US embassy cable - 05TAIPEI3574

UNCLAS SECTION 01 OF 02 TAIPEI 003574 
 
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/MOGHTADER 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF 
GOVERNORS/DAVID SNYDER, AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EINV, EFIN, ECON, PINR, TW, Finance 
SUBJECT:  Taiwan's Q2 Balance of Payments 
 
 
SUMMARY 
------- 
 
1.  Taiwan's balance of payments (BOP) in Q2 of 2005 posted 
a surplus of US$6.45 billion, pushing foreign exchange (FX) 
reserves to US$253.62 billion.  The BOP would have run a 
deficit if Taiwan's Central Bank of China (CBC) had not 
increased its short-term liabilities through repurchase 
agreements with its stock of U.S. bonds.  The island's 
current account (C/A) barely recorded a surplus in Q2 of 
2005, a five-year low.  END SUMMARY. 
 
Overall BOP Surplus 
------------------- 
 
2.  Taiwan's BOP in Q2 of 2005 posted its 15th surplus of 
the past 16 quarters.  The BOP balance in Q2 of 2005 would 
have posted a deficit of US$0.34 billion if the CBC had not 
borrowed US$6.79 billion through repurchase agreements using 
its stock of U.S. bonds.  The CBC's action reversed what 
would have been a deficit in Taiwan's financial account 
(F/A).  Market sources indicated that CBC took the action to 
increase earnings from its FX asset management. 
 
C/A Surplus Sets Five-year Low 
------------------------------ 
 
3.  Taiwan barely maintained its C/A surplus in Q2 of 2005, 
which dropped 70% from a year ago to a five-year low of 
US$1.7 billion.  Poor export performance drove the C/A 
surplus down.  Export growth in Q2 of 2005 declined to only 
6.2% from nearly 30% a year ago.  Import growth, on the 
other hand, grew 11%, mainly because of higher petroleum 
prices. 
 
Expectations for Stronger RMB Led to Capital Outflow in 
Financial Account 
--------------------------------------------- ---------- 
 
4.  Another cause for the 70% drop in C/A surplus was 
expectations for appreciation of the renminbi (RMB) against 
the US dollar (USD) prior to the RMB revaluation on July 22. 
Industry contacts told AIT/T that many Taiwan business firms 
tried to take advantage of the expected RMB appreciation and 
so kept their overseas earnings offshore.  This cut earnings 
from triangle trade (orders received in Taiwan, but produced 
in China, and shipped to third countries) in Q2 by 36.4% 
from a year ago to US$2.7 billion. 
 
5.  Expectations for RMB appreciation also led to US$5.2 
billion of capital outflow in bank loans in Q2 of 2005, a 
sharp contrast to an inflow of US$3 billion in Q2 of 2004, 
as well as an inflow of US$10 billion in Q1 of 2005.  Local 
banks increased lending and repayment to correspondent banks 
overseas as well.  In addition, some offshore customers 
withdrew their deposits from local banks.  This capital 
outflow offset 60% of foreign institutional investors' 
(FIIs) inward remittances of US$9 billion (prompted by the 
Morgan Stanley Capital International's increasing the weight 
of Taiwan stocks in its international index from 0.75 to 
1.00 in May 2005).  The remaining 40% of FIIs' inward 
remittances were totally offset by net outward direct 
investment and Taiwan institutional investors' offshore 
portfolio investment. 
 
CBC's Short-term Debt Offset Speculative Capital Outflow 
--------------------------------------------- ----------- 
 
6.  From its repurchase agreements with its stock of U.S. 
bonds in Q2 of 2005, the CBC obtained US$6.7 billion in 
short-term liabilities from foreign banking institutions. 
The CBC bought products with higher yields.  According to 
the CBC, such repurchase agreements involve little risk and 
are a common practice of central banks in East Asia. 
 
Large FX Reserves 
----------------- 
 
7.  The CBC's US$6.7 billion of short-term liability 
contributed to an increase of US$2.48 billion during Q2 of 
Taiwan's FX reserves to US$253.62 billion, an amount 
sufficient to meet import requirements for 16 months. 
 
8.  Taiwan's BOP remained basically healthy although the 
CBC's repurchase agreements contributed to an increase in 
Taiwan's external debt.  According to CBC statistics, 
Taiwan's outstanding external debt as of March 2005 rose 10% 
from a year ago to US$82.5 billion, and outstanding external 
debt as a percentage of GDP rose from 24.5% to 24.9%. 
Public external debt outstanding at the end of March 2005 
was US$2.4 billion, a sharp rise from only US$0.22 billion a 
year ago.  The public external debt included US$1.59 billion 
in CBC liability arising from its repurchase agreements with 
a stock of U.S. bonds and US$0.8 billion in government bonds 
held by foreign institutional investors. 
 
PAAL