In an effort to develop Taipei into an international financial center, the Central Bank of China (CBC) recently took two major steps toward expanding the nation's one-year-old foreign exchange call loan market (the market for loans repayable upon demand). The market is needed because it provides a convenient mechanism for raising short-term forex funds by all participating members who are strapped for hard currencies. Previously, most forex banks in Taiwan had to rely for the supply of such funds on foreign financial services, such as the Singapore Interbank.
One of the CBC moves was to appropriate another US$1.5 billion (one-third of it in German marks) for the market as seed money. This has boosted the CBC's total appropriations for the market to US$5.5 billion since its inception in early August 1989.
Another step was to expand the market's participation to include foreign currency brokerages and banking institutions around the world associated with Taiwan's foreign banks. Two as yet unidentified multinational forex brokerages are already scheduled to join the Taipei market in late 1990.
Arrangements are being made to link the Taipei market to the Singapore Interbank Market in order to make it an extension of the Eurocurrency and Asian Currency markets. Specifically, the proposed linkage aims to expand Taipei into a money market where both local and foreign financial institutions can raise and lend funds.
As put recently by a senior European banker here, Taipei has got all the makings of a financial center. Geographically, Taipei is well positioned to playa role of that kind. And Taiwan's foreign trade and domestic markets are larger than those of its two neighboring financial centers, Hong Kong and Singapore.
Beginning in 1987, the Central Bank of China allowed ROC residents to freely hold and use foreign currencies.
But central location and market potential alone cannot enable Taipei to become a major financial center. It requires two more important things: free participation by foreign financial institutions and free movement of capital into and out of Taiwan. This can be possible only by liberalizing capital flows and loosening controls on foreign equity participation in domestic financial services. Of course, after these changes are in place, Taipei must still prove itself in competition with Hong Kong and Singapore, something which may require a general upgrading of the financial system in Taiwan.
In the last few years, the ROC government has done much in each of the two areas of financial liberalization, but not enough. Take, for example, foreign investment in important financial services such as banking and the stock exchange. The Banking Law, most recently revised in July 1989, permits the branches of foreign banks to set up savings departments. These can accept passbook savings deposits and time savings deposits which the branches can then use to make long-term loans. Furthermore, foreign bank branches are now allowed to set up trust departments and to apply for licenses as securities underwriters, brokers, and dealers.
But there has been no change in the extremely strict qualifications set for foreign banks seeking to open branches in Taiwan. To qualify, a foreign bank must have over ten years of experience doing business with Taiwan banks. Their annual business volume must have reached US$1 billion or more in each of the three years prior to application. Alternatively, an applying foreign bank must have had a representative office operating in Taiwan for at least one year, have done business with local banks and companies totaling no less than US$1 billion, and rank within the top 500 in the world in terms of assets in the year before application. The top 500 ranking provision was eased in March 1990 from a more demanding requirement that the parent company be within the world's top 150. Lastly, only two foreign branch banks may be established each year.
These stringent regulations have prevented many foreign banks from coming to Taiwan, even though they are eager to do so. This helps explain why Taiwan at present hosts only 38 foreign banks, although it has been three decades since the Dai-Ichi Kangyo Bank of Japan opened its branch here as the island's first guest bank.
Regarding foreign investment in the Taiwan stock market, foreign capital is allowed in the local bourse only indirectly, through government-approved mutual funds. A number of foreign-invested companies have demanded in vain to be allowed to invest in the stock market. Government authorities have rejected their request on the ground that branches of foreign companies are not juridical persons and are thus not qualified to invest in the local stock market. Nor are these branches allowed to invest in the name of their parent companies, which meet the juridical persons requirement. The reason, as given by the ROC Securities & Exchange Commission (SEC) is that foreign companies are usually quite big and could easily influence the local bourse by buying or selling in large amounts.
The SEC has agreed to permit foreign insurance companies here to use their operating funds and legal reserves to buy local stocks and other securities. An SEC official said that this was intended to give the foreign insurers national treatment and allow them to compete with their Taiwan counterparts on an equal footing.
Early this year the SEC approved the applications of Merrill Lynch & Co. and Shearson Lehman Hutton Inc. to establish the first branches of foreign stock brokerages in Taipei. The two were the only securities firms that applied for the three licenses that the government was prepared to issue. The licenses allow the firms to deal in both domestic and foreign securities.
Because of strict qualification requirements stipulating that successful applicants must have capital exceeding US$2 billion and total assets topping US$20 billion, few other foreign brokerages have applied to come to Taiwan. The Big Four securities firms in Japan are eligible, but the Japanese government discouraged them from applying in fear that this would damage relations with mainland China. To get around this, the four are reportedly planning to invest in Taiwan brokerages through their overseas subsidiaries.
