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UNCLAS SECTION 01 OF 04 TAIPEI 003142 
 
SIPDIS 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR SCOTT KI 
 
USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER 
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT 
 
TREASURY FOR OASIA/ZELIKOW AND WISNER 
 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF 
GOVERNORS, AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EINV EFIN ECON TW
SUBJECT: Taiwan's Semiannual BOP Surplus Soaring 
 
 
SUMMARY 
------- 
 
¶1.  Taiwan's balance of payments (BOP) surplus in the first 
half of 2004 doubled from a year ago to US$24 billion, 
increasing Taiwan's foreign exchange (FOREX) reserves to 
US$234.6 billion.  While this sharp increase is unusual, it 
is not likely to continue, and does not presage financial 
problems.  The sharp increase is mainly due to massive bank 
borrowing to meet local corporate demand for foreign 
currency loans.  The loans are being used primarily to 
purchase production inputs for exports, and local banks own 
huge foreign assets roughly equal to the amounts borrowed. 
Taiwan's current account (C/A) surplus almost matched 
capital outflows of direct and portfolio investment.  This 
contributed to a weaker NT dollar (NTD) in the second 
quarter.  The second half will likely bring slower export 
expansion and reduce Taiwan's C/A surplus.   END SUMMARY. 
 
BOP Surplus Soaring 
------------------- 
 
¶2.  In the first half of 2004, Taiwan's BOP surplus totaled 
US$24.15 billion, more than doubled the surplus for the same 
period of 2003.  Depreciation of the Euro and the Japanese 
yen relative to the US$ reduced the US$ value of Euro- and 
Yen-denominated assets by US$0.67 billion.  Consequently, 
Taiwan's FOREX reserves after valuation change increased by 
US$23.5 billion, from US$211.1 billion in December 2003 to 
US$234.6 billion in June 2004. 
 
Banking Sector's Huge Borrowing from Abroad 
------------------------------------------- 
 
¶3.  According to Chen Yu-shiu, a section chief at the 
Central Bank of China's Economic Research Department, banks 
borrowing from abroad to fund foreign currency loans to 
local business firms was a major factor behind the sharp 
increase in Taiwan's BOP surplus.  Foreign currency loans 
reached some US$25 billion in the first half of 2004, about 
2.3 times higher than the nearly US$11 billion in the same 
period of 2003.  These foreign currency loans were needed to 
purchase production inputs used to fill surging export 
orders.  In the first six months of this year, Taiwan's 
imports have shot up by 35%.  The borrowing contributed to 
the banking sector's increased foreign liability from 
US$26.8 billion in December 2003 to US$46.2 billion in June 
2004, while the value of banks' foreign assets remained at 
US$43.5 billion. 
 
Capital Outflow Weakens NT Dollar 
--------------------------------- 
 
¶4.  In response to Taiwan's opening of the stock and bond 
markets to foreign investors in October 2003, large sums of 
foreign capital flowed into the island in the third quarter 
of 2003.  However, political events after Taiwan's March 
2004 presidential election, and fluctuations in New York 
Stock Exchange share prices caused mutual fund managers to 
pull out money from Asian markets, including Taiwan. 
Foreign portfolio investors took US$1.2 billion out of 
Taiwan in the second quarter of 2004, reversing an inflow of 
US$7.3 billion in the first quarter, and reducing foreign 
portfolio investors' cumulative net capital inflow in the 
first half of 2004 to US$6.2 billion, down from US$7.4 
billion a year ago. 
 
¶5.  The capital outflow weakened the NTD and share prices on 
Taiwan's stock market.  The stock market index plunged 25% 
from 7,034 points in early March to 5,316 points in early 
August.  The NTD depreciated 4.3% from NT$32.798 per USD in 
April 2004 to NT$34.199 per USD in late July 2004. 
 
C/A Surplus Offset by Capital Outflow 
------------------------------------- 
 
¶6.  Taiwan's current account (C/A) surplus of US$11 billion 
in the first half of 2004 was almost matched by the net 
capital outflow of US$10 billion in direct and portfolio 
investment.  Outbound direct investment in the first half of 
2004 surged 60% from a year ago to US$3.5 billion, 4.6 times 
inbound direct investment of US$0.7 billion.  Outbound 
portfolio investment declined 33% to US$13.5 billion, but 
was still more than twice the inbound portfolio investment. 
 
Sharp Increase in Service Trade Deficit 
--------------------------------------- 
 
¶7.  Taiwan's service trade recorded a US$2.1 billion deficit 
in the first half of 2004, 74% above a year ago.  The 
increased deficit is partly mainly due to more Taiwan 
residents traveling abroad after the fear of SARS (the 
contagious disease) subsided in late 2003.  Passengers 
departing Taiwan in the first half of 2004 totaled 3.7 
million persons, up 66% from a year earlier and 2.7 times 
the number of inbound passengers.  The "travel account" 
deficit in the first half of 2004 soared 83% from a year ago 
to US$2.5 billion. 
 
