Perng Fai-nan was appointed Governor of the Central Bank of China shortly after his predecessor was tragically killed in a plane crash on February 16 this year. He takes on the heavy responsibility of piloting the New Taiwan dollar through the Asian financial crisis. Having worked in Taiwan's banking sector for thirty-five years, he is well known for his toughness in battling currency speculators.
FCR: What challenges have you faced since you assumed office this past February? What are some of the measures adopted to meet these challenges?
Perng Fai-nan: The Asian financial crisis broke out in mid-1997, and the world economy is still feeling the pinch. This reinforces the fact that in an integrated and interactive global financial network, problems in any region can have far-reaching repercussions. Taiwan is a major player in this network and can be profoundly affected by its malfunction. Within this context, I recognize manifold challenges. Among them, a prioritized objective during the last few months has been to maintain price and financial stability as a precondition for long-term economic growth.
To achieve this objective, the Central Bank of China (CBC) is committed first of all to restoring discipline in financial markets. For instance, we adopted several measures to regulate the Non-Delivery Forward (NDF) market. The intended purpose of NDFs is to hedge exchange rate risks. To prevent NDFs from being abused for speculation purposes, CBC had stipulated that the net NDF position of a local bank not exceed one-third of that bank's foreign exchange position. However, from the onset of the Asian financial crisis, NDF transactions increased sharply, and speculators used NDFs to profit from exchange rate manipulation. In order to meet the speculative needs of their clients, some local banks circumvented the regulations by purchasing NDFs from local enterprises and selling DFs to them simultaneously. Through this operation, they kept their net NDF positions within the one-third limit.
As a result, a vicious circle in terms of the movement of the exchange rates was set in motion. Within three consecutive days starting on January 3 this year, the total amount of NDFs skyrocketed to US$820 million, which caused the New Taiwan dollar to depreciate from 32.7 to 34.4 against the US dollar. The CBC hence prohibited local enterprises from engaging in NDF transactions, effective May 25, 1998. By so doing, we blocked speculators' access to local currency funding. The foreign exchange rate was subsequently stabilized.
We then implemented a moderately easy monetary policy. During this past August and September, we twice lowered required reserve ratios. Our goal is to support the medium- and long-term funding of private investment and public infrastruc ture. We also released postal saving re-deposits to serve the same purpose.
The CBC's foreign exchange measures have aroused controversy. Global Finance, for example, affirmed their contri bution to exchange rate stability, but The Economist in an April 25 article said that CBC policies contradicted finan cial liberalization. What is your reaction?
The Economist, in the particular article you mention, misunderstood the real situation. The CBC did not "turn back the clock," as the article claimed. Our policy concerning the NDF market was aimed at closing a loophole that had been exploited by international speculators. The purpose was not to impose capital controls, but rather to remove distortions from the market so that the exchange rate could fully reflect Taiwan's economic fundamentals. The two are totally different and should not be confused.
While some CBC measures aroused controversy at the time they were implemented, later developments have proved them to be correct. Examples are numerous. In a recent issue on CBC policy, Fortune concluded that Taiwan's method offers enough scope for individuals and companies to do most of their foreign-exchange business, for foreign portfolio capital to enter and leave in adequate volumes to reflect true market signals for both equities and currency, and for financial transac tions not to distort the allocation of resources in the real economy. This is what we intended to achieve, and we did reach our goal.
Other professionals have also spoken highly of our policy. Peter Baumann, President and Country Corporate Manager of Citibank's Taiwan district, praised CBC this August for its foresight in formulating NDF regulations. In response to the view that CBC policy was an economic retrogression, Scott Law, Chairman of the Banking Committee of the American Chamber of Commerce in Taipei, pointed out that "the policy on the NDF market was an appropriate and legitimate short-term meas ure" and that it "was in line with the Chamber's own desire to see the government intervene with precision and determination when essential to reassure investors."
I would like to emphasize that a major source of the instability that led to the Asian financial crisis was short-term capital movements. Evidence indicates there were huge capital inflows before the crisis and massive outflows after the crisis began in the afflicted Asian economies. Taiwan, a small and open economy, can also be severely affected by short-term capital flows, which are volatile in nature and can flood into a market and then leave just as quickly. A major factor contributing to Taiwan's relatively good performance during the crisis is that foreign exchange liberalization has been proceeding in an orderly manner. A recent report by Political & Economic Risk Consultancy, Ltd. indicated that imposing certain restrictions on capital flows has shielded Taiwan from the adverse impacts of the highly volatile international capital movements that have plagued Hong Kong in recent months.
What implication does the possible downgrading by Moody's have on Taiwan's financial system? What will be CBC's responses?
Our financial system is quite healthy. The average non-performing loan ratio of our commercial banks might exceed four percent this year, which is still much lower than that of many other countries. The average capital adequacy ratio is 11.4 percent, far exceeding the eight-percent standard set by the Bank for International Settlements. Besides, more than half of the total loans of our banks are secured, with such loans constituting only sixty to seventy percent of the total value of the collateral. These statistics not only indicate that our commercial banks are equipped with sufficient reserves to prepare for any emergency, but also that their financial structures are healthy enough to meet the needs of their daily operations.
Furthermore, as we have already established a comprehensive regulatory framework for financial monitoring, any early-warning signs will be within the reach of the monetary authorities. We will therefore be able to adopt appropriate measures to respond in a timely manner to any possible situation. In view of the recent increase in the non-performing loan ratio, the CBC has proposed to revise the Income Tax Law. According to the current law, loan loss reserves are tax deductible up to one percent of the loan balance. We propose that the ratio be raised to two percent. Such a change can strengthen the credit quality of financial institutions.
On the other hand, a major weakness in our financial system lies in the local-level financial institutions, such as the credit departments of farmers' and fishermen's associations, whose non-performing loan ratios are higher than average. At present, the government is paying close attention to developments and will adopt appropriate plans in the near future to mitigate potential negative effects.
How has the role of the CBC changed during the process of liberalization?
During the past decade, the process of financial liberalization in Taiwan has been accelerated. Consequently, the effec tiveness of CBC's monetary policy has been somewhat weakened by the deregulation process; however, CBC can still exert an influence on financial markets and the domestic economy by means of various monetary tools. For instance, while follow ing financial deregulation, CBC can no longer adjust the interest rate level directly via the exercise of administrative power, as it did in the early years, but we can conduct open market operations that affect the interest rate indirectly. By affecting the quantity of money supply, the interest rate can still be changed to a level that is in line with CBC's targets.
CBC continuously adapts to the changing environment to ensure that its policy measures are consistent with national economic goals.
What are Taipei's advantages in becoming an Asia-Pacific financial center?
There are several advantages to developing Taipei into a regional financial center. We have had robust economic strength for many years, and we have had abundant foreign exchange reserves. In 1997, Taiwan's per capita GNP reached US$13,233. We are also the fourteenth-largest international trading country and have an advanced manufacturing sector. Our financial markets are well-developed and our financial system is healthy. Among the Asian financial markets, Taiwan's total amount of deposits and loans combined is second only to that of Japan. In terms of size, our money market follows those of Japan and Korea, and our stock market is the largest among the Asian countries in terms of daily dollar volume.
In addition, Taiwan occupies a strategic position in the Asia-Pacific region relative to southeast Asia. The average distance from Taipei to the seven biggest cities in the western Pacific is shorter than from anywhere else in the region. The average flight-time to those cities is less than three hours. Finally, a stable political and economic environment, together with good human resources, is also an invaluable asset in terms of developing Taipei into a regional financial center.