When the experts turned their attention to the economic consequences of Taiwan's worst natural disaster this century, many people expected to hear dire news. But the analysts' findings, while far from rosy, suggest intriguing possibilities for the island's financial recovery.
The most powerful earthquake to hit Taiwan in decades took a devastating toll, at an estimated cost of more than US$14.02 billion. Countless homes, roads, bridges and schools, as well as factories and related production equipment, suf fered extensive damage. Taiwan's widely acclaimed "economic miracle" is now facing a heavy challenge.
Or is it? Thanks to the island's sound economic fundamentals, highly competitive enterprises, and abundant foreign exchange reserves, several economic experts and government officials have expressed optimism about the island's ability to weather this difficult time. "While the earthquake did cause death and tremendous injury and the destruction of property, the impact on Taiwan's overall economy has not been significant," says Hu Sheng-cheng, director of Academia Sinica's Institute of Economics. "That's the only ray of light on an otherwise gloomy horizon."
So why is it possible to regard the island's economic glass as half-full, rather than half-empty? "In the short term, the effect of the earthquake will not be good, particularly on exports," Hu concedes. "But in the medium and long run, things are likely to turn out well, given surging domestic demand bolstered by reconstruction work, as well as the repair of weaknesses in Taiwan's infrastructure and financial systems." There is a widespread consensus, in other words, that necessary reconstruc tion projects will boost demand for building materials like cement and steel, create more job opportunities, and spawn an overall increase in production.
Schive Chi, vice chairman of the Council for Economic Planning and Development, is another optimist. "For now, the negative impact of the earthquake on Taiwan's economic activities will be massive," he says. "In particular, damage to power lines and the transportation network has had a considerable effect on the industrial and tourism sectors." But, like Hu, he has faith in the potential of reconstruction projects and related investments to stimulate the economy. "Looking to the future, the quake's impact on Taiwan's overall economic development and competitiveness will be fairly limited," he says. "As with fires and wars, the subsequent work presents people with an opportunity to make things better."
But certain aspects of the crisis give more cause for concern than others. Hu worries about the plight of financial institutions in the central part of Taiwan, which suffered the greatest damage. The credit unions and farmers' cooperatives in the disaster region are bound to be substantially disadvantaged by the quake, since a large number of customers whose homes were destroyed will have difficulty repaying their mortgage loans. That will pile the pressure on financially weaker institu tions as their asset values dip below their liabilities. "Financial institutions, particularly fishermen's and farmers' coopera tives, are a weakness in our economy," Hu says. "Their financial statements often fail to present a true picture of their business operations." He urges the government to correct this problem by formulating stricter auditing and transparency rules.
Government officials are already moving forward with new plans to help around twenty local-level financial institutions overcome their post-quake problems. The government will offer tax incentives to encourage mergers and acquisitions, or even arrange shotgun marriages, among cooperatives and credit unions. The Cabinet has already approved a bill to authorize these mergers and will soon forward it to the legislature for ratification.
But the problem is not confined to the central region, any more than it is limited to small institutions. The bad-debt ratio will rise dramatically if banks are forced to write off the mortgage loans of people whose houses were destroyed--some estimates predict that the move would push up the average overdue-loan ratio of the local banking industry by one whole percentage point--and that will inevitably affect the island's entire financial system. Immediately after the earthquake, the Ministry of Finance (MOF) asked banks to shoulder this burden, but it seems to be having second thoughts in light of the conflicting advice it is receiving from its financial experts. Another possibility is for the central government itself to accept some responsibility for the money owed.
Schive Chi is adamant that government intervention in this regard should be limited. He is concerned that any attempt to redistribute liability for potentially non-performing residential mortgage bank loans will shortchange homeowners who ei ther have no housing debt or who borrowed money from relatives or friends to finance their purchases. "When natural disasters cause losses, the government has a certain responsibility to share the burden, but it doesn't have to shoulder it all," Schive notes. "A natural disaster is just that--not something that the government did wrong. Its job is to provide relief packages, but it shouldn't be required to compensate each and every loss that anyone suffers."
