(Bloomberg) -- Taiwan’s economic and financial decoupling from China has deepened with the near-collapse of what was once the world’s largest Chinese bond exchange-traded fund market.
It’s the latest example of the widening gap in relations between the two economies over the past decade due to geopolitical tensions, Western-led derisking of supply chains and China’s economic slowdown. And no matter the outcome of January’s critical presidential election in Taiwan, the decoupling — from markets to finance to investments and trade — is likely to continue.
As of early this month, local ETFs that track Chinese bonds, including sovereign and policy bank notes, have seen their total assets under management plunge more than 94% from a peak of over NT$180 billion ($58 billion) in 2019, according to data compiled by Bloomberg.
Taiwan isn’t alone in retreating from China. The cratering value of those ETFs echoes the broader investment landscape, in which global funds have fled China’s bond market due to the nation’s vast yield differential with the US.
But Taipei’s relationship with the world’s second-largest economy is particularly scrutinized, given its role at the center of US-China geopolitics. The consequences of next month’s election are massive, with voters positioned to choose between a ruling party determined to maintain Taiwan’s political independence and an opposition that wants closer ties with Beijing.
The local market for investing in China-linked fixed income securities in Taiwan was introduced five years ago, when the island’s top brokerage house led the charge to launch the first exchange-traded fund tracking China’s treasury and policy bank notes.
That product attracted a lot of interest, with the success of the ETFs at least partially driven by promising yields for yuan-denominated bonds because of China’s more favorable rate differential with the US. Having the Chinese government and policy banks as debtors also helped ensure credibility.
That’s changed with widening US-China yields. Another key contributing factor: The Taiwanese government introduced rules for insurer investments that required them to hold at least a BBB- rating from global ratings agencies.
While the government said the regulation was intended to prevent an over-concentration of insurers’ investments, it effectively made it impossible for those insurers to hold China-backed ETFs.
As long as those restrictions remain in place, “credit ratings from one of the three major global ratings firms are necessary” for Taiwanese life insurance firms to enter the market again, according to KGI Securities, a Taipei-based brokerage.
Taiwanese banks have been reducing their financial footprints in China. Their exposure to the world’s second-largest economy has fallen in each of the last 10 quarters, and are now at record lows, according to Taiwan’s Financial Supervisory Commission.
Many firms are shifting their business out of China as part of a global trend often referred to as “China+1” that involves setting up shop in other regions to manage supply chain risks — whether in the wake of pandemic-related export disruptions or because of geopolitical tensions and trade curbs.
Iconic Taiwanese firms have cited such changes among clients as part of their expansion or diversification plans. Taipei-based Cathay United Bank Co. Ltd., for example, has been boosting headcount in Southeast Asia. Financial conglomerate Fubon Financial Holding Co. said it has capped positions in China since the pandemic.
Through the first 10 months of this year, Taiwanese direct investment into China fell almost 40% from 2022, according to Taiwan’s Ministry of Economic Affairs. It’s on track to record the sharpest decline in year-on-year terms since 2019.
“There have been signs of looser ties in terms of FDI and visitor flows” over the last seven-to-eight years, said Michelle Lam, Greater China economist at Societe Generale SA in Hong Kong.
Lam chalked up part of the drop-off to increased cross-strait tensions. In that time period, the pro-independence Democratic Progressive Party led by President Tsai Ing-wen has been in power. The ongoing US-China trade war and other geopolitical factors are also at play.
That’s also unlikely to change, even if a more Beijing-friendly candidate for president replaces Tsai.
“If a company builds a new factory in Southeast Asia, it’d continue to allocate operational resources and divert orders there,” said Yang Shu-fei, an economist at the Taipei-based Chung-Hua Institution for Economic Research. “It can’t stop doing so just because cross-strait tensions ease.”
China and Hong Kong accounted for around 35% of Taiwan’s total overseas shipments through the first 10 months of 2023, compared to a 44% share in 2020. Goods sent from Taiwan to China fell in almost every category, from food to machinery.
While the world’s largest manufacturing hub remains the linchpin of many supply chains, it has become less attractive in recent years as wages rise and as China offers fewer local subsidies for business. Geopolitical strains once again loom large, too, given Washington’s export bans on Beijing.
Opposition candidates in the upcoming election — including the Kuomintang’s Hou Yu-ih — have stressed the need to build more business links with China. Taiwan People’s Party candidate Ko Wen-je has said he’d prioritize for the island to join the Regional Comprehensive Economic Partnership, of which Beijing is an original member.
Ko has said that deal may be “easier” for Taiwan to join as compared to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which both Beijing and Taipei have applied to join. That trade pact — Asia-Pacific’s biggest — is one that the ruling DPP candidate Lai Ching-te has said he would continue to attempt to lock down.
Even so, the decoupling trends in cross-strait economic ties might be here to stay.
“The presidential election outcome will undoubtedly have a significant impact on cross-strait relations in at least the next 4 years,” said Woei Chen Ho, an economist at United Overseas Bank. “But the diversification story is part of a larger global trend.”
--With assistance from Jack Wang.
©2023 Bloomberg L.P.