The Taiwan dollar climbed twice as fast as the Chinese yuan in the past three months, reaping the benefits of strengthening trade and investment ties with the world’s fastest-growing major economy. The island’s currency appreciated 5.6 percent versus the greenback since Aug. 20, while the yuan has risen 2.2 percent as Chinese President Hu Jintao said this month foreign-exchange policy changes will be “gradual.” Taiwan’s economy expanded 9.8 percent in the third quarter, completing its longest stretch of outperforming the mainland in 19 years. Taiwan’s currency rallied as stock exchange data showed foreigners bought a net $1.7 billion of domestic equities since the start of November, boosting this year’s net purchases to $6.3 billion, after the government signed a trade pact with China in June. Investors pared bets over the pace of yuan appreciation as China deflected criticism of its currency policy at the Group of 20 meeting in Seoul on Nov. 12. “The trade pact has made Taiwan-China relations closer, making it a very good proxy for the yuan,” said Samson Tu, who helps manage the equivalent of $1.6 billion of fixed-income securities in Taipei at Uni-President Assets Management Corp. and is buying Taiwan dollar corporate bonds. “A booming Chinese economy will mean more appreciation of the Taiwan dollar.” Relations Thaw Relations have improved since Taiwan President Ma Ying-jeou won elections in March last year, abandoning his predecessor’s pro-independence stance. The island has enjoyed self-rule since Chiang Kai-shek’s Nationalists fled the mainland in 1949 after losing to Mao Zedong’s Communists in a civil war. Under the trade agreement, China agreed to open markets in 11 service sectors such as banking and to cut duties on Taiwanese imports worth $13.8 billion last year, or about 16 percent of the total. Taiwan’s economic growth of 9.8 percent in the three months through September followed expansions of 12.9 percent in the second quarter and 13.7 percent in the first. The figures were faster than similar rates for China of 9.6 percent, 10.3 percent and 11.9 percent, the longest run of outperformance since 1991. The Taiwan dollar rose 0.2 percent to NT$30.628 as of 5:40 p.m. local time, while the yuan was little changed at 6.6416. The island’s currency has climbed 11 percent in the past five years, lagging behind the 22 percent gain in the Chinese yuan. The correlation between the Taiwan dollar and the yuan increased to 0.65 in October from 0.17 the previous month. A reading of 1 would mean the two currencies moved in lockstep. Forward Cues The 12-month non-deliverable forward reflects bets the yuan will rise 2.9 percent to 6.4625 over a year, while contracts for the Taiwan dollar indicate a 3.7 percent gain to NT$29.53. The annual cost of insuring China’s foreign-currency debt for five years using credit-default swaps fell 2 basis points on Nov. 19 to 60, according to CMA prices. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should the government fail to adhere to its debt agreements. Taiwan has no similar contracts. Taiwan’s benchmark 10-year yield of 1.37 percent compares with 3.74 percent in China and 2.89 percent for the U.S. Treasury bond due in 2020. The island’s stocks have rallied, with the Taiex index closing at the highest on Nov. 10 since June 2008. “It’s Taiwan’s improving ties with China that makes the shares very attractive,” said Yosuke Mimaki, fund manager in Tokyo at Mitsui Sumitomo Asset Management Co., which has $128 billion of assets under management, including Taiwan equities. Flood of Investment Taiwanese companies have poured $8.7 billion into China in the past nine months, compared with $6.1 billion in 2009, according to data from the island’s Overseas Chinese and Foreign Investment Commission. They sold a record NT$344.3 billion of bonds this year, helping fund expansion in China, according to data compiled by Bloomberg. Taiwan’s shipments to China jumped 18 percent in October from a year earlier, accounting for more than 26 percent of total overseas orders. Taiwan’s Foxconn Technology Group, whose flagship Hon Hai Precision industry Co. makes Apple Inc. iPhones and Dell Inc. computers, said Aug. 18 it planned to add 400,000 more staff to its almost 1 million workforce in China in 2011. “A lot of the huge Taiwanese corporations have their manufacturing segments in China,” said Erik Lueth, a Hong Kong- based senior economist at Royal Bank of Scotland Group Plc, who forecasts the Taiwan dollar will be at NT$29.5 by the end of 2010. “The product mixes of China and Taiwan are much more similar than other Asian economies.” Investment Limits China has currency controls in place that have deterred foreign funds from investing in yuan debt, allowing the currency to trade only within a certain range and controlling foreign investment in its markets through quotas. The central bank said it will raise the reserve ratio requirement for the nation’s banks by 50 basis points, or 0.05 percentage point, from Nov. 29, after its purchases of foreign exchange flooded the economy with cash. Taiwan has also acted, with regulators ruling on Nov. 9 that offshore funds can only invest up to 30 percent of their portfolio in the island’s debt. The central bank said Oct. 19 it will step into the market when the currency “overshoots.” The Taiwan dollar has climbed more than 1 percent during the day for the past 14 days, only to lose most of its gains in the final minutes of trading. Spencer Lin, head of the foreign-exchange department at Taiwan’s central bank, declined to comment. “A little bit more liquidity and less regulation might make me consider adding the Chinese yuan and the Taiwan dollar to my fixed-income portfolio,” said Kei Katayama, who helps oversee the equivalent of $55.7 billion as leader of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., a unit of Japan’s second-biggest brokerage. To contact the reporters on the story: Andrea Wong in Taipei at awong268@bloomberg.net; Yumi Teso in Bangkok at yteso1@bloomberg.net To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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