New Political Divisions Test China-Taiwan Economic Ties

An Institutional Investor Sponsored Report on the Greater China

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For the past eight years, perennial rivals China and Taiwan set aside long-held differences to reach their first-ever economic cooperation deals. This phase, beginning in 2008, enabled commerce between the world’s second- and twentieth-largest economies to grow to record levels. But now, under new Taiwanese leadership, relations are cooling as Taipei’s concerns about the Chinese embrace are reviving.
By Ralph Jennings

Taiwan’s President Tsai Ing-wen, since taking office May 20, has stopped formal talks with China because voters feared the previous government’s warmer relations had threatened Taiwanese autonomy. China is unhappy because less dialogue reduces prospects for eventual unification of the two countries under one flag, scholars in Taipei believe. But over her first 100 days in office, Tsai has spoken politely to Beijing while remaining distant from the negotiation table, avoiding incidents that might set off retaliation.

“That would not completely appease China, but the economic retaliation should always remain within acceptable, temporary, boundaries,” says Alicia Garcia Herrero, chief Asia Pacific economist for French investment bank Natixis.

Against this political landscape, economic relations that began in 1990 with Taiwanese investment on the other side and surged under the previous Taiwan administration for eight years, will be sustained by past agreements--but not necessarily forever, analysts say. Without new political momentum--and given weak spots in China itself--those ties are expected to fray. That fate would hamper trade and investment, a disappointment to expansion-minded firms in China as well as Taiwan’s financial services, hospitality and high-tech giants.

Without continued talks between governments, 21 deals drafted by the two sides under Tsai’s predecessor Ma Ying-jeou—but never signed--could go into an indefinite freeze. One agreement would cut tariffs on potentially thousands of items shipped to China, the outgrowth of an Economic Cooperation Framework Agreement (ECFA) reached in 2010. Taiwan’s parliament, controlled by Tsai’s ruling party, also has not ratified a 3-year-old services trade liberalization pact that would accelerate the China business of 144 Taiwanese sectors including tourism and financial services.

Due to the lack of ratification, “No one from Taiwan has a securities joint venture yet,” says Allen Wu, executive vice president of Yuanta Financial Holding Co. in Taipei. “China is our most important market after the U.S. We share culture and language and know each other, which is good for Taiwanese who go to China for business.” Yuanta, with NTD2 trillion (US$63 billion) in total assets and an 11.5 percent share of Taiwan’s brokerage market, has three representative offices in China, where it makes loans to Taiwanese clients at lower interest than charged by mainland Chinese banks.

Free trade of the Chinese yuan currency since 2004 in Hong Kong and 2012 in Taiwan, also under the more Beijing-friendly previous administration, have accelerated deposit rates. This allows banks in Taiwan to make yuan loans useful for business on the other side. The Taiwan yuan deposit rate expanded from 0.6 percent in February 2013, to a peak of 4.5 percent in July last year before slowing to about 3.7 percent of total deposits as of July this year after China devalued the currency last year, investment bank Barclays has found.

Chinese tourism to Taiwan affected
Legislative go-ahead for the services trade agreement also would open Chinese tourism services to Taiwanese investment. Instead, Taiwan’s larger mid-range hotels now face a 30 percent year-on-year reduction in group tourists from China from April through July this year. Arrivals hit a peak of 3.4 million in 2015. Groups began coming en masse in 2008 after the Ma government signed a tourism agreement with China.

Authorities in China are issuing fewer travel permits this year, travel agencies in Taipei say, either to show discontent with the Tsai government or because tourists themselves prefer to stay home to save money, fallout from their country’s economic growth slowdown. Two-way flights that rose from occasional charters to 890 per week over the past eight years also may decline as airlines suspend routes to smaller Chinese cities in light of declining tourism, according to local media reports.

“Under current unclear political circumstances between China and Taiwan, we don’t expect cross-Strait flights to have any obvious growth in the near future,” Taiwan-based China Airlines said in a recent statement. The airline operates 140 China-Taiwan weekly and calls itself the largest carrier in that market. However, China Airlines still expect a longer-term increase in passenger loads.

Tourism from mainland China has started to decline in both Taiwan and Hong Kong, says Angela Hsieh, an economist with Barclays in Singapore. The percentage of tourists from China to Taiwan rose from 17 percent in June 2009 to 40 percent by this year and in Hong Kong from 59 percent to 76 percent, Barclays says. “The influx of Chinese visitors has been the key pillar of support for services employment for both areas and for retail sales, especially for Hong Kong,” Hsieh says. “That said, we think there is emerging concern that the people flow may have peaked.”

High-end hotels in Taiwan’s capital are looking for more tourists from elsewhere in Asia as bookings from mainland China decline, says Achim Hake, general manager of The Sherwood Taipei, a 343-room luxury hotel. They come from Hong Kong, Japan, Singapore and South Korea, he says. The Middle East is forming a “niche market” because of direct flights to Taipei on Emirates Airlines and Turkish Airlines, Hake says.

