Taiwan: Has Market Reform Run Aground Again?

Taiwan's financial markets have had some nasty shocks in the past two weeks. First, the Finance Ministry discovered that Changhua City Fourth Credit Cooperative Bank's general manager had embezzled more than $100 million, nearly three times the bank's assets. On Aug. 2, the ministry shut down the bank temporarily, but not before depositors had withdrawn hundreds of millions of dollars from it and other credit unions. A few days later, a 29-year-old clerk at International Bills Finance Corp. confessed to defrauding IBFC of $400 million in promissory notes and using the proceeds in a scheme to manipulate stock prices. The news sent the Taiwan Stock Exchange plummeting nearly 5% in a single day, to a new 19-month low (chart).

The scandals throw a monkey wrench into plans by Taiwan's monetary authorities to lure more foreign investors. Just when the government seemed to be getting serious about opening its markets, officials must concentrate on wiping out unsavory local practices. In addition, plunging real estate prices and piles of bad loans are putting pressure on the entire banking system. "The [Taiwanese] need to fix their own house at the same time that they are liberalizing the market," says Nate Emerson, head broker for HG Asia Securities Taiwan Ltd.

The spate of bad news could give the government an excuse for slowing down reform. Many banks are paying the price for years of reckless lending to construction companies. Building oversupply caused a real estate crash, and banks are stuck with nonperforming loans. Meanwhile, the Taiwan stock index lost nearly 30% through mid-July, thanks to tensions with mainland China over Taiwanese President Lee Teng-hui's visit to the U.S., depressed prices for chemicals, and the Barings scandal.

Oddly, foreign investors have remained sanguine. Foreign institutions jumped into the Taiwan market this summer, taking advantage of low share prices of the country's fast-growing blue chips. Some $565 million in foreign capital poured into the Taiwan bourse in July alone. And non-Taiwanese banks and insurers are applauding relaxed restrictions on opening representative offices and branches on the island.

But inviting more foreign capital and service providers may not do much to cure the financial system's woes. Although Taiwan's economy is still growing at 6%, further declines in property prices could put a fatal squeeze on many local companies and banks. "Liberalization will be part of the solution," says one analyst at a foreign-securities firm, "but the question is how much brute pain will have to go along with it."

INTERNAL RIVALRY. Also complicating matters is the public feud between the Central Bank of China (CBC) and the Council for Economic Planning & Development (CEPD) over the pace of opening Taiwan's financial markets. CBC gfficials believe that floods of foreign money cause inflation and currency fluctuations, so they advocate a go-slow approach. The CEPD argues that Taiwan needs a financial system that can keep up with its globalizing economy. The rivalry came to a head in mid-July, when the government replaced an old-line central-bank deputy governor with a vice-chairman from the CEPD.

Fear of losing clout, plus the appointment of two liberal governors over the past year, have lit a fire under the CBC, though it's still less aggressive than the CEPD. In July, the bank took a step toward internationalizing the New Taiwan dollar, allowing banks to offer forward contracts in the currency as a hedge against forex trading risks. Then the legislature abolished a 5% gross-business-receipts tax on bond transactions and interbank borrowing that had discouraged market activity.

On July 5, the government also raised the percentage of aggregate shares that qualified foreign institutional investors (QFIIs) can hold on the Taiwan Stock Exchange from 10% to 12% of total market capitalization. In addition, a single QFII may now own up to 6% of a listed company's stock, up from 5%. These are small increases, but they do offer opportunities to gobble up shares in some of Taiwan's big winners this year, such as Taiwan Semiconductor Manufacturing Corp. and PC maker Acer Inc., that have profited from the global technology boom.

More reforms are planned for the second half of '95, with President Lee backing a plan to turn Taiwan into a regional financial center. And Vice-Premier and CEPD Chairman Hsu Li-teh has said that recent scandals should speed changes in Taiwan's financial system. But unless the government takes serious measures to curb abuses, its vision of global financial prominence may be a pipe dream.

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