The Taiwan Banker

Since early 2020, the pandemic has had a profound impact on global economic and financial markets. Many countries responded with expansionary fiscal or monetary policies. It took until March this year for several major central banks to raise rates. Taiwan’s performance in this wave of the pandemic has been commendable, and S&P Global Ratings announced on April 29 that its (long-term) credit rating will be upgraded from "AA" to "AA+", now on par with the US. The outlook is also “stable,” confirming that the short-term rating will remain unchanged at the highest level of “A-1+.” This marks a rare long-term rating upgrade for two years in a row.S&P's “AA+” rating is second only to the highest “AAA” rating enjoyed by countries such as Canada, Australia and Singapore, is comparable to advanced countries such as the US, Finland and Austria, and surpasses neighboring Japan, South Korea and China. It also strengthens the international image of our government and the people. Furthermore, it has reduced the cost of raising funds a critical moment when most central banks around the world are entering the cycle of raising interest rates. All of this could be called a gift package for Taiwan brought by the Ministry of Finance.S&P affirms Taiwan’s performance is not an accidentStandard & Poor’s country risk rating mainly considers four key sub-factors: 1. economic risk; 2. institutional risk; 3. financial system risk, and 4. payment culture and rule-of-law risk. Due to strong export demand for its electronic products, Taiwan’s robust economic performance is gradually increasing incomes to levels commensurate with stronger economic ratings, so economic risks can be effectively controlled. S&P also forecasts that Taiwan's economy will grow by 2.8% in 2022, with per capita GDP increasing to US$ 33,900. Taiwan’s GDP trend growth rate is even significantly higher than other economies with high growth rates due to base period effects.In addition, demand for Taiwanese semiconductors has increased due to the accelerated pace of global digitization caused by the pandemic. As a result, S&P believes that Taiwan’s improved per capita income levels will be sustained by strong growth prospects, and while rising geopolitical tensions represent headwinds to Taiwan’s export-oriented economy, this will not affect its overall export competitiveness. S&P also believes that Taiwan will continue with its reopening policies.Remarkable results two years in a rowBesides the S&P, the long-term credit rating and outlook given to Taiwan by the other two major international credit rating agencies over the years (see Table 1) also reveal some interesting insights.Source: S&P Global Ratings, Trading Economics, collected by authorMoody’s credit rating upgrade on February 24, 2021, for example, is the first time since 1994 that Moody’s has raised its rating outlook of Taiwan (the long-term rating remains at Aa3). This affirms that despite the pandemic, Taiwan’s fiscal performance remains excellent. Moody’s also forecasts that Taiwan’s fiscal deficit to GDP ratio will drop to 1% in 2021, which is significantly lower than other countries with Aa ratings, and the Taiwan government strictly abides by the Public Debt Act. Therefore, Taiwan has more of a fiscal buffer to cope with sudden shocks than other countries. Moody's also said that Taiwan has benefited from strong global demand for semiconductors and high-tech products, the pandemic has been properly controlled, and relevant countermeasures have successfully handled the impact of the escalating trade war better than expected. Of course, a flexible exchange rate policy and substantial foreign exchange reserves have also enhanced the effectiveness of its monetary and macroeconomic policies.Fitch raised its long-term rating to “AA” on September 10, 2021 – the first time it has raised Taiwan's sovereign credit rating in nearly five years, and the first time it has ever upgraded Taiwan to the “AA” level. The main reasons it provided include economic performance relative to other peer countries during the pandemic, further strengthening of trade, and continued fiscal prudence.Taiwan has outperformed other countries in response to the pandemic and related impacts in recent years. The prospects of its semiconductors and other industries are still strong, driving future growth momentum, and it has effectively reduced risks, supported by sound finances.Beyond just direct benefitsSovereign credit ratings are not only important to governments, but also to domestic bond issuers such as financial institutions, corporations and the public sector. Traditionally, the credit rating of the central government is often the highest rating that the country can obtain (the “country ceiling”). It is usually only a small number of large multinationals who could possibly exceed rating of their government.The direct benefit of better long-term credit ratings is lower cost of debt funding for the government and state-owned enterprises. Since the proportion of Taiwanese government bonds held