Winds of change

July 10 2007

Things in Taiwan are looking up. From having been the second worst performer among Asian stock markets for the past two years, in the past two months the Taiex has outperformed every market except South Korea.

The gain has been steady rather than explosive and, given the mostly bullish conditions everywhere in recent times, they have gone largely un-remarked. But they reflect a change in domestic sentiment which in turn reflects a growing belief that next year will be a constructive one in cross-strait relations.

There has long been a fear that the coincidence of presidential elections in Taiwan in early 2008 with the build-up towards the Beijing Olympics could create conditions for rash measures by Taipei, such as a new constitution emphasising its separate status, to which Beijing would be likely to respond harshly.

But the opposite seems likely to be the case. President Hu Jintao continues to signal that he wants to entice the Taiwanese with kind words and business opportunities, rather than strengthen their resolve with threats. Beijing has also been relatively mild in response to president Chen Shui-bian's efforts to play up Taiwan identity, confident perhaps that Mr Chen's standing with the public is now very low on account not of his cross-strait stance, but allegations of corruption which in practice have much reduced his executive authority.

The Democratic Progressive Party candidate for president, Frank Hsieh Chang-ting, a former mayor of Kaohsiung, is seen as more pragmatic and has stated that he is in favour of allowing mainland tourism and reducing restrictions on cross-strait investment flows, which would more likely bring money into Taiwan than encourage more outflow.

Indeed, direct links could bring Taiwan people, as well as money, back from the mainland so that they could enjoy Taiwan's order and clean air, while profiting from mainland labour and markets.

Beijing would obviously prefer a Kuomintang victory, but in practice a Ma Ying-jeou government might be no more easy to deal with than a DPP one headed by Mr Hsieh. Mr Ma, who has a reputation for being indecisive, would have to move cautiously to avoid the impression that, as one of mainland origin who in his heart of hearts yearns for reunification, would sell out Taiwan.

Mr Hsieh, on the other hand, may take the view that the strengthening of the economy which would come from cross-strait links would be popular and might not, as feared by many DPP supporters, erode the island's separate status and identity.

The KMT and its pan-blue allies still look likely to win both the legislative elections later this year and the presidential one. But Mr Hsieh seems to have escaped being tarnished by Mr Chen's legacy and has a reasonable chance of winning - better probably than the DPP has of upsetting the pan-blue legislative majority.

For the time being, cross-strait issues such as tourism are likely to be on hold as Beijing has no desire to offer any benefits to the DPP in advance of the elections. But the charm offensive is likely to turn to practical matters after the elections and as the Olympics approach.

The prospect should continue to bring Taiwan money parked offshore or generated on the mainland back into the local stock market.

The government is showing more confidence. The central bank has begun to reverse its ultra-low interest rate policy, which was supposed to spur the economy, but actually encouraged capital outflow. Higher interest rates have seen a strengthening of the Taiwan dollar and played a role in stimulating stocks.

The currency could yet rise a lot further, given how far it has fallen behind the yuan and the South Korean won. Next to the Japanese yen its low value is out of line with buoyant exports and a massive current account surplus.

Corporate profits have also been very buoyant and dividend yields on major stocks are higher on average than yields on government bonds.

Until recently, local liquidity had been flowing out of Taiwan into other markets. To a small extent it has been a source of carry-trade funding, though only on a small scale compared with Japan.

But political, valuation, earnings and interest rate conditions are now probably moving in its favour. And although some investors are still nervous about the election campaigns and their result, it now has great defensive potential compared with most other regional markets, and potential to boom if mainland money gets a chance to combine with local punters and offshore Taiwan money.

Government funds are also likely to be buyers before the election. The Taiex is still 3,500 points shy of its all time high of 12,682 back in 1990, but if politics and world markets remain benign, that could be within reach by the time of the Beijing Olympics.

That is not to argue the deep ideological rifts will be healed or that direct links will happen quickly and smoothly. But the political cycles are in favour on both sides of the strait, and Taiwan has yet to feel the tide of global liquidity which has already lifted less seaworthy boats.

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