US embassy cable - 05TAIPEI2675

UNCLAS SECTION 01 OF 03 TAIPEI 002675 
 
SIPDIS 
 
SENSITIVE 
 
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:  RMB Appreciation No Help for Taiwan 
 
Summary 
------- 
 
1. (U) Because of Taiwan's massive investment in the PRC, 
the two economies cooperate more than compete in world 
export markets.  Thus export orders to Taiwan firms will not 
benefit from a revaluation of the Renminbi (RMB).  Although 
a revaluation could affect some investment decisions by 
Taiwan firms, high levels of Taiwan investment in the PRC 
are likely to continue.  On balance, a revaluation of the 
RMB would not benefit Taiwan's exports to the PRC because 
most of them are inputs used to assemble consumer goods that 
are re-exported from the PRC.  Overall the effect for Taiwan 
will probably be negligible.  End summary. 
 
Collaborators Not Competitors 
----------------------------- 
 
2. (U) While many of the world's exporting economies stand 
to benefit from the anticipated revaluation of the PRC's 
Renminbi (RMB), which would make China's exports more 
expensive, Taiwan's situation is different from most. 
Taiwan and China are not competitors in international 
markets so much as collaborators.  The cross-Strait economic 
dynamic is mainly one of cooperation with China serving as 
the factory for Taiwan's exporters.  The predominant pattern 
is for Taiwan firms to move labor-intensive manufacturing 
processes to the Mainland, while maintaining technology and 
capital-intensive production of inputs in Taiwan.  Taiwan- 
owned factories in the Mainland fill export orders received 
by headquarters in Taiwan using Taiwan-made components.  In 
2004, more than 70 percent of information technology 
products produced by Taiwan firms were manufactured in the 
PRC. 
 
3. (U) Appreciation of the RMB would generally increase 
prices for exports of Taiwan firms.  Even though many 
production inputs come from Taiwan and would become cheaper 
with the RMB appreciation, exports manufactured by Taiwan 
firms in China would still be more expensive because the RMB 
appreciation would increase the cost of locally sourced 
inputs, especially the labor component.  As a result, export 
orders for Taiwan firms manufacturing their goods in the 
Mainland could fall.  However, some observers point out that 
although Taiwan firms with operations in the Mainland will 
face higher production costs, they will also see the value 
of their Mainland investments rise.  Most estimates put 
total Taiwan investment in the Mainland at USD 100 billion 
or more. 
 
Marginal Change in Investment Strategies 
---------------------------------------- 
 
4. (U) Because appreciation of the RMB will increase 
production costs in the Mainland and make it more expensive 
to invest there, some Taiwan firms may change their 
investment patterns.  In the short run, some Taiwan 
manufacturers may shift some production from China back to 
Taiwan or to other locations.  Some firms may reconsider or 
postpone relocation of production lines to China if 
production costs rise to levels comparable to costs in 
Taiwan.  They may also choose to relocate to places other 
than China.  However, many analysts expect any such reaction 
to be temporary with cost-cutting measures quickly restoring 
the full advantage of production in the Mainland. 
 
5. (SBU) In the long run, RMB appreciation may not have much 
impact on Taiwan investment at all if past experience is an 
indicator.  As Morgan Stanley (Taiwan) President Ho Chi-wen 
pointed out, the RMB gained 20% against the NTD from 1997 to 
2002, but its appreciation never dampened the relocation of 
Taiwan's production lines to China.  Taiwan approved USD 3.9 
billion in PRC investment in 2002, more than double the USD 
1.61 billion approved in 1997.  Approved Taiwan investment 
in China continued to rise to USD 4.6 billion in 2003 and 
US$6.9 billion in 2004. 
 
Trade Balance - Trends Continue 
------------------------------- 
 
6. (U) The RMB appreciation will make imports cheaper in 
China and, therefore, could benefit foreign suppliers. 
However, Taiwan's exports to China are rarely consumer goods 
for local markets.  Some estimates indicate that over 85 
percent of Taiwan's exports to China are production inputs 
that are re-exported after further processing.  The RMB 
appreciation will make the final products more expensive and 
could thus slow the pace or reduce Taiwan exports of inputs 
to the PRC. 
 
7. (U) Theoretically, the RMB appreciation will make Taiwan 
imports from China more expensive and slow down the flow of 
imports from China.  However, products from China could 
remain far cheaper than their Taiwan-made counterparts.  It 
is likely that imports from China will continue increasing. 
The RMB appreciation of 20% against the NTD from 1997 to 
2002 did not lead to any reduction in Taiwan's imports from 
China.  Market liberalization required by Taiwan's and 
China's WTO accession prompted a sharp increase in Taiwan's 
imports.  Taiwan imported USD 7.95 billion from the PRC in 
2002, nearly double the USD 3.9 billion worth of PRC imports 
in 1997. 
 
More Hot Money? 
--------------- 
 
8. (SBU) Investor expectations that the RMB will revalue 
have already produced a large inflow of speculative capital 
(hot money) to China from all over the world.  That flow 
will increase substantially if the PRC adopts gradual upward 
adjustment of the currency value.  Such speculative money 
has begun to spill over to Taiwan with the expectation that 
currencies in the region will follow the RMB.  For Taiwan, 
AIT/T contacts report an increase in advance payment for 
exports and a delay in payment for imports.  Some additional 
hot money has flowed into Taiwan in the form of portfolio 
investment.  However, the flows into Taiwan have not been 
enough to increase the money supply to a degree that would 
increase inflationary pressure.  The capital inflow could 
well reverse once the RMB stabilizes after revaluation takes 
place. 
 
Comment - Negligible Impact for Taiwan Economy 
--------------------------------------------- - 
 
9. (SBU) The net effect of an RMB appreciation for the 
Taiwan economy is likely to be negligible.  A revaluation of 
the RMB would increase the price of PRC-produced goods. 
The dominant link between the two economies is Taiwan firms 
manufacturing products in the Mainland.  Thus, increased 
production costs for the PRC would inevitably mean increased 
costs for Taiwan manufacturers.  However, most analysts 
expect a fairly modest revaluation of the RMB, something on 
the order of ten percent.  Financial markets have already 
adjusted prices with the expectation of this modest 
revaluation, as have Taiwan firms.  Should the RMB revalue 
substantially more than what the market anticipates, then 
the impact on Taiwan will be greater and could dampen 
economic growth. 
 
PAAL