Managing Taiwan’s economic fortunes during the past couple of decades has been far from trivial. Not only has Taiwan – a small, relatively open economy – been hit by global and regional events, such as the Asian financial crisis, a 7.6-magnitude earthquake, the burst of the dotcom bubble, the 9/11 attacks, the Sars epidemic, the US subprime crisis and the European debt crisis. It has also had to manage a complex relationship with a resurgent China, which overall has resulted in closer cross-straits economic integration, as well as increased international isolation for Taiwan.
One of the stewards of Taiwan’s economic success is Perng Fai-nan, governor of the Central Bank of the Republic of China (Taiwan), or CBC, since 1998.
Perng, who joined the central bank in 1971, has built up a formidable reputation as a dedicated public servant (he has rarely taken any time off) who can roll up his sleeves and tackle micro issues while also relating to the broader macro context. After analysing challenges and identifying potential dangers, he has also demonstrated the self-confidence and resolve to implement action plans to address them, despite some of these policy measures often going against developed-world conventional wisdom at that time.
There is little doubt that during his tenure, Perng and the CBC have effectively fulfilled the mandates set out by Taiwan’s central banking law: to promote financial stability; guide sound banking operations; maintain the stability of the internal and external value of the currency; and foster economic development.
Perng has also been an early adopter of macro-prudential measures to forestall asset bubbles, implemented a progressive approach to capital account liberalisation and applied capital flow management to maintain exchange rate stability. Overall, he has been a stabilising force during episodes of international financial crises, as well as several periods of heightened political tension in Taiwan.
Taiwan’s forex architect
One of Perng’s early achievements was to reform the CBC’s ‘centre-rate system’ for foreign exchange (forex), first set up in 1979. The system came under increasing pressure in the 1980s, as it failed to reflect the actual exchange rate in terms of transactions between banks and customers in a timely manner. After being made head of the forex department in 1989, Perng set about transforming the system into what would in effect become a ‘managed float’.
His approach was to enable the spot rate to be determined by the market and fluctuate within each business day (in contrast to the centre rate, which was fixed throughout the whole day). Limitations on bank-customer buying and selling of US dollars were also removed. In the forwards market, both the scheme for setting the reference rate for forwards transactions and the limit on the rate fluctuations were abolished. Commercial banks could determine the forwards rate and individuals were permitted to freely buy or sell in the forwards market.
In principle, this allowed the new Taiwan dollar exchange rate to be determined by market forces. But when seasonal or irregular factors led to what the CBC considered ‘excess’ volatility or ‘disorderly’ movements in the exchange rate, the central bank could step in to maintain an orderly market. Over the years, the CBC has built up a war chest of some $450 billion of forex reserves to deploy when interventions are required. Such a large stockpile of reserves are important, particularly as Taiwan has no recourse to the International Monetary Fund.
“As director of the forex department, Perng became the principal architect behind the creation of Taipei’s interbank forex market,” says Yang Chin-Long, CBC deputy governor.
As director of the forex department, Perng became the principal architect behind the creation of Taipei’s interbank forex market
Yang Chin-Long, CBC
“The work done by Perng at this time remains the basis of the current system today, and the reformed system was later used as a reference model by some other emerging economies to build up their own markets.”
Yang adds that Perng is a “prodigious reader of national income accounts” – a skill he acquired as the head of the balance of payments division earlier in his career: “This special talent enabled him to spot vulnerability in Thailand, Indonesia and the Philippines two years ahead of the outbreak of the Asian financial crisis.”
Perng’s concerns were included in a paper he wrote in 1995 on the Mexican peso crisis for the Encyclopedia of Finance.1 It noted the Philippines, Indonesia and Thailand had all been running current account deficits, and were reliant on foreign capital inflows – which, in the case of Thailand, were mostly of a short-term nature. “This should be a cause for concern,” said Perng.
Two years later, in mid-1997, the Asian financial crisis started, as the weaknesses that Perng had pointed out were exposed. Moreover, the conventional policy prescription – to adopt floating exchange rates and launch expansionary policy – were failing to address the issue. Perng’s view was that conventional policy could exacerbate the problematic conditions during a large-scale crisis, as a free-falling exchange rate could continuously drain domestic financial markets and prompt massive capital outflows, rendering ineffective loose monetary policy.
