viewed as a positive factor by the 
business community. 
 
6.  (C) While local economists predict some impact on 
Taiwan's exports to the United States, appreciation in the 
current 4 percent range is seen as tolerable.  However, 
several Taiwan industry associations have openly called for 
CBC to intervene to slow the NTD's "too rapid" rise, and with 
legislative elections scheduled for December 11, the NTD 
appreciation is a sensitive political issue.  On November 20, 
the Vice Minister of Economic Affairs urged Taiwan 
manufacturers to speed up the globalization of their business 
operations to reduce the impact of currency fluctuations. 
There will be additional upward pressure on the NTD at the 
end of the month, when exporters often sell off their USD 
receipts. 
 
U.S. Election Profitable for Central Bank 
--------------------------------------------- ---- 
 
7.  (C) CBC Foreign Exchange Department Director General 
George Chou told AIT that CBC's Foreign Exchange Trading team 
monitors global foreign exchange markets well beyond regular 
office hours.  In spite of the 13-hour time difference some 
team members are assigned to monitor trading activity in New 
York.  Chou receives updates on U.S. market trends, farm 
reports, payroll figures, and other financial reports well 
into the night.  Chou mentioned that on the night of the U.S. 
presidential election, his foreign exchange trading team 
earned USD 300,000 from management of CBC's assets in foreign 
markets and capitalizing on USD fluctuations during the 
ballot counting. 
 
CBC Will Continue to Hold USG Bonds 
--------------------------------------------- ---- 
 
8.  (C) In general, Chou said, Taiwan's CBC follows three 
principles in managing its foreign exchange reserves: safety, 
liquidity, and profitability, with safety and liquidity the 
priorities.   When international situations pose a threat to 
the safety of Taiwan's foreign exchange reserves, CBC will 
take defensive action, including moving assets out of a 
region.  To illustrate this point, Chou mentioned that CBC 
stopped including Hong Kong dollars in its foreign exchange 
portfolio after Hong Kong's retrocession to China, since this 
made Hong Kong less secure, from Taiwan's point of view.  It 
is with safety foremost in mind that CBC will continue to 
hold a large percentage of its assets in U.S. Government 
bonds, and to keep large bank deposits in the United States. 
While the exact ratios of foreign currencies in Taiwan's 
portfolio of USD 235 billion (as of September 2004) in 
foreign exchange reserves is considered confidential 
information, local economists believe it is roughly USD 65%, 
Euro 20%, and Japanese Yen 15%. 
 
Other Factors Influencing the NTD 
-------------------------------------------- 
 
9.  (C) Chou mentioned that another factor affecting the 
composition of CBC's foreign exchange reserves is interest 
rates.  The U.S. Fed's raising interest rates reinforces 
CBC's intent to keep its deposits in U.S. banking 
institutions.  However, it is also widely believed that over 
the past two years CBC has increased its holdings of Euros to 
take advantage of their appreciation trend.   The PRC's 
recent raising of interest rates for the first time in nine 
years and new lending restrictions designed to cool economic 
growth are expected to result in an increased outflow of 
capital from Taiwan to China Mainland as PRC-based Taiwan 
companies turn to Taiwan financial institutions for cheaper 
working capital.  The capital inflow into Taiwan precipitated 
by the Morgan Stanley weighting increase is seen as short 
term.  As the net inflow of capital lessens in coming months, 
this source of pressure on the NTD to appreciate will also 
lessen.  However, Taiwan's relatively high growth rates 
compared with other Asian economies, and close economic 
relations with China still make the NTD an attractive target 
for speculators. 
 
Contradictory Goals 
----------------------- 
 
10.  (C) Comment: There will always be tradeoffs among CBC 
goals of safety, liquidity, and profitability for Taiwan's 
foreign exchange reserves.  Even a small percentage decline 
in the value of Taiwan's USD 235 billion foreign exchange 
reserve translates into an enormous loss.  In spite of Chou's 
assurances that Taiwan will keep the bulk of its foreign 
exchange reserves in USD denominated assets, as a banker 
conditioned to minimize risk and maximize profit, he will 
surely face strong pressure to protect against the loss of 
value that would result from further declines in the USD. 
From a purely economic point of view the NTD appreciation 
thus far will have only a minor impact on Taiwan's external 
trade, especially given the even greater appreciation in the 
currencies of other economies.  Under the additional pressure 
of loud opposition from local businesses to the rapid NTD 
appreciation, CBC has opted to slow the NTD's rise prior to 
the December 11 elections.   There is likely to be continued 
upward pressure on the NTD in coming weeks.  End comment. 
PAAL