"The government's intervention should be moderate," Hu Sheng-cheng agrees. "What's important for the government to do now is set rules that are acceptable to everybody, such as how the property and loan rights of residents of the same building should be redistributed." The picture is muddied, however, by the fact that the lion's share of the NT$20 billion (US$625 million) in estimated loan-related losses is distributed among three banks that are state-run: the Bank of Taiwan, Land Bank of Taiwan, and Taiwan Cooperative Bank.
Although the matter is still officially under discussion, it is widely believed that the government and Taiwan's eight largest banks have hammered out a compromise that involves the banks swallowing liability for approximately one-third of all their loans secured on damaged or destroyed houses, in exchange for an obligation on the part of the owners to take out new, low-cost mortgages with the same banks for rebuilding purposes. This deal does not affect the underlying land but, if it goes ahead, homeowners will also be given the option of a straight swap of their real estate for other land that is currently owned by the government.
Banking is not the only sector of the economy expected to feel a squeeze. Insurance companies are also beginning to count the cost, as they prepare to meet claims for damage caused by the earthquake. Fortunately, however, most of Taiwan's insurance concerns purchase reinsurance coverage from overseas, which should substantially alleviate actual losses. According to MOF tallies, as of October 19, total claim payments could amount to more than NT$20 billion (US$625 million), with 70 percent of that covered by reinsurance overseas. Tseng Wu-jen, assistant director-general of the MOF's Department of Insurance, says that he expects to see a reduction in domestic reinsurance capacity, coupled with a tightening of the terms offered by reinsurers abroad. The result is likely to be a drastic rise in the value of claims paid by Taiwan's domestic insurers, with a consequential impact on premiums.
Tseng points out that few residential buildings on the island have insurance protection against earthquakes, which is currently sold as a supplement to fire insurance rather than as stand-alone non-life insurance. According to statistics provided by the Taipei Insurance Association, 1,207,322 fire insurance policies were in force in Taiwan at the end of 1998, generating an annual premium income of NT$9.8 billion (US$306.2 million). Of these policies, however, only 13,002 carried earth quake cover, purchased at a cost of some NT$190 million (US$5.9 million). Viewed in another way, earthquake insurance policy supplements comprised only 1.08 percent of all fire insurance policies in number, and 1.94 percent of total premium income. Of the policies covering residential property, just 0.44 percent also carried earthquake insurance.
"This low ratio of householders purchasing quake insurance is something that we definitely have to improve on, given that Taiwan is situated in a fault zone," Tseng says. "The quake will increase public awareness of the seriousness of crises such as this and, let's hope, spur interest in buying appropriate insurance." Besides beefing up publicity campaigns to under line the importance of earthquake insurance, the MOF will encourage Taiwan's domestic insurance companies to provide better information about their products. The next step would be to devise a scheme enabling companies to spread the risk among themselves, and pass it on to overseas reinsurers.
The government has already decided in principle that, starting as soon as possible, all new fire insurance policies of residential property should automatically cover earthquake damage as well. Another scheme under consideration involves making purchase of quake insurance mandatory as a precondition of being granted a mortgage loan to finance the purchase of any kind of property. Many observers believe, however, that the government would do better to avoid a piecemeal approach and instead develop a comprehensive earthquake insurance code, preferably after consultation with representatives of the industry in Taiwan and in countries like Japan that can call on an extensive database of quake experience.
Another set of problems arises out of the topography of the region worst affected by the tremor. The epicenter was located in one of the island's most productive farming areas. Based on estimates by the Council of Agriculture (COA), the disaster caused NT$2.36 billion (US$73.8 million) in damage to crops, livestock, and the lumber and aquaculture industries. Devastated crops comprised more than half of this total loss, at NT$1.48 billion (US$46.2 million). The COA has completed the draft of a nine-point aid plan that will offer farmers NT$1 billion (US$31.2 million) to compensate for damage to their land and equipment, and another NT$5 billion (US$156.2 million) by way of low-interest loans.