Stopping capital flight
Instead, Perng – who was named CBC governor in February 1998 (the US dollar/new Taiwan dollar exchange rate had already fallen from about NT$28:US$1 in June 1997 to below NT$34.5:US$1 by January 1998, despite Taiwan’s current account surplus) – adopted a different set of policies.
“I decided to suspend new Taiwan dollar non-deliverable forwards trading to close the loopholes and shut speculation down,” Perng tells Central Banking. “That decision proved effective in stopping capital from bleeding out. Since devaluation expectations were cleared away and a capital drain averted, monetary easing was able to successfully stabilise the economy and foster sustainable growth.”
The suspension of non-deliverable forwards trading was criticised as a backward step for financial liberalisation. “However, the way I see it, if external negative shocks induced by the free market jeopardise economic and financial stability, the necessary countermeasures are warranted,” says Perng. “Later, this disputed action proved to be the right move that helped Taiwan’s financial market and financial system to shape up.”
Perng’s intervention (alongside Taiwan’s sound economic fundamentals, current account surplus, ample forex reserves and low foreign debt) helped to ensure the Taiwanese economy remained relatively unscathed during the Asian financial crisis.
“Perng’s unique insights on the intricacies and peculiarities of the forex market would allow him to act swiftly and decisively during the darkest period of the Asian crisis,” says the CBC’s Yang. “He not only saved Taiwan from financial ruin, but also provided technical support to several neighbouring countries to fend off currency speculators.”
Capital account management
Central to preserving Taiwan’s stability was Perng’s challenge to the prevailing wisdom of deregulating the capital account without putting sufficient safeguards in place. Perng also believes capital account liberalisation should follow a progressive path with the correct sequencing – something that was implemented in Taiwan long before the IMF relented on its advice related to capital controls in the early 2000s.
Perng also grasped that ‘corner solutions’ are merely a subset of a wider range of policy options that can resolve aspects of the impossible trilemma of monetary independence, fixed exchange rate and capital mobility. The CBC governor believes that an intermediate solution, in which effective capital flow management can make capital mobility compatible with exchange rate stability and monetary independence, represents a superior policy mix for Taiwan.
One of the lessons Perng has learned is that short-term capital tends to be highly volatile in nature. An excessive surge in capital inflows might plant the seeds of a currency crisis
One of the lessons Perng has learned is that short-term capital tends to be highly volatile in nature. An excessive surge in capital inflows might plant the seeds of a currency crisis by contributing to a real appreciation of the local currency, a build-up of external debt, an explosive growth in domestic credit and a current account deficit, and an equity or property market bubble. Once the bubbles burst, a sudden financial reversal can result in a breakdown in the financial system.
As a result, the CBC has closely monitored short-term capital flows to ensure they do not become a disruptive force to the economy. Other policies include removing distortions from the market, improving bank risk management, and providing market participants with accurate and timely information.
At the same time, Taiwan has also opened up to foreign investors. But this has been a gradual opening of Taiwan’s capital account, accompanied by enhanced management to stem capital flow-induced risks – the types that emerged during the international financial crises in 1997 and 2008. This allowed the economy to stay relatively stable compared with the turmoil overseas.
The exchange rate policy adopted by the CBC plays another important role. The movement of the new Taiwan dollar’s nominal effective exchange rate (Neer) has been a key contributor to macroeconomic stability. Studies by the CBC show both the new Taiwan dollar and the Singapore dollar are anti-inflationary and countercyclical, and therefore helpful to macroeconomic stability. The Neer tends to move higher to restrain price increases when inflationary pressure rises. When there is a slowdown in economic activity, the Neer moves lower to moderate the negative impact.
