Taiwan's turn to head into the unknown

IFR Asia 927 - January 23, 2016
6 min read

Allow me to insulate this column from the ongoing global market deluge. There are enough pundits providing helpful commentary about the next Global Financial Crisis.

I find Taiwan a rather more interesting topic than the speculation as to whether Janet Yellen has become the new Hank Paulson, whether China is going supine, implants included, or if the infamous January effect of how the US stock market year ends based on the first month means we will all be bust come December.

Back to the topic: for me Taiwan has always fascinated and now even more, so given that it has just elected the first female head of government from Asia who didn’t rely on her forebears to propel her into the top spot. The country is one of Asia’s best kept secrets (and no I am not employed by the Taiwan tourist board to say this) and filled with wonderful scenery, food and charming people.

Tsai Ing-wen and her Democratic Progressive Party won a landslide victory in last Saturday’s presidential and parliamentary elections in what has been channelled in the local and international media as an effective referendum on Taiwan’s relationship with mainland China.

You will recall that China regards Taiwan as a renegade province ripe for repatriation – the Republic of China, as Taiwan calls itself, must become one with the People’s Republic of China in the latter’s opinion. It seems that Ms Tsai is not about to cosy up to that idea, unlike her predecessor Ma Ying-jeou, who spent most of his near eight years in office cosying up to the the big power on the other side of the Taiwan strait.

She has not stated that she wishes to declare the formal independence of Taiwan from China and instead, in the aftermath of the election victory, stated that she wants peaceful relations with the mainland.

Nevertheless despite these cordial overtones, the newly elected president soon found her Facebook account deluged with messages running into the tens of thousands calling for Taiwan’s repatriation with China and power handed to Beijing.

The bulk of these were thought to have been posted from the mainland, somewhat ironically given the fact that access to Facebook in China has for years been closed off by the Chinese authorities. Such clever hacking would have made Julian Assange proud.

From an investment point of view there may be cause for concern if tensions between China and Taiwan do rise, despite the fact that Taiwan has a recent history of shrugging off financial inputs that might have seemed profoundly troubling.

One reason to be cheerful, however, is that, despite the fact that Taiwan’s economy is on the verge of technical recession, the newly elected DPP is expected to work on reducing Taiwan’s budget deficit, making the country less vulnerable to capital flight than many of its regional peers. The call would therefore be for Taiwan to be relatively well insulated from the regional market meltdown. Let’s see.

Another element of my fascination with the Taiwanese capital markets, apart from their recent history of embracing structured products more whole-heartedly than any other region in Asia (I remember the somewhat bizarre structured notes from a decade ago that would pay out on the basis of force majeur which seemed to consist primarily of someone possibly getting struck by lightning) is their seeming isolation from the global fray.

Would I prefer to own Taiwan dollars over Singapore dollars, Thai baht, Indonesian rupiah, Malaysian ringgit or Philippine pesos? I think I would. Part of the reason lies in Taiwan’s success in connecting its vast onshore pool of liquidity with offshore currencies.

The Formosa bond market, which involves non-Taiwanese entities raising capital onshore in foreign currency debt primarily denominated in US dollars and Chinese renminbi, has been a rather hot arena since the Taiwanese authorities allowed the yield-starved local pension funds and insurance companies to buy these products in the onshore debt markets a couple of years ago.

International issuers flocked to Taiwan to tap this fresh source of capital and lock in the arbitrage savings offered by selling to a limited group of onshore investors. Renminbi was the favourite, closely followed by US dollars.

I have long had problems with the concept of local capital markets raising their skirts to offshore issuers in an alien currency. To me it’s like a fantasy island involving concentration risk at the local level of the capital pool.

And indeed the fantasy nature of the Formosa bond market has been realised. Issuance has dried up.

That onshore liquidity pool, the result of a regulatory twist more than fundamentals, has shrivelled. This is thanks to its full investment in Formosa bonds by Taiwanese pension funds and insurance companies. There’s nothing left to spend.

Meanwhile the apparent arbitrage opportunity which underpinned the appeal of issuing Formosa bonds has also gone. Onshore Taiwanese institutional investors don’t want to own renminbi because the currency is more than likely to collapse. And onshore issuers don’t want to borrow in US dollars because the greenback is likely to appreciate in the medium to long term against their home currency.

The fantasy island which once was a favoured destination for offshore issuers may effectively close its doors. Political reasons may also add to the pressure if Beijing seeks to test the new leadership. Ensuing capital controls based on this would push Taiwan back decades, neither to fantasy island nor banana republic but to the pure unknown.

Jonathan Rogers_ifraweb