US embassy cable - 05TAIPEI3118

UNCLAS SECTION 01 OF 02 TAIPEI 003118 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR AUDREY WINTER AND TIM WINELAND 
 
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, Finance 
SUBJECT:  Effects of RMB Appreciation on Taiwan 
 
1.  SUMMARY.  The renminbi's (RMB) appreciation of 2% 
against the US dollar (USD) on July 21 has caused the NTD 
and other Asian currencies to strengthen against the US 
dollar.  However, market intervention by Taiwan's Central 
Bank of China (CBC) has reduced the NTD appreciation to less 
than other regional currencies.  Small daily fluctuation 
limits set by the PRC will lead to predictability of the 
RMB's gradual appreciation, which in turn will attract 
speculative money to flow into this region, including 
Taiwan, over the next five to six months.  END SUMMARY. 
 
RMB Appreciation 
---------------- 
 
2.  On the night of July 21, 2005, the PRC revalued the RMB 
by two percent from 8.3 RMB per USD to 8.1 RMB per USD.  At 
the same time, the PRC adopted a controlled, flexible 
exchange rate system.  It will allow the RMB exchange rate 
to fluctuate, but the daily fluctuation will be subject to 
limits of 0.3% above and below the closing rate of the 
previous day. 
 
Reaction of Taiwan's Foreign Exchange Market 
-------------------------------------------- 
 
3.  In response to the RMB's 2% appreciation on July 21, 
Taiwan's foreign exchange (FX) market opened July 22 at 
NT$31.55 per USD, 1.26% stronger than the closing rate of 
July 21.  The NTD exchange rate did not continue to gain 
strength, and its appreciation against the USD did not reach 
a magnitude of 2%, as the Japanese yen and Korean won did. 
The volume in the first two hours of the trading session on 
July 22 expanded to US$746 million from normal levels below 
US$500 million. 
 
4.  Local FX observers believe that Taiwan's Central Bank of 
China (CBC) started its intervention right after the FX 
market opened on the morning of July 22.  Consequently, the 
NTD exchange rate declined slightly to NT$31.651 per USD in 
the final hour before the market closed.  Meanwhile, the CBC 
issued a press release to stress that Taiwan's trade surplus 
in the first half of this year dropped 90% from the same 
period in 2004.  The CBC attempted to use the 90% drop in 
trade surplus to justify the NTD's smaller appreciation 
against the USD compared with other currencies in the 
region. 
 
Stock Market 
------------ 
 
5.  Market observers expect the RMB appreciation to drive up 
Taiwan's stock prices.  However, on July 22, Taiwan's stock 
price index did not rise; instead, the index declined 13.3 
points to close at 6,380.73 points.  Observers believe that 
the 13.3-point decline mainly resulted from profit-taking 
after a 10-percent increase over the past five trading days. 
The longer-term trend will override this kind of market 
correction. 
 
COMMENT 
------- 
 
6.  The RMB's 2% appreciation was far less than rise of more 
than 10% expected by the Taiwan public.  Local observers 
believe that the RMB will continue to gain strength over the 
next five to six months.  With the daily fluctuation limits 
of 0.3% above and below the closing rate of the previous 
day, the RMB will follow a predictable trend of gradual 
appreciation over five to six months.  The predictability of 
RMB appreciation is likely to continue to attract 
speculative capital to China and neighboring economies, 
including Taiwan.  The speculative capital will not only 
firm up the NTD, but also drive up Taiwan's stock prices. 
 
7.  The RMB appreciation will blunt the competitive edge of 
China-based production lines.  However, in the short run, 
the RMB appreciation will drive up the value of China-based 
assets (in terms of NTD).  Therefore, the share prices of 
Taiwan companies operating China-based production lines may 
increase over the near term. 
PAAL