After five years of centrist Democratic Progressive Party (DPP) government, Taiwan has made uneven progress toward President Chen Shui-bian’s policy vision of becoming a “green, silicon island” and a centre of regional economic and financial development.
After an unprecedented 2.2% contraction in 2001, triggered by the collapse of the global information bubble, the nation’s sensitive export-oriented economy has rebounded. Its inflation-adjusted GDP expanded by 3.9% in 2002, 3.3% in 2003 and 5.7% last year.
Economic expansion
Although world trade growth is expected to slow, steady expansion in domestic consumption and private capital investment will provide the impetus for a modest 3.6% economic expansion, according to official forecasts.
The transition to DPP administration after nearly 55 years of authoritarian, one-party rule by the former Chinese Nationalist Party (Kuomintang or KMT) has caused some political pain. However, Taiwan has improved its fundamentals in governance, the economy, technology and finance.
International ratings agencies have affirmed this improvement. Taiwan improved its rank in “global growth competitiveness” among 104 countries listed in the World Economic Forum’s (WEF) Global Competitiveness Report 2004-2005 released last October. It moved to fourth position worldwide from fifth in the same institution’s rankings in the previous year. The Swiss-based Institute for Management Development similarly upgraded Taiwan from 12th to 11th place in its world competitiveness rankings, released in May.
But, while Taiwan gains significant credit for its technological and industrial prowess, it slipped from 21st to 27th place in the WEF’s rating with regard to its public institutions.
More broadly, in its biannual survey of global governance in May, the World Bank Institute gave Taiwan an overall rating of 77%, third best among the major countries in Asia (excluding Japan) after Singapore and Hong Kong. Its rating was 78% in 2000.
During this time, Taiwan recorded considerable improvement from 2000 to 2004 in “voice and accountability” (political, civic and human rights), moving from 70.2% to 75.7% to take first place among major Asian nations. Its performance in “regulatory quality” (or market openness) improved from 83.4% to 88.7% and “government efficiency” improved from 83.9 to 85.1%.
Taiwan slipped in “rule of law”, from 79.1 to 77.8%; “control over corruption”, from 76.9% to 73.9%; and “political stability”, from 73.3 to 62.6%, but remained superior to its regional rivals, except the two city states of Hong Kong and Singapore.
Difficult legacy
Although Taiwan is moving quickly up the learning curve in terms of building a viable democracy, a vibrant economy and a progressive society, the key question is whether it is advancing fast enough. Its competitiveness continues to be weighed down by the legacy of the authoritarian period – bureaucracy, excessive state domination, neglect of social welfare, lack of environmental protection and other issues affecting quality of life.
President Chen’s DPP government was re-elected in March with a narrow majority of 50.12% against the conservative ticket of the KMT chairman, Lien Chan, and the allied People First Party (PFP) chairman, James Soong. However, months of political turmoil followed the poll and a bitter deadlock between the DPP-led executive and the KMT-PFP controlled legislature has impeded the progress of political, social and market reforms.
Structural barriers
Taiwan now faces structural barriers on several fronts, including industrial upgrading and retooling, energy, environmental protection and national land recovery, social welfare, fiscal policy and taxes, constitutional political structure and the cross-strait policy with a hostile People’s Republic of China.
The financial sector is another important area for reform. After decades of tight control under the KMT, the sudden liberalisation of the banking sector in the early 1990s resulted in saturation and cut-throat pricing. It also weakened the links between the state-controlled enterprises, banks, party-owned enterprises and conglomerates.
The pressure of globalisation and the Asian financial crisis took their toll in late 1998, causing the “native financial crisis”. This generated a mountain of non-performing loans (NPLs) and assets that peaked in March 2001 with an average NPL ratio of 8% (11.74% including loans under observation).
The DPP government’s “first financial reform” drive to press banks to retire bad loans and upgrade risk controls and credit quality helped to bring the average NPL ratio down to 2.75% (3.67% in broader terms) by April this year. The progress of financial reform can be seen in the improvement of the WEF’s ranking for Taiwan’s bank soundness from 73rd in October 2003 to 68th last year. The effectiveness of auditing and accounting standards moved up from 44th to 34th.
A bigger indicator of renewed health is the steady growth in bank loans and investments since May 2003.
“The first phase of financial reform was relatively easy as no-one opposed pushing down the NPL ratio or setting up the Financial Reconstruction Fund. But the second phase of consolidation will come up against the Taiwanese preference to be ‘the head of a chicken instead of the tail of a buffalo’ and the big gaps in corporate culture among financial institutions,” says Lin Shang-kai, economics professor at National Taiwan University and a former Kaohsiung City Bureau of Finance director.
“If mergers are compelled and are unable to realise organisational re-engineering and a change in operating mentalities, the results could be even worse,” Mr Lin warns.
Fragmented industry
Martin Printz, Goldman Sachs Asia-Pacific research analyst and executive director, observes: “Many problems have been resolved, especially the NPLs. Now the biggest concern is the structure of the industry, which is too fragmented – with 47 domestic banks – and which still features heavy government involvement. The process has suffered from a lack of clear thinking and planning. Now the Financial Supervisory Commission realises the long-term importance of consolidation and reducing the government’s holdings in banks, but there are still obstacles.
“Many people still engage in wishful thinking that consensus-based solutions can always be found whereby everyone will be happy, but some people will need to be seriously upset in order to accomplish the consolidation process.”
Mr Printz adds: “The government wants to push reform. It only controls the executive branch, while the opposition controls the legislature, and many changes, especially relating to banks with over 50% government holdings, require legislative approval. The significant frictions between the executive and the legislature complicate matters.”
Some analysts see signs of optimism. “This is the first year I have believed in the industry merger position,” acknowledges Sophia Cheng, the first vice-president and head of Taiwan research at Merrill Lynch Taiwan.
“There is a fragile balance between seven or eight financial holding companies (FHCs) that have more than 100 branches, and a combination that would allow one of these to leap up to a higher level with a catalysing effect.”
If mergers within the private sector or deliberate action by the government could create a catalyst, Taiwan’s current 14 FHCs could consolidate and their number could halve in a relatively short period of time. “The endgame will probably involve between five and seven dominant FHCs and a handful of niche players,” Mr Printz predicts.
Other weaknesses
Consolidation alone will not be enough to boost Taiwan’s financial and overall competitiveness, especially given the relative weakness in the size, technical sophistication and global and regional networks of Taiwan’s banks. Most Taiwanese banks are thin on the ground overseas and are limited to trade finance, although some have devised innovative solutions to secure at least some corporate finance business by booking loans with foreign banks in China or Hong Kong and collecting guarantee fees.
But the chronic financial deadlock with China may give Taiwan time to upgrade. “Now is the perfect time to reform the banking system,” says Merrill Lynch’s Ms Cheng. “There is no way Taiwan’s small banks can make money there now, so now is the time to do our homework and foster a few big, competitive and respectable banks that can take advantage of the market when it is opened.”
Domestic progress
The critical factor may be whether Taiwan’s government and private sector can accelerate up the learning curves toward global competitiveness while displaying the resolution to overcome domestic obstacles to progress.
“The government needs to learn how to build bridges to allow outstanding international talent to enter Taiwan’s society and market. It must enhance local language skills and the knowledge of global economics, finance and world affairs,” says Ms Cheng. “If people cannot use the media to find out what the global financial, political and economic trends are, they are not going to have a good sense of how to invest their funds. The later one learns, the more expensive the tuition will be.”
