US embassy cable - 05TAIPEI519

UNCLAS SECTION 01 OF 04 TAIPEI 000519 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR SCOTT KI 
 
USDOC FOR 4420/USFCS/OCEA/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: N/A 
TAGS: EINV, EFIN, ECON, PINR, TW, Cross Strait Economics 
SUBJECT: Taiwan Economic Briefing for January 2005 
 
1.  This cable summarizes selected recent economic events in 
Taiwan in January 2005: 
 
- Taiwan-China cross-Strait charter flights 
 
- Taiwan's banking sector performance 
 
- Taiwan's 2005 central budget 
 
- New Free Trade Zones 
 
- Domestic investment slows 
 
- TSMC Chairman on Taiwan's economic performance 
 
- Taiwan's TSMC settles its IPR case with China's SMIC 
 
Wheels-Up for Cross-Strait Charter Flights 
------------------------------------------ 
 
2.  To much fanfare, the first Chinese planes to arrive in 
Taiwan in 56 years touched down at Taipei's Chiang-Kai Shek 
International Airport on January 29.  A total of nine 
flights crossed the Taiwan Strait on the first day of the 
much-anticipated Lunar New Year charter flights for Taiwan 
businessmen in the Mainland.  Seven flights from China to 
Taiwan carried 1,366 passengers.  Two flights brought 239 
passengers to the PRC.  Air carriers report that tickets are 
selling well, particularly on the routes from Shanghai to 
Taiwan, some of which are fully booked with a waiting list. 
The Guangzhou routes are less popular.  For its first 
Guangzhou to Taipei flight, TransAsia reports that 80% of 
seats have been booked.  Because the flights are exclusively 
for Taiwan businessmen and their families, and New Year's is 
the traditional time to return home, traffic headed to the 
PRC before the holiday is naturally much lighter. 
TransAsia's Taipei to Guangzhou flight is only 20% booked. 
The first day of flights was marked with ceremonies and 
fanfare at the airports.  However, high-level Taiwan 
government officials did not attend.  Observers from across 
the political spectrum have hailed the charter flights as an 
important step in cross-Strait relations, but some Taiwan 
government officials have cautioned that more negotiation is 
needed before the charter flights can be expanded to more 
regular air service.  The flights will continue through 
February 20. 
 
Improved Banking Performance 
---------------------------- 
 
3.  Bureau of Monetary Affairs statistics for 2004 released 
in January show that Taiwan has reduced the financial 
sector's non-performing loans (NPL - principal or interest 
three months or more overdue) by a third to NT$590.7 billion 
(US$18.4 billion).  The average NPL ratio dropped from 6.06% 
to 3.8% and bad debt reserves increased from 34.7% of NPLs 
to 41.4%. 
 
4.  Over recent years, NPL reduction efforts such as writing 
off bad debt and selling problem assets have been a major 
factor in the financial sector's low combined pre-tax 
profits.  Taiwan banks posted a combined pre-tax loss of 
NT$104.6 billion in 2002, and a small profit of NT$57.6 
billion in 2003.  Pre-tax profits nearly tripled in 2004 to 
NT$159 billion.  Taiwan banks combined rate of return 
against assets (ROA) rose from minus 0.34% in 2002 to 
positive 0.15% in 2003 and positive 0.63% in 2004.  The rate 
of return against net worth (ROE) also increased from minus 
6.0% in 2002 to positive 2.8% in 2003 and 10.3% in 2004. 
Taiwan banks' average ROA of 0.63% and ROE of 10.3% still 
remains well below international average of one percent ROA 
and 15-20 percent ROE.  Taiwan is promoting consolidation to 
further improve profitability. 
 
Taiwan's 2005 Central Budget 
---------------------------- 
 
5.  Taiwan's Legislative Yuan (LY) passed the 2005 central 
budget just before midnight of January 20, 2005, well past 
the legal deadline of December 31 of 2004.  The approved 
budget slashed the Chen Administration 2005 funding request 
by NT$71.6 billion (US$2.2 billion) to NT$1,402.7 billion 
(US$43.8 billion) and cut expenditure by NT$27.2 billion to 
NT$1,625.6 billion (US$50.8 billion).  Under the passed 
budget Taiwan's 2005 budget deficit will increase to 
NT$277.3 billion (US$8.7 billion) which is 10.3% less than 
the deficit of NT$280.8 billion in 2004.  The 2005 fiscal 
deficit, which includes the budget deficit plus debt 
repayment, will reach NT$336.1 billion.  The deficit will be 
financed by NT$255 billion in bonds and NT$81.1 billion 
coming from past government savings.  The central 
government's outstanding debt should reach NT$3,668 billion 
or 35.7% of GNP by the end of 2005, higher than the 21% in 
South Korea but much lower than the 113.1% in Singapore or 
Japan's whopping 169%. 
 
6.  The LY-approved budget cut by 20% funding for Ministry 
of Economic Affairs (MOEA) efforts to promote private 
research and development activities.  The cut will prevent 
research and development spending from reaching the 
announced target of three percent of GDP by 2008.  Other 
cuts include total elimination of revenues from sales of 
equity shares in state-owned enterprises, removing the legal 
basis for the privatization programs being conducted by the 
MOEA and other agencies.  The LY also passed a resolution to 
block increases in national health insurance premiums 
without express consent of the LY. 
 