Figures released by the National Training Institute for Farmers' Organizations show that thirty-six farmers' credit unions scattered throughout Miaoli, Taichung, and Nantou Counties reported NT$8.45 billion (US$264 million) in collateral losses, while total damage to buildings and hardware amounted to NT$1.74 billion (US$54.4 million). It seems clear that a financial crisis is looming at the grassroots level unless the government steps in to help, but so far there is no agreement about what form that help should take. The credit unions themselves want the government to put up NT$60 billion (US$1.88 billion) to cover collateral losses. So far, however, all that has been forthcoming is NT$10 billion (US$312.5 million) from the Central Bank of China to finance new loans.
In contrast, the stock market bounced back fairly quickly. Trading resumed on September 27, after a five-day hiatus due to quake-related power failures. In a bid to stabilize the market and damp down panic selling, the MOF changed the daily limit on share price movements. Under this measure, which was in effect from September 27 until October 8, the maximum price drop for a given stock during a single trading session was cut to 3.5 percent from the previous 7 percent. The ceiling for a one-day gain remained the same at 7 percent. On the day the market reopened, the TAIEX plunged 212.21 points, or 2.7 percent, to 7,759.93 points: the lowest level seen since February 24, 1996, when mainland China launched military exercises near Taiwan's waters.
That fall was not so surprising, given recent events. What did surprise observers was the resilience the market showed after the restriction was relaxed, when the index managed to rise 54.13 points, led by electronics. Though the market per formed better than expected, however, the volume of transactions shrank substantially. "Because investors decided to take a cautious attitude, turnover in the broad market remains weak," says Yuan Wen-lung, a fund manager for Jardine Fleming Taiwan Securities. "But foreign investors still list local major IC makers such as Taiwan Semiconductor Manufacturing Co. and United Microelectronics Corp. as their biggest targets for increased investment, and since the local stock market is led by electronics and construction shares, projections for the medium- and long-term are good."
According to Academia Sinica's Hu Sheng-cheng, the worst damage to the economy stemmed not from the earthquake itself, but from the subsequent power outages and rationing that disrupted industrial production and normal business opera tions. Fluctuating and unreliable electricity supplies had a negative effect on the manufacturing sector as a whole, particularly the electronics and precision-machinery industries, where around-the-clock production lines are totally dependent on stable power supplies.
The powerful quake damaged about 200 electricity pylons in central Taiwan, effectively closing down one of the main north-south power transmission routes, and forced Taipower to impose rationing on households, commercial facilities, and offices in numerous parts of northern Taiwan. It took about two weeks for power rationing in northern Taiwan's industrial zones to be lifted, and eighteen days for the non-industrial sector to return to normal.
The China Development Industrial Bank estimates that total financial losses by manufacturers brought on by power cuts will exceed US$10 billion (US$312.5 million), and that quake-related damage will cause a reduction of between 1.2 and 4 percent in the gross domestic product. The biggest negative impact is forecast to be on the manufacturing sector, where many operators are now expected to move at least some of their operations abroad, especially to mainland China and other coun tries, where earthquake-related hazards are less pronounced. The effect on Taiwan's silicon wafer foundries, however, will be comparatively minor, mainly because of their strong competitiveness in the world market.
Yuan Wen-lung of Jardine Fleming points out that the major impact of the September 21 quake on the island's electron ics industry stemmed from shrinking business revenues during the month, coupled with late deliveries. "In the long run, the outlook for Taiwan's electronics industry is still robust, and it's popular with foreign investors," he says. "With its strong international competitive edge, particularly in the IC foundry business, Taiwan's electronics manufacturers can expect to see their overseas order books expand more or less without a glitch." Other reasons for optimism, according to Yuan, are an appreciation in the Japanese yen, which is causing some orders to move to Taiwan, and rising global demand for PC products, estimated to grow at a rate of 15 to 20 percent next year.
Wang Kung, director general of the Hsinchu Science-based Industrial Park Administration, says that the primary losses caused by the quake in the park were the result of lost productivity arising from power outages. The factories themselves, their production lines, and their power and water transmission systems largely remained intact. "Thanks to the prompt resto ration of the power supply, firms in the park were able to resume operations at the earliest opportunity," Wang says. "Their efficiency and competitiveness, coupled with an ability to cope quickly with change, meant that they were able to resume normal operations much faster than originally expected." The park, which plays a vital role in Taiwan's economy, was exempted from power rationing, and its electricity supply was completely restored on September 25, four days after the quake.
