The stock market recently fell below the 6000-point level, a more than 40 percent drop from peak levels earlier this year (the index plummeted 25 percent in September alone). In all, the total value of the TAIEX was driven down about NT$5 trillion. All this has prompted many to ask whether Taiwan's economy is on the whole healthy? With industry (especially the technology sectors) maintaining a high degree of growth and glowing profits, why can't this seemingly good foundation succeed in propping up the stock market? Isn't the stock market supposed to be the "window of the economy?"
Yes, it's true. When one looks at the economy, up to the end of September, imports and exports registered in excess of US$100 billion each. Each enjoyed 25 to 30 percent growth over their levels of a year ago, with the economy's annual growth rate holding above 6 percent. But at the same time, there are two hidden problems in Taiwan's industrial, economic and financial markets that are gradually eroding the economy.
First, the negative effect of industries moving offshore has become increasingly apparent. Not only have traditional industries made plans in recent years to invest in China -- one after another -- but technology companies (large ones included) have too.
The state of Taiwanese businesses in China is difficult to monitor. Since there is no way for them to repatriate profits, the performance of parent companies has suffered. What's more, when some companies invest in China, the parent company's resources are shifted to meet temporary needs. Parent companies, however, hold only a small percentage of shares in their businesses. Most of the profits derived from the Chinese subsidiaries fall into the pockets of major individual shareholders -- just one of the ways in which profits get siphoned off.
More egregious still is that when money from Taiwanese companies flows into China, the parent companies allow the situation at home to worsen, ignoring it until a financial crisis emerges, whereupon they must depend upon the government to provide financial relief -- in the form of taxpayers' money. If these two methods continue to be a model for the movement of Taiwanese firms to China, then the road ahead for Taiwanese industry truly gives cause for concern.
Second, from a financial perspective, obstacles have appeared, hindering the money-raising function of the capital markets. Though the Central Bank (CBC,
In addition, the market losses have seriously affected the ability of firms to raise funds. If the financing capacity of the banking system and capital markets is hindered, the operations of business enterprises will certainly be affected.
When investors consider these industrial and financial issues they don't dare be overly optimistic about the future, although they can see the fruits of a glowing economy. The stock market serves as an early indicator of a company's performance. If a firm's operations are not well-managed, the stock market will begin to reflect that three to six months in advance. In other words, if the "earnings" in the price-to-earnings ratio represent future "earnings," then whether the current price-to-earnings ratio is reasonable is still a moot point.
Traditional valuation models are constructed on the total present value of projected future cash flows. If there are uncertainties on the political side, including unclear financial policy, lack of a substitute energy source to replace the Fourth Nuclear Power Plant
Another special characteristic of Taiwan's stock market is that there is too much margin trading, which creates pressure to sell when the market plummets by large margins, eventually becoming a downward spiral. We still recall the stock market of a decade ago, when the index reached an all-time high of 12,000 points and then, barely eight months later -- fell 10,000 units, settling at just over 2,000. Why wasn't there any pressure to sell at that time, or so-called "systemic risk," or appeals for government intervention?
Because at that time, there was only one securities financing company. The margin trading surplus was very small and securities companies themselves couldn't do any financing. In addition, banks at that time wouldn't allow stocks as loan collateral.
But after the 1990s, new banks were allowed to be set up and 16 new banks emerged all at once. Securities financing companies also opened up, increasing their numbers from one to four, and securities firms themselves began providing credit to stock traders. Competition was fierce, and banks were gradually forced to begin granting loans on stock collaterals. Everywhere the stock market's leverage ratio increased and from then on the market needed only to fall 20 or 30 percent and a systemic risk would immediately emerge. Even if the whole market can maintain a loan coverage ratio of 160, a 25 percent fall is enough to make the loan coverage ratio drop to 120. As the standard deviation of the TAIEX's annual rate of return can go as high as 30 percent, the probability of its dropping 25 percent in one year, is quite high.
Thus, the bottom line of government intervention is that it shouldn't be undertaken when the index is at a reasonable level, but rather only when it is necessary to maintain the security of the payment system. Government intervention is not some miracle cure that can return the stock market to its past glory; reflecting on the reasons behind the market's present illness, and treating the patient accordingly -- that is the only way to get to the heart of the problem.
Some people wonder what will happen if a bailout doesn't work, if the government runs out of ammunition and can't stop the drop. Basically, this problem isn't a problem at all. As the government has to establish credibility among the people, once it announces that it will intervene in the market, there's no turning back. No matter how effectively it handles the problem, it must handle it. Otherwise, the next time government intervention occurs, who's going to believe the government?
The best example of this is the CBC's move to protect the New Taiwan dollar currency rate. At the time of the action, the CBC had already established a healthy degree of credibility, and as a result, speculators dared not oppose it. It is also important for the government to protect the security of the payment system. If this much can't be accomplished, then it can't be considered a successful government.
So, what should the government do? As mentioned before, though government intervention can maintain the security of the disbursement system, and rebuild investor confidence, it isn't sufficient to solve the market's woes. I believe that there are three things the government should do in terms of the stock market.
First, reduce financial leverage. This includes restricting the amount of loans made against common stock, as well as the total amount of loans made against the same share. Also, a moderate up-ward adjustment of margin requirements should be made. The government should moreover strengthen investigations into illegal Class C advances.
Second, increase institutional trading activities in the market, in order to lower market fluctuations. In addition, the opening of discretionary account businesses is an extremely important step.
Third, relax regulations of the Company Law
In the banking system, the following course of action should be taken. First, a financial institution merger law
Second, asset management companies should be established as soon as possible, so that banks can cast off bad assets and start anew.
Third, following Taiwan's entry into the WTO, foreign banks should be encouraged to get involved in the management of local banks, via mergers. This will raise business efficiency, and take Taiwan one step closer to having a healthy banking system.
Fourth, policy should strive to be clear. Before a consensus is reached, pains should be taken not to announce individual viewpoints. Admittedly, sending up weather balloons can be helpful in determining public opinion, but putting up too many -- or sending them out too early -- will just make people feel insecure about the government's vacillating policy. Only if political parties, the government and all its agencies adopt the same line can a force be created -- and confidence be brought back.
Lee Tsun-siou is a professor in the department of finance at National Taiwan University.
Translated by Scudder Smith
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