Economy & Business
Taiwan's fund outflows
In late August, it was announced that Taiwan had for the second quarter of 2023, registered its 52nd consecutive quarter of net fund outflows in its financial accounts. Is this a good thing or grounds for concern?
By Paul Shelton
13 years of consecutive net fund outflows
The 2Q23 outflows mean that Taiwan has had 13 years of consecutive net fund outflows. The Central Bank of the Republic of China (Taiwan’s central bank) attributed the outflows to an increase in investments in securities and bonds in the overseas markets, but this is only part of the overall picture. The central bank’s data showed that the flow of direct investment and portfolio investments for the April to June period this year, amounted to NT$681 billion (US$21.05 billion). This was an increase of US$270 million from the same period in 2022. When you combine the figures for the 13 years, the central bank’s data confirm that the 52 quarters marked the longest next fund outflow in Taiwan’s history and totalled some US$763.05 billion.
Taiwan's portfolio investment account, which is quite simply a collection of invested assets such as stocks, bonds, and funds in the second quarter of 2023, saw a net asset increase of US$15.50 billion. Taiwan’s portfolio investment account is made up of Taiwanese residents' portfolio investments abroad, which registered a net increase of US$19.27 billion as Taiwanese banks and entities in the private sector raised their holdings in overseas debt securities.
By contrast, the central bank also announced a net increase of US$3.77 billion in portfolio investments by non-residents, or more simply an inflow into Taiwan for the same period. The central bank attributed this increase to foreign investors raising their equity holdings in Taiwan's stock market but there are other avenues of inflows of investments into Taiwan that we examine later in this article.
During the April-June period, the central bank said, Taiwan's direct investment account recorded a net asset increase of US$1.06 billion. The direct investment account is composed of outbound direct investments by Taiwanese residents and inbound direct investment by non-residents. This direct investment account posted net increases of US$3.04 billion and US$1.98 billion, respectively.
Some of the world’s major central banks get quite nervous in periods of net fund outflows in their respective jurisdictions and the recent aggressive rate hike cycle by the US Federal Reserve has not quelled those concerns. However, Taiwan’s central bank does not seem overly concerned and confirmed that Taiwanese investors are likely to continue to move funds out of Taiwan and into US dollar-denominated assets. The central bank also stressed that this activity was in keeping with Taiwan’s long-term current account surplus. A country’s current account is simply a measure of the exports versus imports of that country.
Taiwan is not unique in experiencing a long-term current account surplus. In this region alone, both Japan and South Korea have experienced long-term current account surpluses. Whilst Taiwan’s current account surplus hit US$22.24 billion in the second quarter, this figure was in fact down by US$2.11 billion from a year earlier. The decline is evidence of Taiwan’s softening export market and the inherent fragility of global demand. Overall, Taiwan’s figures were still admirable in a weak global economy.
Numbers and results of any country ebb and flow, all part of the cyclical nature of economies. For example, the latest quarterly account surplus was the third highest on record for the second quarter, whilst at the same time Taiwan recorded a deficit of US$2.48 billion in its service account in the second quarter, the largest deficit in almost six years.
Taiwan's investment outflows: Where, why and by whom?
Agencies such as the central bank and the Ministry of Economic Affairs (MOEA) diligently track the numbers and watch the vast majority of Taiwan’s investment outflows to its traditional markets of the US, Europe and in third place, Japan. But who are the active parties involved in the outflows?
TSMC and Yageo
Two Taiwanese companies made a combined huge impact on offshore investment results as reported in late June by MOEA’s Investment Commission (MOEAIC). The amount of outbound investment approved by MOEAIC during the period of January-May surged nearly 200% from a year earlier simply due to planned large overseas investments by two major tech companies.
MOEAIC data showed approved outbound investments in the first five months of this year rose 196.82% from a year earlier to US$8.32 billion after chipmaker Taiwan Semiconductor Manufacturing Co. (TSMC) and electronics component supplier Yageo Corp. pledged large overseas investments.