In an effort to forestall future power supply disruptions, the park administration has been encouraging tenants to set up their own power generators. In 1997, a group of firms jointly invested NT$4.5 billion (US$140.6 million) in constructing a power plant, which went on-line in June with the capacity to generate 100,000 kilowatts. Wang hopes that this will be increased to 1 million kilowatts over the next two years.
The return to comparative normality on the national power front is deceptive, however, because innumerable infrastructural weaknesses remain. Over the past three years, plans for the construction of new power transmission lines have met with strong protests and obstruction from local governments and residents. So when President Lee Teng-hui issued an emergency decree to regulate the post-quake clean-up, some observers hoped he would take the opportunity to put such NIMBY (Not In My Back Yard) activists in their place. "The government should make the best use of its rights within the six-month lifetime of the emergency decree to accelerate the speed of current and new construction projects," Hu says. "It should also conduct a comprehensive review of local infrastructure development, and make necessary policy adjustments to solve the problems this quake has revealed."
But a constitutional row followed, with critics contending that to use the decree to force through the construction of another nuclear power plant, for example, could be construed as an abuse of power. The Cabinet has now ruled out the use of the decree for such purposes, although its precise scope remains a gray area. One thing that the decree might well do, however, is improve the position of the independent power providers (IPPs). There are now twelve IPPs in Taiwan, but they are allowed to sell their surplus electricity only to Taipower. The Cabinet will probably revise the rules to permit them to sell to certain other designated customers, as part of the larger strategy to improve the island's power supplies.
Who is going to pay for all this, and how is the money to be raised? To cope with the disaster relief and reconstruction work, the government plans to raise between NT$100 and $120 billion (US$3.1 and 3.8 billion), comprising an NT$80 billion (US$2.5 billion) public bond issue, the Cabinet's reserve budget of NT$18 billion (US$562.5 million), and around NT$40 billion (US$1.25 billion) in budgetary savings. Some observers, among them Academia Sinica's Hu Sheng-cheng, fear that this does not go far enough. They believe that additional taxes may have to be levied, probably on the business sector, but until the final bill is presented, that remains in the realm of speculation.
The Cabinet has decided to curtail or postpone a number of existing or planned public construction projects in the current fiscal year, thereby saving approximately NT$100 billion (US$3.12 million) for quake reconstruction. It is also considering a plan to sell lottery tickets to raise more funds. Meanwhile, the MOF proposes to increase the ceiling for permitted public sector debt to 50 percent of gross national product from the current 48 percent, thereby allowing the govern ment to raise more capital if necessary.
It could have been much worse--that seems a fair summary of what the economists and other financial experts are saying. The quake's epicenter was located in a mountainous region that relies on agriculture and tourism to sustain it, and over that part of the island the shadow of the tragedy will lie heavily for a long time to come. The fields remain devastated, and all but the most insensitive of tourists are likely to stay away until the hotels and roads have been rebuilt. But the worst effects were localized.
One thing the island is currently not short of is economic analyses, predictions, and "guesstimates." The Council for Economic Planning and Development, the Directorate General of Budget, Accounting and Statistics, the Taiwan Institute of Economic Research, and the China Development Industrial Bank are just a few of the heavyweight organizations to have presented preliminary evaluation results that are remarkable for their near unanimity on several points:
· Structural damage and industrial production losses caused by the quake are expected to shave Taiwan's economic growth rate for the year by around 0.2 percent to between 5.4 percent and 5.5 percent.
· Essential expenditures on restoring the island's infrastructure are unlikely to create major financing problems for the government, since Taiwan carries little foreign debt and holds extensive foreign reserves. The latest statistics available from the Central Bank of China show that as of the end of September, Taiwan recorded US$101.6 billion in forex holdings, behind only mainland China and Japan.
· The government's active promotion of post-quake reconstruction projects will help offset the economic damage, while paving the way for medium- to long-term economic growth.
Or, putting it another way, it takes more than an earthquake to destroy an economy as powerful as Taiwan's. It is, as Hu Sheng-cheng remarks, the one ray of light on an otherwise gloomy horizon.