The Long Case for Taiwan - A.K.A China's Cuba

Imagine if Fidel Castro’s successor decided the U.S. was not the enemy and opened up Cuba’s economy to direct trade and investment with the U.S. It would be like turning on the lights, after years of darkness. Replace Fidel Castro with Chen Hsui-Bien, the island of Cuba with the island of Taiwan, and the superpower of the U.S. with the superpower of China, and just such a situation is shaping up to occur in Asia. The Kuomintang party's landslide legislative win in Taiwan significantly increases the possibility that on March 22, Ma Ying-Jeou could be elected successor to Chen Hsui-Bien as Taiwan's President. If he succeeds, it is likely that a host of barriers to closer economic ties between mainland China and Taiwan will fall by the wayside.

Firstly, it is likely that direct flights between Taiwan and mainland China will be inaugurated, cutting travel time between Taiwan and Shanghai from an entire day’s affair to perhaps 2 hours (cutting out an inefficient stopover in Hong Kong). Investment rules limiting Taiwanese corporate investment in China would likely be relaxed, allowing China subsidiaries of Taiwan corporations to return to list shares in Taiwan rather than being forced to take their business to Hong Kong. Taiwanese banks would likely finally be allowed to make investments in China. In addition, mainland Chinese investment and even tourism into Taiwan has been restricted under the current government. Mainland Chinese tourism alone added 3.2% to Hong Kong’s GDP in 2006 and mainland stock listings and investment have made large contributions to Hong Kong’s recent economic success. As a first step, rules restricting the number of mainland tourists to Taiwan would likely be relaxed under a new Kuomintang government.

A lack of confidence in the current Taiwan government has also resulted in a massive outflow of capital (US$206 billion in portfolio investment has left Taiwan since Chen Hsui-Bien was elected president in 2000) and people (over 1 million Taiwanese are estimated to live and work in China and, without direct flights, many are choosing to settle their families in China rather than Taiwan). Consumer confidence has also lagged, in the form of private consumption growth that has trailed GDP growth by 1-2 percentage points since 2001, whereas prior to 2000, consumption growth usually exceeded GDP growth. We would expect that under a Kuomintang government, money would return to Taiwan and consumer confidence would recover leading to a rejuvenation of domestic asset prices and domestic economic growth.

For U.S.-based investors, here are two ways of capitalizing on this potential historic change:

• Taiwan iShares MSCI Taiwan Index ETF (EWT). If money returns to Taiwan and consumer confidence recovers, the Taiwan index, as a broad-based indicator, although more technology focused than other country indices, of economic health in Taiwan, is likely to rise.
• ADRs of Taiwan companies such as Taiwan Semiconductor Manufacturing (TSM) or Advanced Semiconductor Engineering (ASX). The risk here is that TSM and ASX might suffer more from any further de-rating of technology shares as both are major players in the manufacturing of the semiconductor chips used in a wide range of electronic products. However, if the Taiwan market rallies, these shares would likely rally in sympathy.

If you are able to access the Taiwan market directly, then you can consider the following:

• Taiwan financial services companies such as Chinatrust (2891.TW), Yuanta (2885.TW), Cathay (2882.TW) and Fubon (2881.TW). These are the most direct beneficiaries of pro-growth economic policies and a domestic economic rejuvenation. However, some have already risen over 20% since the Kuomintang’s legislative win so it may be best to pick your entry point carefully.

Disclosure: Author holds long positions in the above-mentioned securities

Comments

[No Moss]

The island is divided in population between the Chinese who arrived in 1949 (the KMT party) and those who came over from China before the 20th century. The latter group is dominant in the south of Taiwan and speak Taiwanese (also Hakka and Hokkien). The former group is dominant in Taipei, and speaks Mandarin Chinese, although they still use the traditional script. The southern group feels little affinity with China.

What makes the eventual resolution of the Taiwan question inevitable are family and economic ties. Taiwan is already in too deep to get out.

On the other hand, there are political consequences for getting "too close" to China, so it's hard to have effective talks. Right now it has to be a one-way street, with China giving a bone here and there.

China won't invade. They don't have to. All they have to do is threaten to nationalize the Taiwanese investment in China.

BTW, there are many Taiwanese businessmen who have second families in China, so they aren't too interested in moving their first family to China. It's likely that flights will normalize by about June of 2009, assuming there are no more hiccups in relations.