TSMC, the world's largest contract chipmaker, is investing US$40 billion to build two advanced wafer fabs in the US state of Arizona, and secured MOEAIC approval to send US$3.5 billion to raise the capital size of its subsidiary TSMC Arizona Corp.
Yageo, the world's third largest multi-layer ceramic capacitor provider, planned to send US$720 million offshore to acquire Telemecanique Sensors from French-based Schneider Electric.
So, a significant increase in outbound investment amounts from these two projects although the number of projects approved by MOEAIC fell 7.21% from a year earlier to 206, according to MOEAIC data.
New Southbound Policy outflows
The New Southbound Policy, introduced by the Executive Yuan in late 2016, is intended to diversify Taiwan's risks and minimise overdependence on any single market and strengthen Taiwan's relations with its neighbours to the south, from South and Southeast Asia to Australia and New Zealand.
In the first five months of 2023, the MOEAIC gave approval, under the New Southbound Policy, to US$1.92 billion in investments pledged by Taiwanese companies during the five-month period, up 95.91% from a year earlier, with Singapore, Vietnam, and Malaysia as the top three destinations. This brings total cumulative investments in these countries since records began (in 1952) to US$54.81 billion (according to MOEAIC figures).
Again, based on MOEAIC data for the first five months of this year, approved China-bound investments totalled US$2.56 billion in the first eight months of 2023. The electronics component industry and retail/wholesale industries in China were the top two businesses favoured by Taiwanese investors. China accounts for the largest share of Taiwan’s outbound investments by far. Although investments in recent years have slowed, cumulative investments by Taiwanese investors in China reached US$214.37 billion in August this year, according to official MOEAIC figures. This dwarfs total cumulative Taiwanese investments in other regions, such as the United States (US$28.78 billion), Europe (US$14.35 billion) and Japan (US$12.08 billion).
By way of distinction from the outflow investments mentioned above, Taiwan’s insurance companies are quickly becoming amongst the largest of Taiwan’s offshore investors with some US$94.5 billion as of 2021.
Taiwan’s life insurance firms, which took a hit during the Covid pandemic, have raised their exposure to foreign assets to the maximum allowed under local regulations in order to diversify risk as US rate hikes, mentioned above, have driven up global market volatility in 2022.
Figures from Fitch Ratings, an American credit rating agency and one of the "Big Three credit rating agencies" (the other two being Moody's and Standard & Poor's), show that the overseas investment allocation of Taiwanese life insurers was at the 70% cap in the third quarter of 2022, up from 66% in the fourth quarter of 2021.
Global central banks are raising interest rates as they battle to rein in inflation. The US Federal Reserve has hiked interest rates six consecutive times this year, including four 75 basis point increases, and served notice that it isn’t done yet. The rate hikes have battered markets. There is growing concern of a potential recession and Taiwan is not recession-proof.
Continued global market volatility will drive down Taiwanese life insurance firms’ premium income from investment-type policies, and they are likely to maintain a more conservative asset allocation strategy. Factors such as liquidity, recurring yields and regulatory restrictions are seen as key factors for the life insurers in maintaining, or indeed increasing, where possible, their overseas and alternative strategic allocations. This means continued investment outside of Taiwan and this will continue to rise if Taiwan’s life insurance industry assets continue to increase at an expected compound annual rate of 3.3%.
Central Bank and Deposit-Taking Corporations
In figures released by the central bank in June this year, the central bank, and Deposit-Taking Corporations (per central bank terminology), in 2022, had international investment positions of US$560 billion and US$156 billion respectively. These figures represent an increase from 2021 of 1.1% and 27.8% respectively. More detailed information was not provided by the central bank, but these are significant figures for a nation with a population of just 23.5 million.
Deposit-Taking Corporations and retail Investors
Whilst more detailed information on investment positions by deposit-taking corporations is scarce, we do know that as of August last year, the Financial Supervisory Commission (FSC) allowed banks to engage in wealth management business for high-asset clients to invest in non-Securities Investment Trust (non-SIT) offshore funds. Starting from this year’s first quarter, some non-SIT offshore funds have been offered in Taiwan.
