Taiwan: Lots of Pain, Not Much Gain

Taipei is struggling to retool Asia's model economy

After a near-death business experience, Frank C. Huang is breathing easier. Over the past several months, the chairman and CEO of Taiwan's Powerchip Semiconductor Corp. has watched his company veer toward oblivion and then pull back from the brink. Demand for Powerchip's DRAMs sank, then recovered; the company's stock price plunged, only to rebound; and heavy losses turned into forecasts of a first-quarter turnaround.

The past year has been a roller-coaster ride for many Taiwan tech companies--from chip giant Taiwan Semiconductor Manufacturing Co. (TSM ) to computer maker Compal Electronics Inc. Now, with the U.S. expected to emerge from recession by the second half, Taiwan's tech players expect the good times to roll once again. For its part, Powerchip, which has about 6% of the global memory-chip market, is reviving plans for a $350 million global equity offering. And Huang is accelerating construction on a $1 billion fabrication plant in Taiwan that he says will be open by yearend. "Business," Huang allows, "is looking pretty good."

Too bad one can't say the same for the rest of Taiwan's economy. Even as the island's high-tech exporters pick up the pace, the domestic sector remains in a funk. Talk to execs from the island's struggling banks, steelmakers, and retailers, and you'll hear about rising layoffs, mounting bad loans, falling prices, and eroding profits. "Recovery will be slow," says Jeffrey J.L. Koo Jr., president of Chinatrust Bank, Taiwan's largest private-sector lender. The stodgy economy is upping pressure on the administration of President Chen Shui-bian, who, despite a recent win in legislative polls, still seems unable to take the decisive steps required to put Taiwan back on track.

Four years ago, Taiwan nimbly sidestepped the worst of the Asian financial crisis. Its thriving electronics industry never missed a beat, and its banks were still in better shape than those of its neighbors. Today, with the banking sector under increasing stress, the economy is more and more schizophrenic. Goldman, Sachs & Co. economist Jonathan Anderson likens Taiwan to Japan. Both have dynamic export economies and moribund domestic ones. Indeed, exports account for a disproportionate amount of Taiwan's economy--the equivalent last year of 50% of gross domestic product, compared with 40% in South Korea, 23% in China, and 11% in Japan.

That Taiwan is undergoing a wrenching transition--from export powerhouse to a slower-growing, domestic-led economy--has been clear for several years. "Taiwan's structural adjustment will continue for a long time," concedes Po-Chih Chen, chairman of Taiwan's Council for Economic Planning & Development. Just how long depends on what steps policymakers take to address an array of problems, ranging from an overcrowded financial sector to an inflexible labor market to a hollowing out of manufacturing as PC makers follow other labor-intensive industries to lower-cost China.

As it is, the government is way behind schedule. Because Chen's administration was bogged down fighting the Kuomintang (KMT) opposition in 2001, much-needed reforms have languished. In December legislative elections, Chen's Democratic Progressive Party gained ground against the KMT but fell short of the majority needed to push through economic and financial reforms. At the same time, Chen feels obligated to pay lip service to the pro-independence wing of his party, whose aims are incompatible with the reality of closer economic ties with Beijing.

One particularly pressing issue is the long-promised overhaul of the banks. A series of bills designed to clean up bad loans and encourage consolidation has been passed in the past 14 months, but the payoff has yet to happen. And even though the central bank has cut benchmark interest rates from 4.75% to 2.125% since November, 2000, the banks are lending only to sure bets--freezing out companies that focus on local demand. "TSMC is never going to have a problem with financing," says Goldman's Anderson. "The problem is property and retail; these are the guys who need access to financial resources."

It's little wonder the banks are scared to lend. According to the government, nonperforming loans stand at a record 8% of total loans, and observers reckon the real number is an even scarier 15%. "You've got risk-averse banks that are inclined to lick their wounds," says Michael Kurtz, Asia strategist at Bear, Stearns & Co. in Hong Kong. At the same time, Taiwan is suffering from overcapacity. Analysts say it will take three years for the economy to digest all the office buildings, condominiums, and factories built in the late 1990s.

To be sure, the government has taken steps to shake up the banking industry. They include the passage of a financial holding companies law that could help encourage consolidation. Over the next few years, says Finance Minister Yen Ching-chang, he would like to see Taiwan's 54 banks winnowed to 10. "We need to enhance the scale of financial institutions," he says. But consolidation is running into trouble, in part because the sale of state banks is politically sensitive.

Another major issue the government needs to address is how to replace all the jobs being lost to mainland factories. So far, Chen seems to be following a failed recipe by trying to slow the exodus to China. To dampen China fever, this month the government issued a report alleging that most Taiwan companies in China were losing money.

Chen has also tried another ploy to stem the exodus. In late December, the government lifted some restrictions on high-tech investment in China but maintained a ban for chipmakers. That could buy the government time but hamper the ability of TSMC and United Microelectronics Corp. to match rivals in the booming China market. Still, Powerchip's Huang is one of many who expect the ban to end soon, perhaps by the end of March. In the meantime, Chen and his team are clearly hoping a revival of the electronics sector will provide sufficient lift for them to engineer hard reforms. While the economy shrank about 2% last year, it is expected to grow 2.6% in 2002.

Trouble is, many economists say little of the high-tech bounceback will be felt by the island's banking, retail, construction, and heavy manufacturing--sectors that will continue struggling this year. That means little relief on the unemployment front, and at 5.3%, the jobless rate is at a record high. And with Taiwan having joined the World Trade Organization on Jan. 1, the job picture is unlikely to improve, since the manufacturing and agricultural sectors will be facing tough new foreign rivals.

As Chen enters the second year of a four-year term, he has to spend that newly won political capital. The time is ripe for sweeping changes in everything from banking to labor to economic relations with China. But Chen will have to rise above short-term political maneuvering to realize a broader vision. Meanwhile, Taiwan's miracle economy is turning into something far less inspiring.

By Mark L. Clifford in Taipei and Bruce Einhorn in Hong Kong

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