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TAIPEI -- The Hong Kong stock market's relative resilience to the news from Belgrade shows the robustness of investor sentiment toward Asia at present. It is a moot point whether U.S. embarrassment over the incident will lead to a more compromising approach in Washington on


negotiations. The positive from a Beijing point of view is that the U.S. now has less claim to the moral high ground in terms of the ongoing debate about human rights, espionage and the like. Still, the official manipulation of nationalist sentiment in China may have undermined this tactical advantage, potentially hardening attitudes in the U.S.


Zhu Rongji

, the nearest thing to a free marketeer in cadre China, may be forced temporarily on the defensive against conservative forces naturally suspicious of everything associated with the WTO. But reform will continue. The need to get the economy going has been reconfirmed by the latest inflation data, showing the sharpest monthly drop in consumer and retail prices so far this year. The deflationary trend has not been arrested yet. Still, the real depreciation of the renminbi, which is the natural consequence of continuing Chinese deflation, is reducing the need for a competitive devaluation. This is especially the case since export prices elsewhere in Asia are now rising.

Turning back to world financial markets, all eyes remain glued on the U.S. bond market. The best outcome for everyone would be if rising bond yields do the


tightening job for it. As for equities, the increasingly positive tone of the U.S. stock market, both in terms of greater breadth and better-than-expected reported earnings, suggest that the bull run is not over. Thus, yesterday Wall Street shrugged off

Robert Rubin's

resignation and

Boris Yeltsin's

latest fit of pique. Greed & Fear is cognizant of that favorite City of London maxim, "sell in May and go away," but will remain for now more than fully invested in the dedicated Asian portfolio.

In Taiwan this week Greed & Fear detected concern that the bombing of the Chinese embassy in Yugoslavia would cause Washington to make concessions to Beijing at Taipei's expense. Still, such worries remain a side show to the dominant sentiment, which is growing confidence that the economy is on a solid recovery path as a result of the pickup in exports and the underlying strength of consumption. In this context

ABN Amro Asia

has raised its official forecast for Taiwan's 1999

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growth to 5%. A chief virtue of Taiwan's economy in recent years is that it has been virtually alone in Asia in being consumption-driven. This reflects the reality of a fast-growing economy with positive demographics, where wealth is evenly spread.

The strength of consumption explains why consumer lending is the prime focus of Taiwan's banking industry. Greed & Fear, among others, was worried late last year that Taiwan risked heading into an Asian-style banking crisis. These concerns came to the fore in the selloff in the stock market, which climaxed in early February as evidence of a credit crunch mounted. The banking problem seems to have been addressed by the decisive government policy response announced immediately after Chinese New Year, which combined steep cuts in reserve requirements with aggressive reductions in taxes levied on the banking sector. The package was especially effective, from a sentiment point of view, because the market had been expecting the government to continue to follow the Japanese approach to its banking problems (i.e., to pretend there was no problem and do nothing).

The chief feature of the package was to use taxpayers' money to deal with the banking problem, by cutting the tax on interest income from 5% to 2%, without making the fact that it was a taxpayer bailout transparent. The sensible aim is to get the banks to deploy the money raised from the tax cut to write off nonperforming loans. The positive development this week is that the authorities are maintaining this pressure. The

Ministry of Finance

met with local banks urging them aggressively to write off nonperforming loans and to ensure that the nonperforming loan ratios do not exceed those recorded in April. To encourage this provisioning process, the ministry said that the writing off of the loans will now be fully tax-deductible. At present taxes can be deducted only on nonperforming loans amounting to 1% of total loans.

This latest initiative provides further reason to maintain a positive stance on the banking sector, since further write-offs this year will pave the way for better earnings next year. Particularly interesting could be the three big state-run commercial banks (

Chang Hwa


First Commercial


Hua Nan

), which have more nonperforming loans and therefore will need to do more to make sure those loans stick at April levels. These banks, which have underperformed the private banks in recent months, must benefit from this trend in anything but the short term. Sophia Cheng, ABN Amro's Taiwan banking analyst, who correctly called the turn in the bank stocks in February, remains positive on the sector, arguing that an estimated peak nonperforming loan ratio of 7% to 8% has already been discounted by the market and that the government is now focused on improving the sector's efficiency.