Unpopular abroad …
“Taiwan’s central bank has traditionally been quick to check on and, if necessary, restrict capital inflows, making its governor, Perng Fai-nan, an unpopular figure at certain foreign financial institutions,” said Nomura Research Institute chief economist Richard Koo in 2013. “But it was only because the authorities kept such inflows in check that the Taiwanese economy escaped from the 1997 Asian currency crisis largely unscathed.”2
… but popular at home
Indeed, Perng’s intervention to restrict portfolio flows will remain an enduring part of his legacy. Pro-market financiers, even including some western central bankers, have criticised such interventions in the past. But local business people in Taipei recount with pride Perng’s efforts to thwart the likes of currency speculator George Soros, who made billions of US dollars betting against Asian currencies. “He is something of a hero here,” says one. “He beat George Soros – twice!”
The global financial crisis
The CBC’s monetary flexibility and effective policy responses under Perng’s leadership also appear to have helped Taiwan’s economy ride out the global financial crisis and recover within a relatively short time.
The credit squeeze brought on by the US subprime mortgage debacle was not just limited to the US and Europe. Some Asian economies also experienced liquidity shortages, particularly as western banks withdrew funding. In response, Perng once again focused on the forex market first, to keep the new Taiwan dollar dynamically stable compared with other currencies.
The CBC then moved quickly to provide liquidity to financial institutions in 2008, to ensure sufficient funds to support economic growth. The overall effort ultimately included reducing reserve requirements, expanding repurchase facilities and cutting the policy rediscount rates seven times (2.375 percentage points). Taiwan’s success in maintaining price stability was due in large part to the “central bank’s credibility and its timely and effective policy implementation”, said Fitch Ratings in a credit report in 2009.3
The CBC response to the global financial crisis once more showed Perng’s resolve when dealing with frothy prices. It demonstrated he was not a subscriber to the prevalent doctrine among most leading developed-world central banks at the time that it was better to clean up after bubbles burst, rather than to use policy to lean against potential bubbles – a viewpoint that was subsequently reversed post-crisis.
The CBC response to the global financial crisis once more showed Perng’s resolve when dealing with frothy prices
When, in 2009, a combination of property tax cuts and local residents repatriating their overseas investments back to Taiwan because of fears of a freefall in asset prices in global markets financial crisis led to increased housing prices, particularly along new subway lines in Greater Taipei, the CBC imposed restrictions on housing loans in specific areas, on land-collateralised loans and on high-value housing loans. The CBC’s efforts, along with the government increasing property tax, cooled the speculative demand for houses.
“These measures, now known in developed countries as macro-prudential policy, have been a part of Taiwan’s monetary policy responses,” Perng tells Central Banking. “We know it as selective credit management, and have used it to promote economic and financial stability as needed. We have achieved great results with macro-prudential measures. The housing prices have begun a soft landing, and banks have greatly enhanced their credit risk management.”
As the IMF said in 2011, the CBC’s targeted prudential measures for the housing market “have been effective in limiting the build-up of risks to financial stability”.4
Support for SMEs
Another important support for the Taiwan economy at this time stemmed from Perng’s earlier intervention to change the way credit support to small and medium-sized enterprises (SMEs) was protected. Taiwanese officials say Perng took the initiative to modernise the SME credit guarantee programme, when in 2003 he recommended that Ministry of Finance, a financial regulator at the time, hand over the programme to the Ministry of Economic Affairs, an economic planner.
His logic was that, while a financial regulator must look out for the security of banks, an economic planner is more likely to ensure credit continues to flow to the SMEs when conditions are tough. In the midst of the global financial crisis in 2008, Perng urged the government to increase funding to the SME credit guarantee programme, relax the eligibility of applicants, and expand the size and coverage of credit guarantees. These measures helped ensure credit continued to grow to Taiwanese SMEs, during a period when their peers in both the US and Europe were experiencing a severe credit crunch.
Predetermined macro-pru targets
Meanwhile, once the CBC’s macro-prudential policies hit their predetermined target levels, and housing prices were no longer a severe threat to financial and economic stability, Perng began to relax part of the measures against property lending from August 2015. Moody’s gave a positive review for how Taiwan had proactively and effectively used macro-prudential measures and taxation to boost housing market soundness. Fitch Ratings, meanwhile, pointed to the resilience of Taiwan’s banks, saying they would have sufficient capital as a buffer to sustain a 30–40% slump in housing prices. “Perng’s methods are often unorthodox,” says Yang. “He defied prevailing wisdom when he introduced macro-prudential measures to stabilise Taiwan’s real-estate market in 2009. By targeting specific geographic hot spots and particular segments of the housing market, Perng engineered a soft landing that saw house prices tapering, rather than collapsing.”
