Taiwan Readies for Yuan Convertibility

Starting Saturday, Chinese and Taiwanese banks are expected to be able to freely conduct currency exchanges in both the Chinese yuan and the New Taiwan dollar, paving the way for the island to become a regional offshore yuan trading hub in direct competition with Hong Kong and Singapore.

The opening is also expected to bring about very concrete benefits for Taiwanese exporters, particularly the taishang, as Taiwanese China-based businesspeople are called. But although a major portion of Taiwan's population wish to open yuan accounts themselves, the political ramifications of Chairman Mao's currency gaining a firm foothold on the island seem manageable for the time being.

For decades, China's yuan and Taiwan's NT dollar have been non-interconvertible, so that the 80,000-odd Taiwanese companies operating in China, such as food giants Uni-President and Want Want, have been forced to resort to the US dollar as an intermediary before changing their yuan into the NT dollar and vice versa.

Most of the currency flow goes through Hong Kong's banks. It has been estimated that 30 percent of the 1.5 trillion yuan (US$240 billion) that annually pass through the territory as cross-border currency settlement is linked to the taishang. When Beijing and Taipei signed a memorandum of understanding on currency clearing on Aug. 1, it became clear that the Taiwan-related windfall for Hong Kong, the testing ground for offshore yuan transactions and the largest financial center for the trading currency, comes to an end.

But it is not only the avoidance of significant foreign exchange transaction losses that is good news for Taiwan. The NT dollar has appreciated 3.6 percent against the US dollar so far this year, gnawing away at the profit margins of the island's exporters and small-to-medium enterprises and making Taiwanese goods more expensive relative to trade rival South Korea's.

Some analysts believe the new option to hold yuan deposits will encourage the taishang to keep more revenue in the Chinese currency, which they might later need to upgrade their factories in China and for trade-related payments there. Demand for NT dollars is expected then to cool significantly, halting the appreciation. Such an outcome would by no means be a small matter for Taiwan, especially in face of Seoul's free trade agreements with the EU and US that came into effect in July 2011 and March respectively.

Taiwan's Joe Public also welcomes the yuan with open arms, if Standard Chartered Bank is to be believed. According to the findings of a recent poll conducted by the British lender's Taiwanese branch, more than 40 percent of Taiwanese have expressed keen interest in owning yuan deposits.

The higher interest rates the Taiwanese banks have already begun dangling for yuan time deposits in addition to the almost certain appreciation is partly due to Washington's relentless pressure on Beijing to allow the yuan to rise further, apparently convincing Taiwanese individual savers. A major run on domestic banks is expected to materialize shortly. Local media are reporting that Taiwanese lenders are planning to add hundreds of frontline staff members next year.

“Although Standard Chartered didn’t disclose its survey's sampling methods, Taiwan's huge FDI on the mainland, trade, investment, asset allocation and hedging undoubtedly create huge demand for yuan,” said Hu Sheng-Cheng, an economist at Academia Sinica, Taiwan's foremost research institution. “It is the mainstream view here that as soon as yuan-clearing is introduced, 10 percent of the NT$31.5 trillion [US$1 trillion] Taiwanese banks currently hold as deposits in total will be in yuan.”

Hu added that foreign currency deposits in Taiwanese banks currently amount to NT$ 2.5 trillion, or 8 percent of total deposits.

From Beijing's perspective, the relative cost to Hong Kong in terms of currency transactions – which it already rules over – for the good of Taiwan, which it wants to rule over – by facilitating the withdrawal of yuan liquidity from Hong Kong seems the only drawback to the opening. In order to reduce reliance on the US dollar, China has been expanding its currency relations with trade partners to promote greater use of the yuan in global trade and investment, and the move to allow Taiwan to become a yuan hub obviously kills two birds with one stone. It will not only boost offshore yuan internationalization but also do its share in spinning the island quicker into Beijing's orbit.

Asked about the political implications if 40 percent of the Taiwanese population—or 4.4 million, if the 30 to 60 age bracket is counted—now turn to yuan-linked products and services, Steve Tsang, director of the University of Nottingham's China Policy Institute, agreed that Standard Chartered's survey must be taken with a pinch of salt since whether the respondents will actually do what they have told the pollsters is open to question.

“[But nonetheless] the two economies across the Taiwan Strait are already so intertwined that having a significant percentage of Taiwanese opening a yuan account, presumably with Taiwanese banks, should not change the equation enough to make a big difference,” he said. “If 40 percent of Taiwanese should keep the bulk of their savings in yuan but not in NT dollars it would be a different matter and would be hugely significant.”

Tsang emphasized that such a scenario is not on the horizon.

Neither does Ronald A. Edwards, an expert on China's political economy and a professor at Tamkang University in Taipei, expect the direct political impact to be significant. But the developments do indicate “a widespread willingness for people in Taiwan to open the door for potential transactions with the mainland.”

However, for such transactions to come about on the large scale it takes more trust on the Taiwanese side, he believes.

“A good share of people would like to see a few 'example cases' where disputes between parties on either side of the Taiwan Strait are mediated and rules are applied before engaging in any large transactions,” he said.

Edwards added that the two currencies' inter-convertibility might impact somewhat financial reporting and company structure in Taiwan so that it could facilitate white-collar crime, an issue that so far hasn’t gathered much media attention.

“Effective regulation will now depend on the cooperation with mainland officials,” he said.

“These are untested waters, and we will have to see how it works in practice.”