The Inflation Beast Is Restless

With Taiwan's economy growing like a weed, it's not surprising that inflation is now a critical concern for investors.

Real gross domestic product in the first quarter surged 7% from a year ago, the fastest pace in three years. Consumer spending grew at a 6% clip, but exports soared 23.3%. Exporters sold more to China and Hong Kong, collectively Taiwan's biggest trading partner. And thanks to the strong yen and U.S. expansion, exports rose 32% to Japan and 13.7% to the U.S.

The downside to rapid growth has been the resurgence of inflation fears. In the first quarter, consumer prices grew at a 4.2% annual rate, far above the 3.5% projected by the government in late 1994. In fact, the government has had to raise its inflation forecast for all of 1995, from 3.7% to 3.9%, and private economists think it could top 4%. In response, the stock market plunged 20% from early January until late May.

Inflation has been tamer this quarter, thanks to slowing money-supply growth, high interest rates, and a strong currency. In May, consumer prices rose just 3.3% annually, down from April's 4.3%. Investors voiced approval with an early-June rally in the stock market.

To check inflation, Taiwan's central bank, the Central Bank of China, is likely to rely on tight money growth and a rising currency. In April, the broad M2 money supply grew 11% from a year ago--hefty, but still the lowest rate in four years. Meanwhile, the Taiwanese dollar has climbed 3% against the U.S. dollar so far this year. And with its $97.9 billion in foreign reserve, Taiwan can easily guide its dollar's future direction.

A strong currency, though, may hold back exports--a huge 59% of the economy. Another risk is the slow growth in the U.S. and Japan. Together, the two nations buy 36% of Taiwan's exports, so softer-than-expected upturns in the world's two largest economies could hurt Taiwan's growth later on. Investors, however, are counting on a slowdown to ease their inflation worries.

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