Renminbi and cross-straits relations
Meanwhile, as Taiwan’s trade relations with China grew, starting in 1993, the CBC gradually opened up banking between the two sides, albeit with some setbacks as tensions flared. To facilitate the settlement of cross-border trade for Taiwanese companies, offshore banking units and overseas branches of Taiwanese banks were approved to conduct renminbi business in July 2011.
The CBC also started discussions with the People’s Bank of China about establishing a currency clearing mechanism. Taiwanese officials say Perng spotted the renminbi’s potential as an international currency, as well as the potential for Taiwan to be a major offshore renminbi centre by leveraging Taiwan’s trade surplus with China.
Perng is credited in Taiwan as being a driving force behind the signing of a memorandum of understanding on cross-straits currency co-operation in August 2012 between the CBC and the People’s Bank of China
He is credited in Taiwan as being a driving force behind the signing of a memorandum of understanding on cross-straits currency co-operation in August 2012 between the CBC and the People’s Bank of China. This paved the way for the development of the local renminbi business by making the Chinese currency available for settling cross-strait transactions and meeting growing local demand for renminbi-denominated financial products (although a cross-currency swap agreement remained elusive because of political issues). Taiwan’s domestic banking units started to conduct renminbi banking services in 2013 and Taipei is now a major offshore renminbi centre, alongside Hong Kong, Singapore and London.
Perng also encouraged the broader development of Taiwan’s foreign currency clearing system, which came into operation in 2013. His vision was to create a settlement platform that would connect domestic banks not only with each other, but also with local securities depositories, international settlement platforms and foreign securities depositories. Such a platform would process transactions involving multiple currencies, whether the counterparties are located in the same country or in different time zones, on a payment versus payment or delivery versus payment basis.
This vision has largely been realised with the successive introduction of renminbi, US dollar, yen and euro settlement platforms in Taipei over the past three years. Both legs of a transaction involving two different currencies can now be both settled in Taipei simultaneously with no time-lag risk at a fraction of the original cost. The operation of the platform helps shorten processing time and reduce costs, with the foreign currency clearing platform saving the public more than NT$1.9 billion ($64.3 million) in processing fees, according to the CBC.
The recognition of the importance of a real-time gross settlement system (RTGS) to lower systemic risks during periods of financial turmoil was recognised back in 2002, when Perng set up a task force that ultimately revamped the entire domestic payment system. Thereafter, all interbank payments in Taiwan were settled on an RTGS basis.
This proved to be critical five years later, when RTGS effectively contained the damage created by two failing financial institutions, The Chinese Bank and Great Chinese Bills Finance Corporation, and prevented the spread of panic to the entire banking system.
“Much of Perng’s work is mundane and underrated, but no less consequential,” says Yang. “He laboured tirelessly to improve Taiwan’s financial infrastructure in order to boost resiliency. His pre-emptive efforts to revamp RTGS, for example, paid off handsomely when a systemic crisis was averted following the collapse of two local banks in 2007.”
Taiwan’s economic performance and financial development during Perng’s tenure is noteworthy and demonstrates success in all four of the CBC’s mandate under the Central Bank Act. For example, Taiwan has exhibited remarkably low and stable inflation: Between 1998 and 2016, Taiwan registered an average consumer price index inflation rate around 1%, with 1.11% annual volatility. It is a similar story with the dynamic stability of the new Taiwan dollar exchange. CBC statistics for annualised 20-day standard deviation of exchange rate change indicate it is far less volatile against the US dollar than the euro, yen, won and even the Singapore dollar. Meanwhile, the non-performing loan ratio of domestic banks has declined from 11.27% in 2001 to 0.27% in December 2016, while the provision coverage ratio has risen to 502.93% over the similar period.
