Stocks are down, private consumption is falling, leading indicators are heading south and the confidence is at its lowest point in recent years. If that is not enough, the budget deficit at a record high, which leaves financial officials angst-ridden.
Well, not exactly, if history is any indication. The current situation makes for a perfect scenario to turn on the monetary taps (translation: cut interest rates). The Central Bank of China (CBC) should cut its reserve requirement ratio (RRR), interest rate banks pay for deposits kept at the CBC as a ratio of their own total deposits, as soon as possible to inject the much-need confidence and money into the economy.
Cutting the RRR will surely send the stocks north, thus abruptly reversing the anemic sentiment in the stock market, which has now lost nearly 15 percent since the President Chen Shui-bian's
First, higher share prices will feed into the economy and allow domestic financial institutions more breathing space to redress their balance sheets. Most investors have borrowed money with stocks as collateral, which means as prices plunge, the value of collateral go down as well. That may force banks to sell their collateral, which may push the stock market down in a negative self-reinforcing cycle. In short, a nightmarish scenario for the new government.
Second, with the US economy slowing down, lower interest rates will give the island's troubled traditional industries a much-needed boost. It will lower the cost of capital for the companies, which are financed by bank credit, thereby creating a win-win situation for both lenders and borrowers.
Third, lowering interest rates will help desynchronize the local economy from the US business cycle. By so doing, the CBC may help the local economy become less vulnerable to the now-confirmed slowdown in the US.
Fourth, the local stock market has now become almost dreadful in its mimicry of the Wall Street, thanks to the symbiotic ties of the high-tech industry between the two countries. Lower interest rates in Taiwan may indirectly inject resilience in the Taiwan's stock market by pushing up or at least, stabilizing the non-high tech shares such as banking, property and other blue-chip industrials, even though such shares seems set to head south.
Fifth, the good news is that Taiwan has plenty of room to cut interest rates, for its reserve requirement ratios still remain one of the highest in the world.
Sixth, few in the markets are expecting a interest rate cut now. Central Bankers love to surprise the markets with surprise moves, because only by adopting unexpected moves do they achieve the desired ends.
Tsering Namgyal is a Masterlink Securities research economist.
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