Taiwanese firms look beyond China
China also is fading as a manufacturing hotspot and market for Taiwan’s signature high-tech industry. Taiwan-based Hon Hai Precision, a contract tech assembly giant better known as Foxconn, still assembles Apple goods in China. But it is expanding in Vietnam and Indonesia instead of focusing on new factories in China as it did before 2010. This shift to Southeast Asia reflects rising land and labor costs in China.

The quick rise of Chinese Android smartphone brands such as Oppo, Vibo and Xiaomi also has frustrated the chief Taiwanese smartphone developer HTC-- which has aimed its cheaper devices at Chinese consumers since 2012. HTC’s world market share has plunged from 10.7 percent in 2011 to just 2-3 percent today and U.K.-based market research firm Strategy Analytics says its China market share has fallen from 4.4 percent in 2012 to 0.4 percent in the second quarter of this year. “HTC is unlikely to regrow significant market share in China any time soon due to its limited retail presence, modest brand awareness and a smartphone portfolio that is largely undifferentiated from its Chinese rivals,” says Neil Mawston, Strategy Analytics’ global wireless practice executive director.

China and Taiwan will eventually find a common goal in promoting “smart” medical care devices and “smart energy,” says John Chen, senior industry consultant with Market Intelligence & Consulting Institute, a government-backed tech research firm in Taipei. China’s goal of becoming “more beautiful” can draw on the Taiwan government’s focus on promoting renewable energy development while ambitions in China to improve healthcare may expand the market for Taiwanese medical devices, Chen says. Under Ma, former vice president Vincent Siew had set up the Cross-Strait CEO Summit with committees in charge of tech cooperation and Chen expects the summits to continue under today’s government as long as politics stay out. “Somehow China and Taiwan are heading in the same direction and the Institute believes the potential for cooperation will concentrate on smart medical care...and smart energy in the years to come,” Chen says.

But Taiwan’s $131 billion high-tech economy, about a fifth of GDP, faces a broader threat from improvements in the quality, scale and supply chain in China. Quality of goods such as PCs and smartphones has improved in China, long known as the world’s low-cost producer. Chinese manufacturers have improved after decades of plant inspections by foreign investors and from competition for domestic consumers, economists say. The supply chain also has matured, so Chinese hardware developers can source parts for mass production without looking offshore. Taiwanese trade officials say their tech sector still leads China’s in precision technology and niche devices.

It may not just be tech that eases away from China. In her inauguration speech, Tsai said Taiwan would focus its direct investment policy on Southeast Asia and India to “bid farewell to our past over-reliance on a single market,” a reference to China. Infrastructure in Southeast Asian countries popular with Taiwanese firms has improved, Tsai said before taking office, and those companies have already expanded in that region, so investment risk has declined. About 3,500 Taiwanese firms were investing in Vietnam alone until 2011 as they found costs lower than in China, a Taiwanese chamber of commerce official in Ho Chi Minh City estimates. Taiwan remains among Vietnam’s top five investment sources.

Chinese aim to invest more in Taiwan
Chinese firms, especially in tech, are eager to invest in Taiwan to grow offshore as the home market gets too competitive. Their mergers and acquisitions outside China this year had totaled $111 billion through May 2016--more than for all of 2015, investment bank UBS says. The major fixed-line phone provider China Telecom, for example, signed a peering agreement in May with the fixed-line division of Hutchison Telecommunications Hong Kong Holdings.

The goal is to grow China Telecom’s “global coverage” by using Hutchison’s “extensive reach and throughout Hutchison’s mobile affiliates,” China Telecom said in a statement. As part of the agreement, mobile network operators and carriers served by both parties can use the IP platforms of either to deliver traffic from 4G data roaming, mobile signaling and Voice-over-IP.

Taiwan appeals to Chinese companies because of the cultural and linguistic similarities, relatively well-off consumers and precision technology expertise. The companies are keen to acquire advanced technology and “established brands” offshore, DBS economist Ma Tieying says, making Taiwan’s precision technology a particular draw.

But because of public concerns about the degree of mainland Chinese investment, she says, Tsai’s administration will probably curb any major deals. “There have been public concerns in Taiwan regarding the rise of Chinese capital, which may cause a technological loss in Taiwan’s corporate sector and importantly, pose threats to national security,” the economist says. The government “can be expected to take a cautious approach on this front,” she adds.

China’s internal worries, such as falling GDP growth and lack of a long-term replacement for manufacturing as the chief economic engine stand to hit Taiwan’s investments as well. Chinese authorities are trying to stimulate consumption and private investment rather than factories, which are finding cheaper production bases in other countries. Taiwanese firms have invested a total of about $100 billion in China versus $1.24 billion the other way. Two-way trade of $115 billion recorded by Taiwan’s Foreign Trade Bureau last year also favors Taiwanese companies with exports 61 percent of that total.

“As China slows, Greater China inevitably faces new economic challenges,” Garcia of Natixis says. She notes despite projections for a longer-term increase in passenger loads, weaker retail sales in Hong Kong and two years of declining casino revenues for next-door Macau, both due to fewer arrivals from China. “Taiwan is not alone,” say Garcia.