The Asian Financial Crisis: Disaster or Opportunity for Taiwan?

On Christmas Eve of last year, Miss Lin, an office worker, heard that the South Korean won had depreciated sharply. It occurred to her that this would be a good time to visit Korea, so she gathered some friends and went to Korea for a shopping spree. In the shopping centers of downtown Seoul, she saw deals that made her heart skip a beat: a camera made by Samsung for less than NT$10,000; and a very sharp wind-breaker for onlyNT$200. But her first reaction wasn't joy on finding such great prices. Instead, she thought, "We're finished! How is Taiwan going to compete with Korea after this?"

The weakening of the global economy and the depreciation of the currencies of Taiwan's neighbors are dual threats to Taiwan's export industries. Fortunately, the domestic market is strong enough to provide a refuge for local firms. The photo shows a local branch of the British DIY superstore, B & Q. （photo by Pu Hua-chih）

Prices spiraling downwards

The Asian financial contagion began to spread at the beginning of last July. After more than 20 years of cooperation and relative stability among the nations of the region, from Japan to the economies' of the four Little Dragons (South Korea, Taiwan, Hong Kong and Singapore) and the four Little Tigers (Thailand, Malaysia, the Philippines, and Indonesia), 1997 is a very pairful memory for all.

Take Indonesia for example, which has been hardest hit by the crisis. At the end of last June, the Indonesian rupiah was trading at 2400 to the US dollar. As of the middle of this February, it was trading at more than 9000 to one, a fall of nearly 75%. This means that the purchasing power of the currency is only one-quarter of what it was. The situation in South Korea is similar. Before the crisis, the won traded at about 800～900 to the USD, but now it trades at about 1600 to the dollar, a depreciation of over 40%. In contrast, the value of the New Taiwan Dollar (NTD)has dropped by only about 15%.

A large depreciation in a nation's currency shrinks the capital of its people and sends the economy into recession. A weaker currency causes domestic prices to soar, hurting the economy still more. However, in the long term, for export-oriented economies such as those of East Asia, this depreciation makes local goods more competitive on the US dollar-denominated international market. For example, the something over R2000 which it may have cost to produce a mug in Indonesia used to equal US$1. But with the depreciation in the rupiah, this same mug now costs only about US$0.25 to produce.

Given that most other regional currencies have depreciated more than the NTD and given the attractiveness of cheap goods, will Taiwan lose orders from the US and Europe? Will the competitiveness of Taiwan's exports suffer?

These concerns are not Chicken Littleesque fears. There are many Taiwanese firms which are already experiencing "price turmoil."

Near the end of the year, Taipei's World Trade Center puts on its annual computer and information technology exhibition. The masses of people attending and their buying frenzy attest to the success of the transformation and upgrading of Taiwan's industries.

Slash and slash again

Textured yarn, which is spun into a variety of threads which are then woven into all kinds of fabrics and artificial leather, is an example. Taiwan is the world's largest producer of textured yarn, accounting for36% of the world market, and thus has a decisive influence on global prices. But this advantage is now being challenged.

"The depreciation in the won and the extreme price cutting by South Korean manufacturers scrambling for dollars is also pulling down Taiwan's firms," says C.T. Chan, chairman of Yi Jinn Industrial, a Taiwanese textiles manufacturer. He continues angrily that textured yarn originally sold for US$1.8/kilo, but now has slipped to only US$1.3/kilo, a decline of about 30%. "With the depreciation of the currencies of South Korea and Southeast Asian nations, these countries are making more profit at the current price than they were at the old one. We, however, are suffering." But in order to pre serve their market share, Taiwan's producers are gritting their teeth and cutting their prices, too.

Chan says that in this era of global competition, if others can sell at such low prices, you have to do so, too. If you don't, then you are out of the game. Since the recent financial turmoil began, things have gotten worse. Foreign customers all come in with expectations. They think that production costs have fallen in Asia and that firms are all fighting to get their hands on US dollars to save themselves. To them, it seems only right that prices should be slashed and slashed again.