by foreigners is very low, the immediate short-term impact may not be significant. According to Central Bank statistics, the external balance of long-term and short-term public debt at the end of 2021 was US$ 1.572 billion.The second benefit is the higher credit ratings of state-owned enterprises and financial institutions, and subsequent lower cost of debt financing. Following S&P’s long-term sovereign upgrade, on May 4, China Credit Ratings (CCR) announced a long-term credit upgrade of AIDC from “twAA-” to “twAA,” and also affirmed Taipower, Taiwan Water Corporation, Taiwan Railway and Taoyuan Airport Co., Ltd. at “twAAA/twA-1+,” the highest long- and short-term ratings.In addition, two days later on May 6, CCR also upgraded the credit rating of Taiwan Cooperative Bank, receives special government support due to its systemic importance in the domestic banking industry, from “twAA+/twA-1+” to “twAAA/twA-1+,” and upgraded its subordinated bonds issued in 2012 from “twAA” to “twAA+.” At the same time, CCR also affirmed the ratings of several private financial institutions such as Bank of Taiwan, Agricultural Bank of China, Changhua Bank, Cathay United Bank, and Taipei Fubon. Thus, sovereign ratings upgrades can bring substantial benefits to the financial sector.Considering the information asymmetry between the buy and sell sides of the bond market, credit rating agencies are an indispensable reference indicator, helping determine the liquidity of bonds and degree of investor acceptance. Therefore, in addition to the signal of the rating upgrade itself and associated impact on capital cost, the greater significance is the information released, and impact on domestic and foreign markets.Ensuring long-term development advantagesThe attention from the upgrade will be temporary. In the longer term, it is important to plan and implement policy action to ensure these results and advantages can be maintained. Therefore, we need to make good use of the resulting foreign investment confidence, capital inflow, and lower capital costs to strengthen investment to improve subsequent economic performance.Looking at the current capital supply side in Taiwan (Figure 1), excess savings has been considerable in recent years, and is still expanding. The continuous outflow of funds from Taiwan has failed to substantially aid industry development. This pattern does not consider the country’s long-term interests, and also limits the added value and business mentality of the local financial industry. Source: National Income Statistics SummaryTherefore, this is a critical moment to review our overall development environment and find ways to combine the real economy with financial capital. In recent years, we have seen more and more risks, from the US-China trade war, outbreak of the pandemic and Ukraine war to the rise of inflation, causing increasing financial market turmoil. If Taiwan can make good use of the rating upgrade, it may be able to create a new round of opportunities. For example, we could take this opportunity to raise funds to strengthen investments such as infrastructure, and produce more profitable investment projects. The repatriation of funds from Taiwanese businesses overseas will assist long-term GDP growth and industry development.Just as leverage can magnify ROE for financial institutions, deficit budgeting is not an appropriate policy tool for governments. It is wise to borrow for infrastructure when the benefits of the funding cover the principal and interest of the resulting debt. Neighboring Singapore’s AAA rating, for instance, is related to its careful investment in public works over the past years.In addition, the government and related organizations can take this opportunity to fund public construction, or encourage development of forward-looking industries. In addition to guiding savings to reshape Taiwan, they can also support bond market planning. A system of public bonds can be established, as in the US. Issuance of more diverse bonds and instruments, coupled with systems to encourage financial institutions to enter the market, and attract and cultivate financial talent, thereby introducing liquidity from domestic and foreign capital, and completing the domestic primary and secondary public bond markets, will bring about a positive cycle in domestic fixed income markets. This will help build a yield curve with more complete information, and even re-awaken development of the government bond futures market to match the primary and secondary markets with each other, as well as spot and derivatives markets.This achievement in ratings has not come easily, and the recent improvement in IMD World Competitiveness Ranking also demonstrates Taiwan's stable finances, industry advantages and responsive performance over recent years. In addition to the immediate short-term effect, it will also be necessary for Taiwan to coordinate development of an industrial and financial transformation strategy.The author of this article is Deputy Director of the Communication and Publication Center of TABF.