To the relief of businessmen foreign and domestic, the government is taking major steps to put Taiwan's financial house in order. The following three articles by Osman Tseng examine three of the major topics in this complex task: the liberalization of the Taiwan Stock Exchange, the expansion of the foreign exchange market, and the legalizing of the futures market.
Tseng, formerly Vice President of the China Economic News Service, is now a freelance writer on economic and political affairs. He is based in Taipei and is a regular contributor to FCR.
The Taiwan stock market has fallen a staggering 60 percent since February 10, 1990, when the Taiex index reached its peak of 12,490 points. The draining of funds caused by sustained Central Bank tight credit policies and by rapidly increasing outward investments are among the main reasons for the stock market's unprecedented plunge. One measure that may help to steady the erratic situation is a government plan to liberalize foreign investment in the market. Initial steps of the plan include allowing foreign financial institutions, such as insurance companies and mutual funds, to invest in the local bourse. By bringing in these investors, much needed capital could be infused into the market.
Just looking. After the Taiex bubble burst, car sales plummeted.
Moreover, government officials expect that by inviting the participation· of foreign institutional investors, the unhealthy investor structure of the market will improve. At present, individual investors make up as much as 90 percent of stock buyers. The market's volatility has long been blamed on the abnormally high ratio of individual investors because they tend to look for quick profits and rush to buy or sell shares based on rumors circulated by big players and other unreliable sources in the marketplace.
The ROC Ministry of Finance is in charge of coordinating policy changes that will open the stock market to foreign institutional investors. Under existing regulations, no foreigners or foreign companies can open NT dollar accounts in the stock market. Also, annual inward remittances of foreign currency are limited to US$2 million for each individual or company for non-trade related transactions. Relaxation of all these restrictive regulations is now under consideration. There is also a possibility that government authorities may decide to give special treatment to foreign institutional stock investors with respect to inward remittances and opening of local currency accounts, a move that might eliminate the need for changing the existing restrictions.
Plans are already underway to regulate foreign investors as well as to protect domestic listed companies. One regulation will specify the categories of stocks in which foreign institutions are permitted to invest. Another will restrict foreign investors from holding more than 5 percent of the shares of any listed company. In addition, funds sent in for investment in stocks cannot be used for any other purpose.
The government has been reluctant to open the stock market to overseas investment. Foremost among the reasons for this position has been the fear that foreign investors, with the backing of their huge resources, might invest in the market in order to manipulate domestic share prices and control the management rights of listed companies. Currently, foreigners are allowed to invest in the local bourse only indirectly through four securities investment firms, including the International Investment Trust Company. Early this year, the Securities & Exchange Commission approved the applications of two U.S. brokerages, Merrill Lynch & Co. and Shearson Lehman Hutton Inc. to set up branches here to deal in domestic as well as foreign securities.
But in spite of the restrictions, many foreign institutional and individual investors have found ways to invest in local brokerage houses and stocks over the years, mostly using surrogate names. According to unofficial estimates, about 10 percent of the shares of listed companies are held by foreign investors. This ratio compares with 4 percent held by foreign investors in the Japanese market, and 6 percent in the United States.
The liberalization of margin lending is seen as another major method of rescuing Taiwan's stock market, and the government is moving to act on this possibility. Through the years, only one firm, Fuh-Hwa Securities Finance, has been allowed to provide securities financing. Because of its inability to meet investors' financing needs, Fuh-Hwa's monopoly has contributed to a thriving illegal margin lending business. These illegal operators have caused numerous problems in Taiwan's financial environment.
By allowing integrated brokerage houses and other financial institutions to carry out securities margin lending business, as is now being considered, government authorities also hope to boost the funds available for buying shares. The increased availability of funds may also help ease selling pressure because investors will not have to unload their share holdings at cost in order to raise cash.
Liberalizing margin lending may help but at this point it is not certain that 'it will pump enough money into the stock market to turn it around. Credit has continued to be in very short supply under the Central Bank's tight money policy, and the supply of money in cash and checking accounts registered a decline of 3.4 percent in May 1990 for the fourth consecutive month.
"Our stop at the brokerage house has been canceled" —tour directors, like other businessmen, are facing an economic slump because stock investors have reined in their consumerism.