Though it hasn't lost orders from Europe or the Middle East, the result of this price cutting has been thinner profits for Yi Jinn. Luckily, as petroleum prices have remained low over the last two years, the costs of textured yarn's component materials PTA and EG have fallen greatly. In addition, the production of textured yarn is not labor intensive, so labor costs only account for about 30% of total production costs. This means that prices for the materials which make up 70% of production costs have dropped.

"The drop in the price of raw materials came at just the right time. It gives us a little room to breathe and means we won't lose money," says Chan.

Taiwan and South Korea are aggressive rivals in the petrochemical, steel and textile industries, as well as in parts of the information technology sector. While the regional crisis has meant growth for Taiwan and decline for South Korea, it remains to be seen who will ultimately come out on top. The picture is of China Shipbuilding's Kaohsiung yard.

Taiwan and Korea battle for business

Looking at the future, Chan lists several key items to watch for: Once Taiwan's rivals finish selling off their inventories, will they be able to gather enough US dollars to purchase raw materials priced in US dollars? And if they are using their devalued currencies to purchase these raw materials, will their costs exceed their expenses, causing them to lose more and more money until they simply close up their factories? Since the crisis began, interest rates have risen. In South Korea, they have shot up to current levels of around 20%. In addition, with the devaluation in the won, the foreign debt burden has increased by several times. How many companies can avoid going under? Not long ago when the crisis was at its worst, Korean companies were failing at a rate of more than 100 per day. If Taiwan's companies can only hold out until their rivals collapse, their worries about slashed prices and lost orders will be over.

Christina Y. Liu, a professor of finance at National Taiwan University, feels, "The reason orders haven't gone elsewhere might be because the situation in East Asia is still somewhat chaotic. Although American and European firms want to get their hands on lower-priced goods, they also worry that firms may go under and be unable to ship their goods. Therefore, they are not ordering from just anybody." Liu thinks that when the situation becomes more stable, lower prices will gradually take away more orders and Taiwan's firms must be prepared to respond.

Li Kao-chao, vice chairman of the Council for Economic Planning and Development, thinks that in the chemical and heavy industries, Korea's most important industries, Korea's rival is Japan. And it was Japan which was first to be hit by the depreciation in the won. Taiwan and Koreadon't compete in so many areas. Those items over which Taiwan and SouthKorea are struggling for market share are concentrated in textiles (including textured yarns), petrochemicals, steel, and information technology products such as D-RAM and monitors.

Formosa Plastics' (FPC) main product, PVC, can be used to illustrate the situation in the Petrochemicals industry. "ln Asia, the price of PVChas already fallen from US$700/metric ton to US$600/metric ton, which is below the international price," says Li Chih-tsun, chairman of Formosa Plastics. He says that although this decline is in part a result of the fall in the price of ethylene, PVC's main component, the dumping of PVC is also a factor which has pushed down prices.

For the last few years, expansion in the petrochemicals industry has occurred at a rapid pace and warnings about overcapacity and excess supply are constantly heard.

Li Chih-tsun says that every year at the annual global petrochemicals conference held on Japan's Hokkaido, South Korea's ill-considered use of debt to grab market share by expanding production to 50% above the level of its export sales has been frequently mentioned and criticized. Korea, like Taiwan, must rely on imports for all of its petroleum and therefore suffers from high costs. If it exports these products, profits are eaten up by transportation costs and customs duties. Such business doesn't profit the company at all. Li says it's just a shame that the over-arching ambition of the Korean petrochemicals industry pushes it to constant expansion. Following the mistaken business model of the SouthKoreans, Thailand and Indonesia also expanded their petrochemicals industries and sowed the seeds of their current disaster. In the wake of the regional financial turmoil, the end of expansion plans in all three countries will be of benefit to FPC.

Companies still producing goods in Taiwan have upgraded themselves. Those which could not be have been looking for overseas production sites. This kind of arrangement makes Taiwan's firms flexible and less vulnerable. The picture shows President Enterprises' Tainan headquarters.

Sorting the weak from the strong

However, Li Chih-tsun thinks that falling prices and shrinking profits are a short-term concern. Much more worrisome is the longer-term possibility that the crisis in Asia will weaken the global economy, destroying demand and sending the industry into depression. Fortunately, Taiwan's domestic market has not shown signs of going into a depression. This circumstance helps to keep things calm at FPC, which sells mainly to the domestic market. "The domestic market alone is enough to keep Formosa going," says Li Chih-tsun.

