Taiwan dollar continues to rise despite cross-strait tensions
By Paul Golden
00:00, 6 December 2021
It has been a good year for the New Taiwan dollar. As of late November, the 1.8% appreciation in USD/TWD made the pair one of the best performing in emerging market Asia in 2021, only bettered by the Chinese yuan and Indian rupee in total returns despite a negative carry.
The country’s sizable current account surplus has acted as a buffer for TWD against record outflows from Taiwanese equities this year.
According to the Central Bank of the Republic of China (Taiwan’s official name is the Republic of China), Taiwan’s foreign exchange reserves reached record levels in October on the back of a fall in the US Dollar Index.
“TWD is one of the best-performing Asian currencies this year,” says Ho Woei Chen, an economist at UOB.
“The Taiwanese dollar has also performed relatively better than the currencies of the country’s trade partners, appreciating around 3.2% on a trade-weighted basis.”
Strong demand for Taiwan exports
Ho says this currency strength can be partly attributed to the strong demand for electronic components and ICT products and investments in machinery, as well as reshoring of manufacturing.
“Private consumption is likely to recover in the fourth quarter after Taiwan experienced an earlier downturn during the local Covid outbreak from May to June,” she adds. “The government’s consumption voucher programme is likely to contribute to this recovery.”
Such strength would normally attract Washington’s attention. Indeed, ING FX strategist Francesco Pesole said Taiwan meets all three of the US’ criteria to be designated a currency manipulator.
However, it was spared that designation in the April 2021 report.
Geopolitical factors count
Pesole’s analysis of the factors likely to influence the US Treasury Department’s next semi-annual report to Congress on developments in exchange rate policies across the US’ major trading partners, concludes that Taiwan will continue to be ignored.
“As a general rule, anything in the FX report should be filtered through a political/geopolitical analysis,” says Pesole.
“When it comes to Taiwan, we doubt there is much interest in changing the approach to label it as an FX manipulator.”
Taiwan itself is not taking any chances though. In a report to Parliament in late September, Taiwan’s central bank stated that it had spent a net $8.73bn to “avoid serious disorder” in the FX market in the first six months of 2021, compared with $39.1m in 2020.
Unusual FX intervention by Taiwan
Intervention on such a scale is unusual, says Iris Pang, ING's chief economist for Greater China.
“If all Asian currencies appreciate together, the relative exchange rates among Taiwan’s peers should be stable and not induce frequent intervention.”
Michelle Lam, Greater China economist at Societe Generale says Taiwan’s FX market intervention is in fact falling, potentially due to seasonality, since trade surpluses tend to be bigger in the second half of the year as the shipping season usually starts in summer.
“FX intervention probably declined in Q3 2021 compared to Q3 2020 judging by the CBC's FX reserves and balance of payments data,” she says.
Taiwan trade surplus falls
“There are two reasons for that – firstly, the trade surplus was not as large as in Q3 2020 due to higher commodity prices; and there were increased capital outflows stemming from Taiwanese residents’ investments in foreign debt securities,” Lam adds.
One reason for the intervention could be Taiwan’s export driven economy. So with the TWD running at historically high levels and its economy experiencing a booming demand for products such as semiconductors, managing the exchange rate is a challenge.
However, ForexLive’s chief currency analyst, Adam Button, says order books for exports globally are so strong right now that a further gain in the Taiwan dollar could be easily absorbed.
“Policymakers will have to balance that short term boost against the long term health of the economy,” he adds.
Strong demand for semiconductors
“The export boom will eventually subside and that will be a tricky moment, but it is not likely to happen until 2023. In the meantime I would expect new highs, but in a gradual way that reflects light intervention.”
Taiwan had a significant trade surplus with the US in 2020 and continues to run a large current account surplus. However, Lam says US authorities are cognizant of the macro trade flow reasons behind this.
“US policymakers understand that Taiwan’s strong exports and current account surplus was due to strong demand for semiconductors and that TWD appreciation (and more inflation) would be unfavourable for them,” adds Lam.
Pang says markets have not even noticed Taiwan’s presence on the US Treasury’s “monitoring list”, while Button reckons US warnings about manipulation have lost their ability to affect the market for anything more than a day or two.
Taiwan is US military ally
“Outright manipulation has gone unpunished forever and making an example out of a strategic military ally is unthinkable,” he adds.
The central bank governor has previously downplayed the gravity of being on the US Treasury Department’s radar, stating there was no expectation that Taiwan would be subject to a Section 301 investigation by the Office of the United States Trade Representative (USTR).
The only country to be subject to such investigation recently is Vietnam, which the USTR opened a case against last October.
However, Capital.com reported this was closed in July with the USTR determining that no action was required since Vietnam had agreed to refrain from any competitive devaluation of the Vietnamese dong and improve exchange rate flexibility.
The central bank governor’s lack of concern was summed up by comments he made to Parliament earlier this year.
Tensions with China
The governor said that Taiwan’s trade surplus with the US could be reduced by selling fewer semiconductor chips, adding that this was unlikely to happen because of the US industry’s reliance on Taiwanese technology manufacturers.
Taiwan’s currency strength has occurred during a period of heightened tension with China. Pang says that although the risk of a military event is very small it could be a black swan.
However, Button, says events in Hong Kong last year with the introduction of the National Security Law need to be accounted for.
He says that the threat of China attacking, blockading or interfering with Taiwan’s economy is greater than ever.
Covid risk to Taiwan economy
While describing the outlook as positive, UOB’s Ho accepts that geopolitical conflict is a risk and also warns that the threat of higher coronavirus infection rates cannot be dismissed given the country’s relatively low vaccination rate.
ING’s Pang also warns of the potential for a Covid upswing to impact Taiwan’s booming economy and says this will keep monetary policy loose.
“Until the economy is fully recovered - and for this a full reopening of the borders is required, which is difficult given the lack of Covid vaccines - the central bank won't consider raising interest rates.”
Rising commodity prices are expected to put a significant dent in Taiwan’s current account surplus next year though, while lower investor appetite for technology stocks as a result of fears around inflation and tighter monetary policy in the US is likely to lead to further equity outflows.
More headwinds for the TWD
According to Abbas Keshvani, FX strategist at JP Morgan Singapore, this leaves TWD more susceptible to rising global yields than the yuan.
Although USD/TWD is better placed than other high-beta Asian currencies such as the Korean won because of Taiwan’s leading position in the global tech supply chain as well as a more permissive central bank, it is unlikely to be fully insulated from a possible rise in DXY.
“The fact that the central bank also tends to view TWD as anti-inflationary points to potentially greater central bank tolerance on additional headroom in nominal effective exchange rate strength in the face of rising price pressures.”
Mayank Mishra, global FX and macro strategist at Standard Chartered Bank reckons rich valuations are likely to remain a headwind to further gains.
“TWD outperformance versus peers has pushed the nominal effective exchange rate to all-time highs, while the real effective exchange rate has risen to the highest level since 2006,” he says. “This is likely to keep policy makers concerned about excessive currency strength.”