Many investors and their supporters have called for the Central Bank to ease its credit policy to release necessary funds to the stock market, but the bank has refused. A number of government officials and private economists back the Central Bank position. They, in fact, oppose any kind of government intervention, citing economic and social reasons. For example, Lin Chuan, associate professor of finance and taxation at National Chengchi University, says: "Loosening credit at this time could certainly increase the flow of capital into the stock market, but it could just as well add to inflationary pressures at a time when transportation fares, food costs, and salaries for public functionaries have all registered increases."
Lin doubts that government intervention can rescue the market. He says that the market can regain a head of steam only when exports (which grew less than 1 percent in the first six months of 1990) improve and when there is also a slowdown in capital outflow (which topped US$8 billion in the same period). The growing tide of capital outflow has meant less money available to buy stocks.
K.C. Lee, director of the economic research department of the cabinet-level Council for Economic Planning and Development, describes the stock market's current sharp fall as a natural result of its past sharp increases, referring to the tenfold rise in the Taiex index in the three years before the latest round of corrections on the market.
"The deep correction will adversely affect our economic performance, but it could also do us good in two important ways," Lee says. "First, the correction might help cool the speculative fever and rectify the financial and economic disequilibrium it causes. Second, a major adjustment of the market could force many of the numerous stock buyers back into more productive jobs."
Economists disagree in their assessment of how seriously the stock market's plunge—from its peak of 12,500 points on February 10 to 4,500 on July 7—will affect the nation's economic performance during the rest of the year. But most observers agree it could knock one or two percentage points off the 7 percent economic growth rate targeted for the year. The slowdown will come mainly as a result of investors cutting back on consumer spending because of their shrinking earnings from stock trading in the wake of the market decline. Businesses such as real estate, automobile dealerships, restaurants, and tourism are all suffering reduced sales. Businessmen blame weakened demand from the individual investors who make up roughly 80 percent of the 3 million stock trading accounts.
Among the hardest and most directly hit, however, are the approximately 380 brokerage houses that mushroomed throughout Taiwan during the last two to three years to cash in on the island's stock-buying spree. These houses collect a flat 0.15 percent fee for all buy and sell transactions. Until recently, they enjoyed astronomically high profits as the market's trading volume shot above US$5 billion a day. Now that daily transaction volume has dropped to around US$1.5 billion, almost all of the brokerage houses are suffering losses. Even the twenty-five or so integrated brokerage houses are not exempt from this fate. In addition to brokerage services, these houses also provide underwriting services and buy and sell stocks on their own account.
Despite heavy losses, few brokerage houses are known to have closed down as of mid-year 1990. But the enthusiasm for entering the brokerage business has certainly cooled, at least for now. According to figures from the Taiwan Stock Exchange, sixteen new brokerages which were scheduled to start operations this year have asked for cancellation of their registration.
Many market observers predict an inevitable industry shakeout if stock trading continues to remain at its present low level. The market's current daily turnover bf US$1 billion to US$1.5 billion simply does not provide enough business for the many houses to survive. According to Daniel Chiang, vice general manager of the International Investment Trust Company, an integrated brokerage house, the firm needs to generate a trading volume of at least US$18.4 million a day to break even.
Chiang says that up to one-third of the 380 brokerage houses may eventually be forced to close down, while others will merge to consolidate operations. "Generally speaking," he says, "the brokerage houses that upgrade their operations and provide more sophisticated services to investors are the ones that will survive the shakeout."
Come again, when you can pay your bills.
During the market's go-go years, at least one million people were believed to have been directly involved in stock transactions. Most of them gave up their jobs or closed down their businesses to personally play the stock market on a full-time basis. The stock market boom caused both a decline in productivity and a change in the work ethic. People decided that they could make easy money by playing the stock market and tended to forget the traditional Chinese value of hard work.
As for the Taiwan stock market itself, the latest round of correction appears to be basically healthy. The steep fall in the market's capitalization from US$257 billion in February 1990 to US$135 billion at mid-year has been a major correction of its over-priced situation. The average P/E ratio, which was more than 100-fold in the recent past, has now dropped to 28-fold, indicating that the market is maturing in line with international standards. Danny Chan, managing director of the Taipei-based Fidelity Securities Investment Consulting Corporation, is optimistic about the future of the market. "The stocks that have good fundamentals will perform well, while those with no fundamentals will perform poorly," he says. The attitude indicates an important shift in perception. Perhaps the previously common event of share prices surging entirely beyond the level justified by the actual performance of the listed companies will become a thing of the past.