Unlike traditional investment methods, non-SIT offshore funds allow various channels of investment, including private equity funds and other alternative investments allowing deposit-taking corporations to provide their clients with numerous investment plan options to arrange and allocate their assets.
Whilst the stock and relevant bond markets have continued to be volatile due to the ongoing dual impact of inflation and interest rate hikes, alternative ways of investment are less affected by the fluctuations in publicly traded market assets such as stocks and bonds, thereby achieving portfolio diversification that reduces investment risk. With diverse strategies, alternative investments can hedge against inflation while pursuing investment returns. Even with rising interest rates, alternative investments can maintain a robust performance in helping clients to maximise returns.
These non-SIT offshore funds have required Taiwanese deposit-taking corporations to establish collaborative relationships with a number of world-renowned asset management companies, thus increasing the regulatory complexity of Taiwan’s financial market. With the global tightening of money supply and slowing economic growth, it is crucial to construct investment portfolios for high-asset clients that can reduce risk in traditional equities and bonds.
The Taiwan Stock Exchange
Foreign investors seem to be undeterred by the possibility that growing tensions between Taiwan and China could precipitate fund outflows from the Taiwan market, according to a recent statement by the chairman of the Taiwan Stock Exchange.
Up until the end of June this year, foreign investors were investing heavily in Taiwan stocks with net foreign buying over the previous six months totalling US$12 billion, a high-water mark not reached since the first half of 2008. Taiwan's benchmark index performance was up 16% in US dollar terms this year, among the best benchmark performances in Asia.
But the net buying rally quickly changed course in the third quarter of 2023, shifting to a net selling of US$2.62 billion for July, US$3.2 billion in August and NT$168.03 billion (around US$5.25 billion) in September. The FSC has since announced that foreign institutional investors registered an aggregate net sell of more than NT$77 billion or US$2.39 billion worth of shares on Taiwan's stock market in the first nine months of this year. However, the FSC said foreign institutional investors still recorded a net fund inflow worth US$10.56 billion into Taiwan in the first three quarters of the year despite a net fund outflow of US$3.28 billion in September.
The Taiwan Stock Exchange sees this as a natural plateau after a rally rather than a sign that foreign funds are fleeing the market.
Research for this article also revealed that for foreign investors, including from countries such as Japan and Singapore, cross-strait tensions barely register as a concern.
MOEAIC approved inflows
In terms of inbound investment, during the five-month period of this year, MOEAIC approved 938 foreign direct investment (FDI) projects valued at US$4.27 billion, down 0.51% from a year earlier, with companies from Germany being the largest investors, pledging to invest US$958 million, ahead of the United States (US$577 million). Europeans are the largest investors in Taiwan with cumulative investments of US$70.59 billion (as of August 2023), followed by the United States (US$26.6 billion) and Japan (US$26.4 billion).
The New Southbound Policy inflows
MOEAIC approved investments from the 18 countries under the government's "New Southbound" policy totalled US$481 million during the January-May period, up 59.35% from a year earlier as Singapore, Malaysia and Thailand served as the top three investors.
Since Taiwan lifted a ban on Chinese investments in June 2009, the government has approved about US$2.58 billion in funds from China, according to MOEAIC.
The MOEAIC said it approved a total of US$12.75 million worth of investments pledged by companies in China during the same five-month period of this year, up 45.62% from a year earlier and the increase largely came after Arizon RFID Technology (Hong Kong) Co. announced plans to invest NT$275 million (US$8.9 million) in its branch in Taiwan.
Domestic investment by the Taiwanese government and private investors
To provide a complete picture, having discussed outflows and inflows, we should also review domestic investments by both the government and private investors.
A key indicator is what is known as Gross fixed capital formation (GFCF). GFCF is a component of the expenditure on gross domestic product (GDP) that indicates how much of the new “value added” in an economy is invested rather than consumed. It measures the value of acquisitions of new or existing fixed assets by the business sector, the government and households minus the disposal of any fixed assets.
