Relations between the United States and China will be reshaped after the Taiwan elections. The markets are just waiting.

 Relations between the United States and China will be reshaped after the Taiwan elections.  The markets are just waiting.

Taiwan is kicking off a record year for elections around the world, with voters heading to the polls on Saturday. The outcome could cause ripples in the tense relationship between the United States and China – which claims democracy on the island as its own.

However, the impact on markets may be more subdued.

Although Taiwan is small, it casts a long geopolitical shadow. Not only is the country’s dominant semiconductor industry vital to the global economy, but the island is located in a critically important location militarily as the rivalry between the United States and China intensifies, giving the presidential election a great deal of attention. Voters in Taiwan prefer to maintain the status quo even as Chinese leader Xi Jinping said in his New Year’s speech that reunification is inevitable.

Opinion polls show a close race, with Vice President Lai Ching-ti, of the ruling Democratic Progress Party, ahead of former KMT candidate Hu Yu-a, favored by mainland China, a former policeman turned KMT convert. Ko Wen-jie, former mayor of Taipei and member of the New Taiwan People’s Party (TPP).

A DPP win – which would be unprecedented because it would be the first time the party has secured a third consecutive term – could hit the market a bit at first as investors worry about China’s reaction. Analysts pointed out that Beijing likes Lai even less than current President Tsai Ing-wen. Lai’s comment in the recent presidential debate that China and Taiwan had no affiliation sparked a backlash from Beijing.

Fund managers and analysts see little impact on markets in the near term, even as they expect the election to reshape cross-Strait relations over time. This view could be upended if the election is affected by political interference, if the results lead to protests, or if a landslide victory by the ruling Democratic Progressive Party prompts China to respond in new and more aggressive ways than it did when former Speaker of the House Nancy visited. Pelosi Taiwan in 2011. 2022.

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Markets appeared to reflect the muted view in the near term, closing at a record high of 27% as foreign and domestic investors increased their allocations amid expectations of a recovery in semiconductors and AI-related companies. the

iShares MSCI Taiwan

The ETF is down 4% so far this year.

How China responds will be crucial. Lai’s party is expected to win by a narrow margin, and the opposition is likely to obtain a majority in the Legislative Council.

“Beijing would need a bigger provocation than simply electing Lai — such as aggressive pro-independence rhetoric — for it to resort to a major show of force,” Gavical analysts Yanmei Xie and Tom Miller wrote in a note to clients. “Investors are right to discount downside risks and position themselves for the upside.”

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While China may resort to sanctions, Mark Williams, chief Asia economist at Capital Economics, expects such moves to be relatively modest and in line with a decline in the status quo in recent years. He said any sanctions would block the island’s biochips and other tech products, which China has not previously sanctioned — likely because they would cause damage to its economy.

“This reticence is unlikely to change with another DPP leader winning the presidency, as long as Lai does not deviate from President Tsai’s policies,” Williams wrote in a note to clients.

However, an opposition victory could lift stocks – in Taiwan and perhaps those related to China, as it pushes fears about a Chinese invasion of Taiwan from the list of near-term geopolitical risks. China could also roll back some of the sanctions it imposed on Taiwan, where travel sanctions, with a ban on individual tourist visits that began in 2019, have had the greatest impact. A complete reversal could lift Taiwan’s GDP by about 1% over the next two years, according to Capital Economics.

If the opposition wins, TS Lombard’s chief economist Rory Green favors local Chinese companies with exposure to mainland China, such as Foxconn Technology.

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; And tourism and agricultural companies as Beijing seeks closer cross-Strait relations. He will also sell Taiwanese defense companies because the opposition is unlikely to spend the same amount of money on strengthening the army.

For investors concerned about China’s future unification plans, the focus is on how China will respond over the coming year.

“China faces enormous economic challenges right now, and the focus is very much on that,” economist Qiu Jin, author of “The New China Rules of the Game: Beyond Socialism and Capitalism,” said at the City Year Ahead conference this week. “The desire for peace is underappreciated in a country with so many people who have a vivid memory of what turmoil and instability mean.”

Gafkell analysts also downplayed the risk of a heated conflict in the Taiwan Strait in the next two years, pointing to reports of chaos in China’s armed forces as Xi has fired more than a dozen senior military officials. US intelligence reportedly found missiles filled with water instead of fuel.

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If the report is correct, analysts expect it will be some time before Xi is able to launch a successful military action against Taiwan. Perhaps the biggest ticket will come from the US elections in November, and how the new administration handles its relations with China.

The biggest risk in the medium term could be Beijing’s economic blockade of Taiwan rather than an invasion. Those looking to prepare for global risks in the event of a DPP win could buy Korean chipmakers and sell Taiwanese chipmakers as companies look to diversify, TS Lombard’s Green said at a recent press conference.

Write to Reshma Kapadia at [email protected]

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