Export Expansion Prompts Imports to Grow Faster 
--------------------------------------------- -- 
 
¶8.  Taiwan's C/A surplus in the first half of 2004 declined 
23% from a year ago to US$11 billion due to: 1) imports of 
production inputs, and 2) a sharp increase in overseas 
travel.  Imports on fob basis totaled US$74.5 billion, an 
increase of 35% while exports were US$83.5 billion, 25.8% 
greater than a year ago.  The overall BOP trade surplus fell 
by 19% from a year ago to US$9 billion.  The export growth 
increased demand for industrial materials and semi-finished 
goods. 
 
Income from FOREX Reserves Declines 
----------------------------------- 
 
¶9.  Interest from CBC FOREX reserves has historically kept 
Taiwan's "factor income" account in surplus. Taiwan's FOREX 
reserves are mainly deposited in U.S. and Japan banks, and 
foreign government bonds.  However, a steady decline in 
interest rates in the United States prior to early July 2004 
drove the CBC's interest earnings down by 8% to US$5.2 
billion.  According to George Chou, Director General of the 
CBC's Foreign Exchange Department, the rate of return for 
Taiwan's FOREX reserves in the first half of 2004 averaged 
3.5 - 4.5%, less than the average 5-6% in the past, but 
higher than bank interest. 
 
Prospects 
--------- 
 
¶10.  Tsai Hung-kun, Deputy Director of the DGBAS' 
Statistical Bureau, predicts Taiwan's C/A surplus will 
likely continue in the second half of 2004 but will decline 
due to slower export expansion.   He expects export growth 
to slow to barely above 10% in the fourth quarter of this 
year and to 7% in 2005.  He also foresees improved cross- 
strait relations resulting from the recently cancelled 
military maneuvers, and expects foreign portfolio investors 
to bring capital back to Taiwan.  Unless fluctuations in 
foreign stock markets prompt a large redemption, this would 
extend the BOP surplus through the second half of 2004, and 
subject the NTD to heavy appreciation pressure. 
Appended Table 1 
Taiwan's Balance of Payments for 1st Half of 2003 & 2004 
(unit: million US$) 
 
-                                      1st Half  1st Half 
Item                                     2004      2003 
-------------------------------------  --------  -------- 
¶A. Current Account (C/A) 
¶B. Merchandise Trade 
-  Exports (fob basis)                   83,529   66,413 
-  Imports (fob basis)                  -74,496  -55,297 
-  Surplus                                9,033   11,116 
¶C. Service Trade 
-  Credit                                13,680   10,622 
-  Debit                                -15,771  -11,825 
-  Deficit                               -2,091   -1,203 
¶D. Factor Income 
-  Credit                                 7,322    6,943 
-  Debit                                 -1,564   -1,258 
-  Surplus                                5,758    5,685 
¶E. Unrequited Transfer 
-  Credit                                 1,606    1,257 
-  Debit                                 -3,311   -2,496 
-  Deficit                               -1,705   -1,239 
 
¶F. Current Account Surplus (B through E) 10,995   14,359 
 
¶G. Capital Account (deficit)                -48      -39 
 
¶H. Financial Account 
 
¶I. Direct Investment 
-  Outbound                              -3,469   -2,172 
-  Inbound                                  747      559 
-  Deficit                               -2,722   -1,613 
¶J. Portfolio Investment 
-  Outbound                             -13,477  -20,031 
-    Equity Shares                       -8,841  -12,117 
-    Bonds                               -4,636   -7,914 
-  Inbound                                6,162    7,382 
-    Equity Shares                        4,406    6,168 
-    Bonds                                1,756    1,214 
-  Deficit                               -7,315  -12,649 
¶K. Other Investment 
-  Assets                                 3,633    6,003 
-  Liabilities                           21,268    4,865 
-  Surplus                               24,901   10,868 
 
¶L. Financial Account Balance 
   (I through K)                         14,864   -3,394 
 
¶M. Net Errors & Omissions                -1,664      796 
 
¶N. Overall Balance (F+G+L+M)             24,147   11,722 
 
¶O. Change in CBC's Net Assets 
-  Prior to Adjustment of 
-  Valuation Change                     -24,147  -11,722 
¶P. Valuation Change                         670   -3,327 
¶Q. Change in CBC's Net Assets 
-  after Adjustment of Valuation Change -23,477  -15,049 
-  in Foreign Assets                        654   -3,308 
-  in Gold                                   16      -19 
--------------------------------------------- ----------- 
Source: Central Bank of China 
 
Appended Table 2 
Gold & Foreign Exchange Held by Taiwan 
As of June 2003 and June 2004 
(Million US$) 
 
-                                        June      June 
Item                                     2004      2003 
-------------------------------------  --------  -------- 
Central Bank of China: 
Gold                                     4,524     4,409 
Foreign Exchange Reserves              230,092   176,686 
-                                      --------  -------- 
International Reserves                 234,616   181,095 
 
Deposit Money Banks: 
Foreign Assets                          43,485    43,176 
Foreign Liabilities                     46,161    26,800 
-                                      --------  -------- 
Net Foreign Assets                     231,940   197,471 
--------------------------------------------- ------------ 
Source: Central Bank of China 
PAAL