Taiwan’s GFCF data is updated quarterly, starting with US$21.2 billion in the fourth quarter of 1983 all the way through to the second quarter of 2023. The data reached an all-time high of US$54 billion in the third quarter of 2021 and a record low of US$3 billion in the first quarter of 1984.
Taiwan’s GFCF in the second quarter of this year was US$48 billion, but this was actually a decrease from the number for first quarter which was US$50 billion.
What are these figures telling us, other than the fact that Taiwan’s domestic economy may, like many other countries, be softening and that the outflows still represent a significant amount of money leaving Taiwan and not being invested locally?
Taiwan is critically important market for regional and global trade and investment and is one of the world’s top 20 economies in terms of GDP. Taiwan is an export-dependent economy with a highly skilled workforce, and it is at the center of global and regional high-technology supply chains due to its manufacturing industries of semiconductors, 5G telecommunications, AI, and the Internet of Things (IoT).
All of that is great at this point in time. But Taiwan must continue to move forward. In many other countries it would be the government and domestic investors leading the charge, not only in terms of investment but also direct participation in the development of the nation whilst still allowing foreign investment. However, other than the activities of companies such as TSMC, it is sometimes difficult to see direct evidence of substantial domestic private investment.
But credit (no pun intended) should be given to a few of the larger Taiwanese banks, such as Cathay United, Taipei Fubon and CTBC, that are helping to financially support infrastructure projects, particularly in the renewable energy sector. More is needed and it is not encouraging to speak with domestic bankers who say their lack of participation is due to an inability to assess and therefore price the risk of such major infrastructure projects or do they simply not have the appetite?
Arguably, the government is trying to do its part, with programmes such as the Forward-looking Infrastructure Development Program. This programme aims to build infrastructure for national development in the next 30 years in areas such as railways, water environments, green energy, smart city projects and urban and rural projects to balance regional development.
However, it seems that to achieve these goals Taiwan still needs to turn to foreign investors as its finance, electronics, and wholesale and retail sectors remain top targets of inward FDI.
But there are also signs of some stagnation in this inward FDI and in some cases a reluctance by foreign investors to continue or extend their activities in Taiwan. Some have even chosen to leave the market and invest elsewhere. There are real structural impediments in Taiwan’s investment environment, such as excessive or inconsistent regulation, market influence exerted by domestic and state-owned enterprises (SOEs) in the utilities, energy, postal, transportation, financial, and real estate sectors and foreign ownership limits in sectors deemed sensitive.
It does not help the domestic cause when Taiwan has one the lowest levels of private equity investment in Asia, although private equity firms are increasingly pursuing opportunities in the Taiwan market. But even foreign private equity firms have expressed concern over the lack of transparency and predictability in the investment approvals, as well as exit processes and various regulators’ reliance on administrative discretion when rejecting certain transactions. Major industry and business groups have also called on Taiwan authorities to re-examine Taiwan’s energy generation mix and high local content requirements, which complicate foreign firms’ competition with domestic suppliers and have driven up overall costs for foreign offshore wind developers, putting Taiwan’s future energy security needs at risk.
Clearly, Taiwan needs more domestic investment. It cannot all come from a handful of the major banks and some domestic private equity investments. If that increased domestic investment comes at some expense to the levels of quarter after quarter of net fund outflows, then so be it. A solution must be found.
It is never an easy task to balance the government’s goals for growth and financial stability and investors’ demands for investment returns. Balancing any economy is not a job for the faint hearted. Taiwan must step up its domestic investment levels. Given the continued prospects of a global recession, despite a war chest in terms of its balance of payments, Taiwan must be careful to avoid the risk of overreliance on companies like TSMC. At present, the central bank, MOEA and FSC seem to be providing a steady course but there are challenges in the present and there will always be challenges in the future. Let’s see if we get to 53 quarters of net fund outflows.
Paul Shelton is a consultant with 30 years of experience in the international financial services and related industries with skills in all aspects of legal and financial crime compliance and regulatory relationship advisory and management.