By Ralph Jennings
TAIPEI, March 1 (Reuters) - The threat of military conflict between Taipei and Beijing has been fading, but investors in Taiwan still face a range of political risks.
Following is a summary of key Taiwan risks to watch:
* INTEREST RATE POLICY AND CAPITAL CONTROLS
The central bank says it will maintain a loose monetary policy for now, and economists expect rates to stay relatively low through 2010 unless the U.S. Fed acts sooner. Policy tensions could arise if the central bank feels the need to start focusing on containing inflationary pressures while the government remains committed to sustaining the nascent economic recovery.
Another key issue is coping with flows of "hot money" that have been buoying Asian asset prices. The central bank has said it hopes $11 billion in foreign speculative money would start flowing out, and moved to stop speculation in the island's currency market. The monetary authority regularly intervenes in the currency market to offset appreciation due to foreign fund inflows, dealers say. Earlier this year the central bank told local and foreign banks to ensure they follow regulations when trading foreign exchange forward contracts, a move seen as another effort to discourage hot money.
What to watch:
-- Comments by ministers and the central bank on monetary policy, for hints of when the benchmark discount rate will be raised.
-- Any sign that capital controls could be tightened further, if hot money inflows do not subside. This would push down the Taiwan dollar. However, analysts do not expect the kind of rigid capital controls that would cause a major exodus of foreign investors.
* CROSS-STRAIT RELATIONS
President Ma Ying-jeou's promotion of closer economic ties with China has boosted trade and reduced the risk of military conflict. The government will press ahead with achieving an economic cooperation framework agreement, the precursor to a free trade deal. Taiwan's stock market opened this year to qualified Chinese investors. But the issue of ties with China remains highly divisive in Taiwan and there is always the risk of new controversies, most recently the Sino-U.S. row over Washington's planned $6.4 billion arms sales package to the self-ruled island that Beijing claims as its own. In local elections last December, seen as a test of Ma's policy of engagement with Beijing, his government lost some ground.
What to watch:
-- Fallout from the row over U.S. arms sales. If the issue threatens progress in closer economic ties with China, the impact on Taiwan asset prices will be negative, with stocks of firms that have benefited from greater access to China hit the hardest.
-- The chance of a historic meeting between Ma and Chinese President Hu Jintao, tipped to take place in 2012 if Ma wins reelection that year. It would signal strongly improved ties.
-- Results of tense year-end local elections covering about 60 percent of the electorate and the island's major cities. If the ruling party wins big, it signals more trade dialogue with China. If the opposition gains, China relations could sour.
* GOVERNMENT EFFECTIVENESS
Ma has a strong mandate to govern, as the KMT controls parliament and the presidency. This has been positive for government effectiveness and avoiding political deadlock.
But widespread criticism of the response to Typhoon Morakot last year dented government popularity and led to a cabinet 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. The high degree of polarisation between the two major parties, the China-friendly Nationalists (KMT) and the anti-China opposition Democratic Progressive Party (DPP), raises questions about government effectiveness.
What to watch:
-- Markets are unlikely to be impacted much by any political controversies unless they significantly weaken the KMT's hold on power. If that happened, the risk of policy deadlock and frostier ties with China would weigh on prices.
* ECONOMIC REFORM
Taiwan continues to place limits on foreign portfolio investment and restricts foreign direct investment in some sectors. As the economy recovers, investors will start to focus again on whether economic reform may relax some restrictions.
What to watch:
-- Any announcement from the government on economic reform and measures to boost foreign investment. This would be broadly positive for the stock market.
(Compiled by Andrew Marshall and Ralph Jennings)