Taiex players check their stocks-the local bourse is larger in volume and capitalization than Hong Kong, Singapore, Bangkok, and Jakarta combined, but foreign capital is allowed in the market only indirectly.
Specialists say that for Taipei to stimulate the improvement of its financial services and become an international financial center, the government must allow foreign companies to invest in the Taiwan stock market, which is bigger in daily volume and capitalization than Hong Kong, Singapore, Bangkok, and Jakarta combined.
Taipei must also liberalize controls on capital flows. Since mid 1987, the Central Bank has taken several major steps toward liberalizing foreign exchange controls. It first lifted the ban on current account transactions and for the first time has allowed ROC residents to freely hold and use foreign currencies. For capital account transactions, a company or an adult may purchase foreign currencies up to an annual limit of US$5 million without prior approval. No restriction on the use of such outward remittances has been imposed.
Many forex controls remain in place. For example, the Central Bank still stipulates that both local and foreign forex banks are not permitted to borrow foreign currency loans exceeding their business volume, nor may they oversell foreign currencies by more than US$6 million a day, that is, sell in excess of US$6 million more per day than they purchase. Also, inward remittances are limited to US$2 million (raised in mid-July 1990 from US$1 million) for each individual or company per year, despite recent easing of other provisions in this area.
The restrictions were imposed by the Central Bank about three years ago to check the inflow of speculative money to capitalize on exchange rate differences, thus taking advantage of the then steady appreciation of the New Taiwan dollar. But the restrictions have come under fire at home and abroad ever since. The United States, for example, has charged that the ceilings on foreign liabilities and short positions are affecting the efficient management of forward foreign exchange by the banks.
The revised Banking Law now permits branches of foreign banks to set up trust departments; apply for licenses as securities underwriters, brokers, and dealers; and accept passbook savings deposits and time savings deposits which they can use to make long-term loans.
Washington's criticism of the limit on Taipei's inward remittances is especially severe. Treasury Department officials consider the limit to be a government intervention designed to prevent the appreciation of the NT dollar. As recently as late May 1990, the U.S. authorities once again requested that Taipei remove this restriction as well as the limits on taking out foreign currency loans and overselling foreign currencies.
The Central Bank should indeed relax the restrictions inasmuch as the original reason for their imposition no longer exists. The NT dollar has long ago ceased to appreciate. In fact, it has come under steady downward pressure since early 1990. If it were not for Central Bank intervention, the NT dollar would have dropped to below 27.50 to one U.S. dollar by this time.
The NT dollar's downward trend has eliminated the incentive for speculative money to flow into Taiwan. In fact, Taiwan is now experiencing rapidly increasing capital outflows for investment in overseas factories, real estate, securities, and foreign currencies. As measured by the oversell in Taipei's forex market, capital flowing out of the country in the first five months of this year totaled a high US$7 billion. The Central Bank logically needs to raise the US$2 million limit on inward remittances to match the ceiling of US$5 million for outward remittances to encourage capital inflows.
Relaxation of inward remittances also appears necessary to meet the needs of investors. With Taiwan's outward investments now growing to more than US$10 billion a year, annual inward remittances of principal and retained earnings by local investors are bound to increase, and the tight capital inflow limit certainly cannot meet their remittance needs.
Liberalizing the banking industry is a slow process. There is still no change in the extremely strict qualifications set for foreign banks seeking to open branches in Taiwan-and only two foreign bank branches may be established each year.
The Central Bank certainly cannot have failed to notice the need to relax controls over forex management. It has apparently been reluctant to do so because the increased capital outflows may ultimately prove to have been a temporary phenomenon caused by social and political unrest in the last year. If public confidence is restored by successful reforms and renewed political stability, domestic capital spending should rebound and slow down outward investment of all kinds. As soon as this happens, the now depreciating NT dollar is likely to become the object of renewed U.S. pressure for a rise in its value.
As a matter of fact, the recent devaluation of the NT dollar has already raised concern in Washington. The authorities at the Treasury Department said the U.S. would oppose a further decline. They contend that, given the ROC's still large trade surplus with the U.S., the NT dollar ought to be allowed to appreciate in the months ahead. The U.S. officials cited studies by two private organizations to back up their point. Merrill Lynch predicts that the NT dollar will rise to its peak of 25 to one U.S. dollar before the end of this year, while the International Institute of Economics expects the Taiwan currency to go even higher than that, somewhere from 23.2 and upwards against the greenback.
The value of a currency tends to fluctuate with economic changes. Thus whether the New Taiwan dollar should go up or down ought to be determined by market forces. Seeking to influence its trend in either direction by imposing controls on capital flows seldom works and only serves to distort the market. Furthermore, keeping controls on capital flows tends to discourage foreigners from investing in Taiwan's financial services. In short, the government needs to further liberalize laws and regulations in favor of free participation in local financial services by foreigners, and it must provide an environment for free capital flows if it is to turn Taipei into an international financial center.