Greed & Fear would concur with this view. It is also a fact of asset allocation that, with the finance sector accounting for 28% of the Taiwan


constituent index and with foreign investors traditionally having low exposure to this sector, there is a powerful incentive for fund managers to increase their holdings in banks at a time when plunging 64-megabit memory-chip prices are reminding people once again of the commodity nature of the dynamic random-access memory business. Exposure in Taiwan is needed, especially given the risk that if MSCI moves Taiwan to a 100% weighing it would comprise, based on end-of-April data, 26% of the

MSCI Far East Free ex Japan

index. After electronics, banking is the major sector foreign investors can buy.

The Taiwan banking industry is worth putting into some context given its history and its growing profile. It is an extremely fragmented industry, the result of the entry of 15 private-sector players in 1991. This led to a significant decline in the return on equity achieved by the industry as the new banks competed for business. Still, the fragmented nature of the industry masks significant differences between players, since the nonperforming loan burden is not evenly spread. This is why banks with low nonperforming loan levels, such as

Bank Sinopac

, will enjoy a windfall from the tax cut announced in February since they do not need to take the same amount of write-offs. Sinopac's nonperforming loan ratio is only 0.8%.

But the main bullish point for the long term is that the scare caused by the severity of the recent credit crunch, as manifested by plunging stock prices and high-profile corporate failures, has served one critical function. It has made the government realize it needs to promote consolidation in the industry to produce a much healthier banking sector in which economies of scale will allow for greater long-term profitability and which should be sufficiently capitalized to withstand the inevitable future post-WTO fallouts as Taiwan's domestic businesses are exposed to more foreign competition. With the country's private sector dominated by medium-size and small enterprises, corporate lending is inevitably that much riskier than in some other countries, especially given the local penchant for zaitech.

Real consolidation in the banking sector will have to wait until after next year's presidential election in March. But the trend in official policy seems clear. If the local banks prove reluctant to move in this direction, the government may opt for the stick of allowing foreign banks to take over one or two local players to provide the necessary pressure for change. Another trend to watch out for in terms of the future development of the financial services industry in Taiwan is mergers of banks with local securities companies. Given the banking sector's focus on consumer lending, the attraction of linking up with Taiwan's retail-oriented securities firms seems obvious, with the ultimate objective of developing a business based on American-style cash management accounts.

So the mini-financial crisis, which gripped Taiwan during the last months of 1998 and the first quarter of 1999, will therefore probably turn out to have been a catalyst for healthy change in the local banking sector. Meanwhile the attitude of Taiwan banks to credit extension remains relatively cautious, especially in corporate lending, given the recent scare and still-rising nonperforming loan levels. But Greed & Fear hears that local banks have just in the past month become more willing to make commitments in the syndicated loan market. This is another sign of improving sentiment.

One of Greed & Fear's present obsessions is the contrasting demographics between aging Japan and the rest of Asia. Greed & Fear heard one Taiwanese banker this week tell fund managers in a presentation that the average age of the firm's employees was 31, while a DRAM producer claimed an even younger demographic profile, with the average employee aged only 28.

The contrast with Japan, where companies are continuing to meet labor-reduction targets by not hiring graduates, could not be greater. The unemployment rate in Japan for those aged between 15 and 24 was 10.9% in March, double the official overall figure of 4.8%. The system could hardly be more screwy. Japan is finally restructuring but in its own way. The rigidities and perversities of the Japanese labor market should, however, not be underestimated.

Christopher Wood is the global emerging market strategist for ABN Amro and the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While Wood cannot provide investment advice or recommendations, he welcomes your feedback at