In addition, an object of much attention is Formosa's soon-to-be-completed sixth naphtha cracker. It will produce ethylene, a raw material for many petrochemical products. In the past, China Petroleum (CPC) was the island's sole producer of ethylene. Insufficient production capacity at CPC meant that the island was able to supply less than 40% of its own demand and most of the island's ethylene had to be imported. Once the sixth naphtha cracker begins production, Taiwan will be able to supply 90% of its own demand. As long as nothing happens to the local economy, the sixth naphtha cracker should generate strong profits.

Taking everything together, "Although the external situation is unstable, FPC has the vital domestic market to lean on. With the start of production at the sixth naphtha cracker, our business will grow while their ssuffers. FPC will have a good year," says Li Chih-tsun in an expression of optimism not usually heard from the cautious and conservative old hands at Formosa.

Li Kao-chao agrees, stating, "In a situation wherein the global economy weakens and trade shrinks, Taiwan's exports will be hurt and the domestic market will serve as a life-line for many local firms." He goes onto say that, fortunately, several years of stimulus by the government through its economic recovery plan led to 14% growth in private investment last year, a five-year high. This year, with the start of construction on the island's high-speed rail line and privately-owned power plants, as well as the rebuilding of mixed-use commercial-industrial zones, there is optimism about further growth in investment.

"After many years of sowing, now, when Taiwan most needs it, we are reaping a bountiful harvest. This is the result of hard work and good luck," says Li Kao-chao with satisfaction.

D-RAM is another battleground for Taiwan and South Korea. As in petrochemicals, the price war is taking place without regard for production costs. It costs about US$3～4/ piece to produce 16MB D-RAM, but at one point it was being sold for only US$1.7/ piece. Manufacturers were faced with a situation in which the more they sold, the more money they lost. TI-Acer, jointly owned by America's Texas Instruments and Acer, produces mostly D-RAM, so its product line overlaps that of South Korean manufacturers. As such, last year it lost NT$5.0 billion, the most that has ever been lost by a domestic company in one year, and was forced to stop production on one six-inch-wafer production line.

Luckily, most of Taiwan's semiconductor producers are foundries, which means they build chips to clients' specifications rather than producing their own chips for sale on the open market, or produce very high-tech products such as flash memory. In this they are different from Korean companies, which produce massive amounts of DRAM.

"The semiconductor industry developed earlier in Korea than in Taiwan, and the size and power of its conglomerates are staggering. Therefore, when Taiwan began to develop its own semiconductor industry, to avoid direct competition with these conglomerates, it intentionally went in another direction," says Huang Ho-ming, president of Hewlett-Packard, Taiwan.

The financial crisis is beginning to lose its steam. As other nations begin to lick their wounds, East Asia's economic topography is being quietly redrawn. What will Taiwan's place be in the new order? It's something for everyone to think about.

Diversity, quality, and low volume

Huang observes that the greatest difference between Taiwan and Korea's development lies in another area. In the past, both Taiwan and Korea used labor-intensive manufacturing for foreign firms and export processing to accumulate capital. But in the last ten years, the two nations' paths to development have gradually diverged. Korea has imitated Japan, with huge financial conglomerates leading industrial progress. At the same time, it has aggressively expanded its chemical and heavy industries. With its national resources concentrated in a few hands, the speed at which firms such as Samsung, LG, Daewoo, and Hyundai expanded was startling. Through mass production and aggressive global marketing, Korea quickly grabbed a piece of the global markets in steel, automobiles, home electronics and photo-electric products. By the end of 1996, Korea had pushed its way ahead of the other "Little Dragons" and had entered the Organization for Economic Cooperation and Development, sometimes known as the "Rich Nations Club." It had not only become Japan's main rival, but also the object of Taiwan's admiration.