This has taken place against a backdrop of continuing economic growth – the Taiwanese economy expanded at an average rate of 3.89% in 1998–2016, more than 1 percentage point higher than the global average of 2.77%.
“During Perng’s 20-year tenure, he has not only fulfilled is legal mandates successfully but also carried out pioneering work and reshaped the thinking behind conventional central banking policy,” says Yang.
Throughout this time, Perng has also been a fierce defender of central bank independence, something that has been recognised externally. “Taiwan’s central bank is fully independent and enjoys one of the best reputations in Asia for its cautious and reliable interest rate policies,” says Bertelsmann Stiftung in its 2016 Taiwan country report.5
And Perng stands out as a guardian of financial and economic stability. “We live in a fast-changing world, especially in the economic and financial areas – that’s why I have set out to ride the rapids with flexible monetary and forex policy and pre-emptive financial reforms,” says the outgoing governor.
Nomura’s Koo tells Central Banking: “He allowed the Taiwanese economy – a small, open economy facing the threat of over 2,000 Chinese missiles aimed at it for the last two decades – to weather both the Asian currency crisis in 1997 and the global financial crisis in 2008. And he was able to do so because he stood firm against pressures from those financial types who wanted Taiwan to become just another playground for them to play and speculate in.”
Koo says Perng is “a role model” for all central bank governors “who must balance the benefits of open capital account and the need for domestic financial stability”.
And the Nomura chief economist is not alone in his praise. “Governor Perng has been an outstanding central banker,” says a former top central banker and regulator in the region. “I can’t fault him for long service and a steady helm.”
No greater calling
For Perng himself, there appears to be no greater calling than public service. When he retires in February 2018, he will have spent 43 years with the central bank, 20 of them as governor. His tenure spans four different presidents and 14 premiers. In addition to lucrative private-sector openings, he says he was offered the premiership by former president Ma Ying-jeou (who awarded Perng the ‘First Rank Order of Brilliant Star’, the highest civilian order of the nation in 2016) on two separate occasions. He also says he was asked by the current president, Tsai Ing-wen, to be her running mate during both her 2012 and 2016 election campaigns. He never yielded. Placing integrity and independence before power and prestige, he stayed where he felt he could do the greatest good.
“I really appreciated their kind offers,” Perng tells Central Banking, but adds that he viewed it as important to “see through the job on my hands”: “Doing solid work in the central bank to steady and steer Taiwan’s economy towards sustained prosperity – that is my best place to serve the country.”
Perng Fai-nan’s ‘anti-hero’: Alan Greenspan
Asked by Central Banking in his offices in Taipei if he had any role models that had offered him guidance and insight during his 43-year career, Perng Fai-nan replies “Alan Greenspan”, chairman of the US Federal Reserve Board from 1987 to 2006.
Perng goes on to explain: “Mr Greenspan had certainly set many good examples. However, what intrigued me more was how the Fed, while committed to its inflation target, did not put the same level of emphasis on financial surveillance and failed to spot the speculative bubble inflated by lax management in property-related financial services.”
Perng adds that Greenspan dismissed the worries of a bubbling housing market, describing the situation as merely local “froth” in his US Congress testimony in 2005: “By 2007, the Fed and other regulators were finally alarmed, but that problem had reached a point beyond saving.”
Perng believes Greenspan’s failings served as a “negative role model” – not “only to me”, but to “the world’s central bankers”.
1. Perng Fai-nan, ‘The Mexican peso crisis’ in Encyclopedia of Finance (Springer, 1995).
2. Weisenthal, Joe, Richard Koo: emerging markets are in for a ‘tumultuous new era’, Business Insider, August 27, 2013.
3. Fitch Ratings, Credit Analysis: Taiwan, November 2009, page 8.
4. International Monetary Fund, Policy responses to capital flows in emerging markets, April 2011, pages 25–26.
5. Bertelsmann Stiftung, BTI 2016: Taiwan country report, 2016.
The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Rachael King, Victor Mendez-Barreira, Iris Yeung, Joel Clark and Tristan Carlyle
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