US embassy cable - 05TAIPEI875

C O N F I D E N T I A L SECTION 01 OF 02 TAIPEI 000875 
 
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 
TREASUREY FOR OASIA/LAILEE MOGHTADER 
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: 03/01/2025 
TAGS: EINV, EFIN, ECON, PINR, TW 
SUBJECT: RAPID TAIWAN DOLLAR APPRECIATION 
 
 
Classified By: AIT ACTING DIRECTOR DAVID KEEGAN, REASON 1.5 B/D 
 
1. (SBU) The Taiwan dollar (NTD) in heavy trading on March 2 
broke the NTD 31/USD 1 barrier for the first time since 2000, 
having appreciated by about 10 percent against the US Dollar 
(USD) since mid-2004. The NTD will face even more 
appreciation pressure as fund managers bring in capital in 
expectation of further appreciation and in response to the 
Morgan Stanley Capital International Company increase in its 
limited investability factor (LIF) index for Taiwan from 0.75 
to 1.00, scheduled for May 2005.  Taiwan's central bank 
continues to keep about three-quarters of its foreign 
exchange in USD-denominated assets, a share unchanged in the 
past year.  END SUMMARY. 
 
Drastic Appreciation 
-------------------- 
 
2.  (SBU) The NTD broke the NT$31-per-USD point to close the 
morning of March 2 at NT$30.879 per USD.  The trading volume 
was US$2,059 million, the sixth largest ever.  The NTD has 
appreciated nearly ten percent since the middle of 2004.  In 
the first two months of 2005, the NTD has gained 2.8% against 
the USD, less than Korean Won's appreciation of 3.1%. 
However, in the same two-month period, the Japanese Yen and 
the Euro have depreciated 1.63% and 2.55% against the USD, 
respectively. 
 
NTD to Continue Appreciation 
---------------------------------------- 
 
3.  (C) The NTD will continue to gain strength as foreign 
portfolio investors send capital into Taiwan in anticipation 
of further appreciation and to be ready for the upward 
adjustment of the Morgan Stanley LIF index from 0.75 to 1.00 
scheduled for May 2005.  Alex Pan, a senior foreign exchange 
trader of the Bank of America, told AIT/T that foreign 
portfolio investors usually start to send capital into a 
market two or three months prior to such an adjustment to 
take advantage of the projected increase in stock prices. 
Huang Wen-jur, a senior consultant of the SinoPac Securities 
Company (SSC), noted that the NTD appreciated from NT$34 per 
USD to NT$32.9 per USD three months before Morgan Stanley 
raised the LIF from 0.55 to 0.75 in early November 2004. 
During the three-month period, foreign portfolio investors 
sent US$7.94 billion of funds into Taiwan.  In the subsequent 
eight trading days, foreign portfolio investors posted net 
stock purchases of NT$57 billion. 
 
Central Bank Response to Hedge Funds 
--------------------------------------------- ------- 
 
4.  (C) Officials at Taiwan's central bank (CBC) suspect the 
recent rapid appreciation of the NTD and Korean won against 
the USD has been partly the result of hedge fund attempts to 
force appreciation of those currencies.  The SSC's Huang 
Wen-jur told AIT/T that large sums of capital from foreign 
mutual funds was currently "waiting on the sidelines" of 
Taiwan's stock markets.  Director General of the CBC Foreign 
Exchange Department George Chou told AIT/T that the amount of 
foreign funds brought into Taiwan for the stated purpose of 
trading in securities, but not invested, had reached as high 
as NT$260 billion.  He said these funds do not earn any 
interest rate from Taiwan's bank accounts but are likely 
earning 2-4% from their deposit in European and U.S. banks. 
Chou said he believed these funds would be pulled out of 
Taiwan without any securities trading after earning foreign 
exchange gains from the expected NTD appreciation.  Vice 
Premier Wu Rong-yi and Chia-hsin Cement President Chang 
An-ping told AIT/ADIR in a conversation on March 2 that they 
expected to see continued appreciation of the NTD within the 
next three to six months. 
 
5.  (C)  After CBC analysts became aware of the huge scale of 
these "not-invested" funds brought into Taiwan, Director 
General Chou met with local and foreign fund managers to 
request that they pull the funds out of Taiwan if the money 
was not being used to trade in securities, as stated in the 
inward remittance statements.  According to Chou, CBC 
Governor Perng Fai-nan (Peng Haui-nan) has proposed 
restricting foreign mutual funds from leaving Taiwan if such 
funds have not been used to trade in securities.  (Chou said 
this proposal was modeled on a South Korean restriction on 
foreign mutual funds.)  However, Kong Jaw-sheng, Chairman of 
the Financial Supervisory Commission (FSC), opposed the 
restriction, in part because this would cause the speculative 
funds to flow in the stock market, inflating stock prices in 
the short run, and setting the stage for price falls when the 
funds are withdrawn after the currency appreciates.  Chou 
said that in the end, the CBC and the FSC agreed to work 
together to closely monitor the movement of foreign mutual 
funds to prevent manipulation of the NTD exchange rate. 
 
Foreign Exchange Reserves 
------------------------------------ 
 
6.  (SBU)  As a result of foreign capital inflows and 
Taiwan's trade surplus, Taiwan's foreign exchange reserves in 
December 2004 increased to US$241.7 billion, up from US$206.6 
billion at the end of 2003.  Taiwan's reserves are continuing 
to build in response to the influx of foreign portfolio 
investments. 
 
7.  (C) In speaking with AIT, Director General Chou denied a 
recent local press report that the CBC had sold 
USD-denominated assets from Taiwan's foreign exchange 
reserves.  According to Chou, USD-denominated assets are 
still 74.5% of Taiwan's total foreign exchange reserves, and 
the percentage has remained unchanged over the past year.  He 
indicated however that the CBC occasionally changed the 
composition of Taiwan's foreign exchange reserves by moving 
from one USD-denominated asset to another as a part of 
"financial management."  Consequently, a foreign bank holding 
a portion of the reserves may see a decline in a certain type 
of USD-denominated assets.  According to Mr. Chou, 22% of the 
CBC's foreign exchange reserves are denominated in Euros and 
the remaining 3.5% in Japanese Yen and Pound Sterling. 
 
8.  (C) According to the Chunghua Institute for Economic 
Research the appreciation of the NTD could significantly slow 
Taiwan's real economic growth in 2005 to 2.6%, down from the 
4.6% forecast earlier as investment and production in Taiwan 
becomes more expensive relative to offshore production. 
However, an economist from another institute cynically noted 
to AIT that  most Taiwan manufacturers in a position to 
consider offshore production have already left Taiwan. 
 
9. (C) Comment: Hedge funds, "hot" money, and ordinary 
investors are looking to take advantage of the expected 
continued appreciation of the NTD.   We anticipate that 
central bank and security regulators will indeed keep a close 
watch on fund flows into Taiwan  but note the risk that the 
large volumes of capital being moved into Taiwan mayl create 
instabilities in the financial sector beyond the ability of 
the regulators to control.  End comment. 
PAAL