Taiwan's industrial structure, on the other hand, is built around small and medium-sized enterprises. Such firms are limited in terms of capital and production capacity and so cannot take the market in one fell swoop. Instead, Taiwan's industries found their own niche--low volume and high-quality, diverse product lines and responsiveness to customers. Whether in traditional industries such as shoes or clothing, or in high-tech fields such as semiconductors, Taiwan's firms all exhibit these characteristics.

Huang takes information technology products as an example. In the case of low end monitors (14-and 15-inch), the differences between different clients' products are slight and so monitors can be produced on a large scale. Korea, therefore, has a production advantage. Most of Taiwan's manufacturers, on the other hand, have had to move their facilities to Southeast Asia and mainland China to better compete. But in the case of motherboards, which are the computer's nucleus, the design and features of those of each client are different. In addition, information technology products have a short life-cycle and clients update their products frequently. In this area, South Korea can't compete.

"Taiwanese firms are willing to put in the extra effort to satisfy the differing needs of different customers, something other Asian nations can't do," says Huang. This is also one of the reasons Hewlett-Packard's purchases from Taiwan have grown every year.

Although some time is still needed to fully understand the impact of the depreciation of the won on Taiwan's industry, local firms are girding themselves for battle. The situation in Southeast Asia, however, is very different.

More cooperative than competitive

"Southeast Asia is focused on labor-intensive industries. Its level of development lags behind Taiwan's," says Li Kao-chao. He states that the relationship between Taiwan and Southeast Asia is characterized by a mutually complementary vertical division of labor--Taiwan produces intermediate materials and key components while Southeast Asia relies on its cheaper land and labor to do assembly and export processing. Therefore the relationship between the two is more cooperative than competitive.

According to research by the Taiwan Institute of Economic Research, sharp depreciation in the currencies of Southeast Asia will have a relatively strong impact on only a few traditional export industries such as lumber, furniture, leather, rubber and textiles. But these industries only account for a very small proportion of Taiwan's exports and their influence on Taiwan's economy is slight.

However, many of the Taiwanese firms that have relocated production to Southeast Asia still buy intermediate materials and equipment from Taiwan. In addition, as those local economies prospered, they imported a large amount of consumer goods from Taiwan. This has led to Southeast Asia becoming Taiwan's fourth largest export market, after the US, mainland China, and Europe. Last year, it accounted for 12% of Taiwan's exports, of which half were intermediate materials for export processing.

Put another way, Taiwan shouldn't be worrying about greater SoutheastAsian competitiveness in exports eroding its own share of the global market. Instead, Taiwan should be worried that if Southeast Asia's exports stagnate and its economies bottom out, Taiwan won't be able to sell anything to it.

Put another way, Southeast Asia simply can't compete very well with Taiwan and, in fact, competes with the mainland. Many scholars cite 1994's33% devaluation of the mainland's currency, the Renminbi (RMB), as one of the factors which sparked the current Asian financial turmoil. The devaluation of the RMB increased the competitiveness of the mainland's exports, taking some of the wind out of Southeast Asia's sails. Now the worm has turned and it is the mainland that is sacrificing export competitiveness to protect its currency. The many thousands of Taiwan's firms for which the mainland is a primary market and production base "are all in the same boat" and the seriousness of their situation cannot be understated.

Take Yi Jinn, which produces textured yarns, for example. The mainland market accounts for 30% of its operating revenues and most of its customers there are Taiwanese exporters. Since the financial storm began, the company has seen its mainland China orders drop by 20～30%, causing its operating revenues to drop by nearly 10%.

Data shows that last year, Taiwan's trade surplus with Hong Kong (and the mainland) was a record-setting US$26 billion, three and a half times Taiwan's overall trade surplus of US$7.6 billion. The situation is the same as that in Southeast Asia in that the overwhelming majority of the products Taisells to the mainland are intermediate materials which are purchased by Taiwanese firms doing export processing. If the competitiveness of the mainland's exports begins to weaken and the trouble spreads to Taiwanese firms, it is possible that Taiwan could begin running a trade deficit.

The good news is that many Taiwanese firms, whether they are engaged in sales or production, are employing a "double down" strategy in Southeast Asia and the mainland. If mainland demand shrinks, then these firms will throw themselves into opening up Southeast Asian markets to make up for lost mainland revenues. If production costs drop in Southeast Asia, then they will transfer a portion of their production there. By distributing their risk, no matter where these firms are producing or selling their goods, money is going to continue to flow into their pockets.