Free Trade Ports Struggle to Find Tenants 
----------------------------------------- 
 
7.  Taiwan's government has approved three FTZs, including 
one in Keelung which began operating in October 2004, 
another in Kaohsiung which started operating in January 
2005, and a third in Taichung scheduled to start operating 
in October 2005 (reported septel).  As of mid-January, 
officials of Kaohsiung and Keelung Harbors reported lower- 
than-expected interest in the new free trade zones. 
Kaohsiung Harbor officials report that 11 firms have signed 
letters of intent to participate in the FTZs, but media 
reports indicate that only two firms have actually submitted 
applications to operate in the zone.  Keelung, which started 
accepting applications earlier than Kaohsiung, has only 
received one such application.  Factors discouraging 
investors include a requirement that 5% of employees in the 
FTZs must be Taiwan aboriginals, and the fact that many of 
the tax benefits offered in the FTZs are similar to those 
offered in Taiwan's science parks and other special economic 
zones. 
 
8.  In addition to the above-mentioned three FTZs, another 
three are under reviewed by ministerial agencies, including 
one near CKS Airport, one to transform existing export 
processing zones into an FTZ, and one to be located at 
Taipei Harbor.  According to the Council for Economic 
Planning and Development (CEPD), some 50 business firms have 
expressed interest to move into the FTZ near CKS Airport. 
Local governments and business conglomerates have expressed 
interest in construction of five others FTZs, including one 
in Kaohsiung City, two in Tainan, one at Mailiao Industrial 
Port of Yunlin, and one at Chang Bing Industrial Park of 
Changhwa. 
 
Rate of Investment Slows Down 
----------------------------- 
 
9.  Taiwan's domestic investment, slowed from 20% growth in 
Q2 to 10% growth in Q4 of 2004.  Recent approval of NT$100 
billion for ten major public construction projects will 
contribute to a public investment increase of 3.1% in 2005. 
Projects such as the fourth nuclear power plant, Ta Tan 
natural gas power plant, and the sixth north-south power 
transmission line will cause SOEs' 2005 investment to grow 
9.4%, compared to a decline of 12% in 2004.  However, 
according to the Chunghua Institution for Economic Research 
the private sector will see a steady decline in investment 
growth in 2005, down from 10% in Q1 to seven percent in Q3. 
Factors behind the decline in private investment growth 
include higher oil prices and higher interest rates. 
 
When Morris Chang Speaks. 
--------------------------- 
 
10.  An Economic forum on Taiwan's prospects in 2005 
(conducted in Taipei on January 31 in English) featured as 
speakers Taiwan Semiconductor Manufacturing Corporation 
(TSMC) Chairman, Minister of Economic Affairs Ho Mei-yueh, 
and Financial Supervisory Commission Chairman Kong Jaw- 
sheng.  The press turned out in force for the event.  The 
government speakers lauded Taiwan's macroeconomic 
performance in 2004 and predicted solid growth in 2005. 
Minister Ho emphasized the sharp growth in private 
investment in 2004 (in spite of the quarter-to-quarter 
decline in growth rates), predicting that rapid growth would 
continue in the coming year.  Chairman Kong highlighted the 
improved financial condition of banks in 2004 and 
confidently predicted development of a regional financial 
services industry in Taiwan in the coming years.  Morris 
Chang spoke about Taiwan's competitiveness, citing Michael 
Porter's study done for the World Economic Forum that ranked 
Taiwan as the world's fourth most competitive economy. 
Chang was very complimentary about Taiwan's success in 
developing a wide variety of international leading 
industries, emphasizing that real GDP growth was good, 
noting that in terms of purchasing power parity, Taiwan's 
real growth is in the same class as OECD countries, and that 
technology leads the way for Taiwan's future growth.  The 
press waited with baited breath for Chang's presentation, 
which came last of the three.  In fact, they dogged his 
every move.  When Chang left the room briefly during Kong's 
presentation, the entire press crew (including 
photographers) caused quite a stir when they decamped to see 
what he was doing.  Chang stuck it out to the very end of 
the discussion group following the seminar presentations 
while the government representatives left immediately after 
their presentations: the press crew hanging on his every 
word, recording his every move. 
 
TSMC and SMIC Settle Lawsuit 
 
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---------------------------- 
 
11.  Taiwan Semiconductor Manufacturing Corporation (TSMC) 
announced an out-of-court settlement with the PRC's 
Semiconductor Manufacturing International Corporation (SMIC) 
of its U.S. lawsuits alleging violations of patents and 
theft of trade secrets (reported septel).  SMIC agreed to 
pay TSMC US$175 million over six years - US$30 million each 
of the first five years and US$25 million the sixth year. 
TSMC Chairman Morris Chang told media "the payment is 
 
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acceptable despite not being satisfactory."  The agreement 
also includes provisions for the two firms to license each 
other's patent portfolios through 2010.  The price of TSMC 
stock on the Taiwan Stock Exchange rose 4% the day after the 
announcement. 
 
PAAL