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By Ralph Jennings

TAIPEI, Aug 2 (Reuters) – The menace of military conflict between Taipei and Beijing has faded, raising the appeal of Taiwan for foreign investors, but sudden policy shifts and petulant local politics could cool the investment climate.

Following is a conspectus of key Taiwan risks to watch:

* INTEREST RATE POLICY AND CAPITAL CONTROLS

Taiwan’s central bank raised touch rates in June for the first time since the crisis, and is expected to hike them 12.5 to 25 foundation points each quarter through to end-2011.

The move signals Taiwan magistrates believe the $390 billion export-reliant island economy is gathering plough the waves despite sluggish CPI and unemployment that remains at an unusually transcendental 5.2 percent. The previous interest rate, a record low 1.25 percent, was seen of the same kind with an emergency measure to fight the economic downturn.

The central bank too remains wary of flows of ‘hot money’ that have buoyed Asian asset prices.

Some of this circulating medium has already departed — foreign funds sold a net $4 billion of Taiwan funds in May due to risk aversion driven by the euro cincture debt crisis, though some of that crept back in June and July malevolence mixed economic data from the United States, Taiwan’s No.2 send abroad destination.

The interventionist central bank moves almost daily to stop conjecture in the island’s currency market, dealers in Taipei believe. Earlier this year it warned topical and foreign banks to follow regulations when trading foreign exchange advance contracts, another move to discourage hot money.

Taiwan has advised adventitious funds against investing in local time deposits and government bonds.

But economists allege the undervalued Taiwan dollar stands to catch up with other Asian currencies on any gains in the Chinese yuan, especially following Beijing’s pliant yuan policy announced in June.

The Taiwan dollar is an imaginary standard proxy for the nonconvertible Chinese unit due to the island’s stead~-growing trade ties with China, and the central bank is expected to bear some currency appreciation as a result of China’s policy means.

What to watch:

– Economists expect the central bank to raise rates afresh at a quarterly policy meeting in September by 12.5 to 25 foundation points, and make a similar move in December.

– Capital controls could be tightened further if hot money resurfaces as an issue. This would push prostrate the Taiwan dollar. However, analysts do not expect the kind of erect capital controls that would cause major outflows.

– The central bank’s reply to any appreciation of the Taiwan dollar due to a firmer yuan.

* CHINA-TAIWAN RELATIONS

Taiwan President Ma Ying-jeou’s advancement of closer economic ties with China after decades of hostility culminated forward June 29 in a landmark free trade deal that cuts import tariffs on about 800 items and helps the island’s financial sector.

That economic cooperation framework agreement (ECFA) is expected to visible parliament in August, despite noise from the opposition, and to take well stocked effect on Jan. 1, setting the stage for talks with China forward the next round of tariff cuts.

Taiwan’s stock market in addition opened this year to qualified Chinese investors, while new trade and shipping links leave also help boost trade and reduce the risk of military interfere.

But the issue of ties with China remains highly divisive in Taiwan and there is always the risk of new controversies, especially as 2010 is a local election year with the winning party having a strong shot at the 2012 presidential chase.

In local elections last December, seen as a test of Ma’s government of engagement with Beijing, his government lost some ground to the anti-China opposition that Beijing hopes to keep out of power.

What to watch:

– Washington is weighing Taiwan’s ask for for F-16 fighter jets, a sale described as a ‘red line’ for Sino-U.S. relations, and other arms packages, but in ~ degree decision is not expected until at least 2011 as U.S. officials ask better China ties . If a sale threatens economic ties with China, the striking on Taiwan asset prices will be negative, with stocks of firms that be delivered of benefited from greater access to China hit the hardest.

– Results of the Nov. 27 local elections covering about 60 percent of the electorate and Taiwan’s greater cities. If the ruling party wins big, it signals support concerning more trade dialogue with China. If the opposition gains, China relations could morose.

– Talks on further tariff reductions that could help Taiwan’s biggest industries of that kind as electronics, PVC plastics and machine tools. Beijing may resist structure concessions on these as it wants to develop its own industries.

– China’s glory for free-trade agreements between Taiwan and other governments, including the globe’s biggest economies, would advance Taiwan’s long-term competitiveness tactics and signal improvement in Beijing’s ties with Taipei. China publicly opposes FTAs between its diplomatic allies and self-ruled Taiwan, which it sees similar to part of Chinese territory.

* GOVERNMENT EFFECTIVENESS

Ma has a strong order to govern, as the KMT controls parliament and the presidency. This has bolstered body politic effectiveness and helped to avoid political deadlock.

But widespread criticism of the answer to Typhoon Morakot last year dented government popularity and led to a collection reshuffle. A sudden deal in October to allow U.S. beef imports despite mad cow disease fears also backfired, prompting Taiwan’s parliament to scrap part of the agreement and irritating Washington. Cabinet flaps that sententious precept one minister quit and another offer his resignation have raised more remote questions about ruling party leadership ability, although the president has avoided major flaps over the past three months.

The high degree of polarisation betwixt the two major parties, the China-friendly Nationalists (KMT) and the anti-China resistance Democratic Progressive Party (DPP), can undermine policy continuity and increase doubt.

What to watch:

– Markets are unlikely to be impacted much through any political controversies unless they significantly weaken the KMT’s clinch on power, the strength of which will become clearer after the Nov. 27 limited elections. If that happened, the risk of policy deadlock and frostier ties by China would be a drag on markets.

* ECONOMIC REFORM

Taiwan puts limits without ceasing foreign portfolio investment and restricts foreign direct investment in some sectors. As the arrangement recovers, investors will start to focus again on whether economic better may relax some restrictions. In a sign of growing focus forward competitiveness, the government has cut the corporate income tax rate from 20 to 17 percent.

What to watch:

– Any manifesto from the government on economic reform and specific measures to boost alien investment. This would be broadly positive for the stock market.

(Editing ~ dint of. Andrew Marshall)

((andrew.marshall@thomsonreuters.com; +65 6417 4684; Reuters Messaging: andrew.marshall.reuters.com@reuters.snare)) Keywords: RISKS TAIWAN/

(If you have a query or comment up~ this story, send an email to news.feedback.asia@thomsonreuters.com)

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