Positive, but for how long?

Because Taiwanese firms have their own niche markets, they feel that the effect on them has been negative in the short term, but will be positive in the long term. If they can but survive the current depressed prices and this period of economic adjustment, Taiwan's sound firms will look very good in comparison to their beat-up rivals.

Sylvia Hu, a market analyst specializing in the Korean market at the Institute for Information Industry, has her doubts. She wonders how long this positive "long term" will last. And what comes after this "long" period?

William W. Shang, president of Chung Shing Textiles, feels that Korea's technology and production capacity have not been destroyed overnight; they still exist. And neither Southeast Asia's natural resources nor the economic vitality that has been created by the development of the last few years have disappeared. He uses the metaphor of a race to illustrate his point: "Maybe your opponent has fallen down in a turn and losta heat, but that doesn't mean he's out of the race. With the guidance of a good coach, he'll be right back in the thick of things in the next heat, and you can't really predict who'll win in the end."

Ray B. Dawn, director of Research Division Ⅵ at the Taiwan Institute of Economic Research, thinks that the financial storm is losing some of its strength. If things go smoothly in each country--the political situation remains stable, there are no riots, and economic reforms are implemented-- "there will be a two- to three-year recovery period." In other words, Taiwan can use the time while these other economies are licking their wounds to move in. "To the north, it needs to catch up with Korea. To the south, it needs to increase the lead it has over the countries of Southeast Asia," states Dawn.

Lately many firms have become interested in acquiring or investing in companies in South Korea and Southeast Asia, a policy which Dawn approves of. He says that for something like a semiconductor plant, construction and equipment costs run to tens of billions of NT dollars. "They are built of money." If it happens that the supply of capital is cut off, others can take advantage of a company's financial needs to become partners in it or acquire it. He feels that turning a rival into an ally is a good approach. Not long ago, there were rumors that Samsung, Daewoo and others were interested in approaching Taiwan for financial assistance. Taiwan's northward ambitions may be on the verge of becoming reality.

A warning to Taiwan

Hu, who has a deep understanding of Korea, reminds Taiwan's industries not to be overly optimistic. She says that its current economic slowdown and limited capital mean that Korea is facing a redistribution of resources, "but regardless of how it changes, high technology will still be its first priority. It won't be easy for Taiwan to take a piece of its pie." And buying into a firm only helps it to weather the crisis and rebuild, something of limited benefit to Taiwan.

In fact, it is Taiwan's firms which are clearest on these points. Last year, Acer and Taiwan Semiconductor were involved in discussions on building a chip packaging plant with Korea's Anam Group, the world's largest chip packager and the possessor of much-desired technologies. Negotiations had been wrapped up, but the plans had to be brought to a halt because the regional financial crisis had left Anam unable to raise the money to buy into the partnership.

If these companies think so highly of Anam, why didn't they loan it the money themselves? Acer had it reasons. Philip Peng, vice president of corporate finance and investment management at Acer, says, "If Anam didn't put its own money into the venture, it wouldn't have been much hurt if the venture failed. It would therefore have taken this joint venture less seriously." He says that Acer hopes for a close partnership and real cooperation. Therefore Acer is not really very concerned about a delay; it can wait. And when Anam has the money, they will see what happens.

Korea has invested big money in research and development and in buying technology from Europe and the US. It naturally has a technological edge over Taiwan in industries such as semiconductors, photo-electronics, consumer electronics and cars. And Taiwanese firms naturally would like to take advantage of the depreciation in South Korea's currency to buy technology from it. But the recent shocking accusations involving Taiwan's Nanya Technology have poured cold water on these plans.

Hu says it all started in July of last year when Nanya signed contracts with a Korean technology broker. At that time, who knew that Korea would be sucked into the regional crisis? When the authorities were tipped-off, Korea had just been given loans by the International Monetary Fund (IMF), and their national pride was smarting at the "economic bailout." The breaking of this case made Taiwan appear to Korean eyes like a thief come to steal from a burning house.

Hu remembers being shocked at seeing newspaper headlines which read "A Warning to Taiwan" when she visited Korea to gather information at the end of last year. "At such a moment, what Taiwanese would dare discuss cooperation with the Koreans?" ask many scholars.

Taiwan and Korea have been competitors for many years, and so it is very difficult to make any moves northward at such a sensitive time. On the other hand, Taiwan and Southeast Asia have been working together or many years. It seems that now is the time to move southward.

Stabilization and expansion to the south

"As a friend, Taiwan can encourage private investment in Southeast Asia," says Council for Economic Planning and Development head P.K. Chiang, who just returned from a fact-finding mission to the region. He says that the government can, by providing funds to banks, make money available to Taiwanese firms operating in the area to help them solidify their already extant operations. It can also encourage those with the resources to go further by making new investments.

"We can tread the paths of stabilization and expansion simultaneously," says Chiang. (See "Go South Ⅱ--Can Taiwan Help End Asia's Crisis?" in this issue.)

C.Y. Kao, CEO of the President Group and chairman of the Chinese National Federation of Industries, went with Chiang on his trip. Kao feels that now is the time to make investments and acquisitions in the region. With the exception of Indonesia, all the countries in the region are stabilizing and the crisis seems to be winding down.

"If you wait for things to settle down completely, they won't want your money anymore." Kao thinks that if you want high returns, you have to take some risks. But the potential reward must be greater than the risk.

The President Group currently has two factories in Southeast Asia--an instant noodle factory in Indonesia and a fruit juice factory in Thailand. But based on his own experience Kao says, "In investing overseas, money isn't the problem, people are." In setting up a factory--the construction, sales, finances, management, etc.--a few people are not enough. And on top of all this, you have to collate all kinds of information onl ocal laws, the political situation and the business environment. "If a firm relies entirely on its own resources to enter a market, it's an exhausting business!"

The recent fact-finding mission arranged many meetings between overseas Chinese business people and Taiwanese business people. But in the wake of all the hubbub, how many deals will be worked out? It's still too early to say.

Kao bluntly states, "President won't flatly refuse any cooperation, investment or acquisition opportunity. But we don't have the personnel to do research and evaluate such opportunities. We can only wait passively for our opposite numbers to send information to us."

In order to deal with the difficulty of finding suitable people overseas, Kao recommends that business people follow the same model that Taiwan employed in Central America: firms put up the capital to establish a holding company which then gathers information, makes evaluations, provides advice and invests on the parent company's behalf. This method not only saves manpower, it also reduces the risk of failure. "If you want to jump in, you'd better move fast. It would be best to have your funds ready to go and start looking for investment opportunities within a month," Kao advises. Although nearly 70 years old, Kao is as aggressive as about achieving his ambitions as a young man.

It's not over 'til it's over

Regardless of how many opportunities there may be to take investment southwards, the eyes of most firms are fixed upon the Chinese mainland. YiJinn, which has five factories in Taiwan, has already decided that its first overseas plant will be located in the mainland city of Hangzhou. And last year Acer received approval from the Investment Commission of the Ministry of Economic Affairs to set up a factory in the Zhongshan areas of Guangdong. Before the regional crisis, many Taiwanese firms had plans to move production from Southeast Asia to the mainland because currencies in Southeast Asia were relatively high and labor costs had risen. However, now that these currencies have dropped sharply, Southeast Asia has become much cheaper than the mainland and many firms will likely give up these relocation plans, choosing instead to stay where they are.

But much remains uncertain. As Hewlett-Packard's Huang Ho-ming put it, the Asian financial crisis was like a boulder dropped into a lake. The financial world was right at the point of impact, while the manufacturing industries were spread around the edges. The affects of the crisis are coming to them like waves from the center. When will an industry be affected? How strongly will it be hit? Taiwan's firms can only keep forging ahead through the waves.

While the foreign media has been heaping praise on Taiwan of late, saying that it is the least affected of the Asian economies, a "lucky survivor" which stands to benefit, local firms have not forgotten that disaster and good fortune are two of a pair.

"We can't relax. It's not over 'til it's over," says Kao.