Taiwan's Currency Conundrum: The Risks Of A Sharp TWD Rebound

Taiwan’s export-driven economy has long depended on a carefully managed exchange rate to maintain global competitiveness, particularly in high-tech sectors like semiconductors and electronics. But mounting financial and geopolitical pressures are now exposing a deep structural vulnerability: the risk of a sharp and potentially destabilising appreciation of the Taiwan dollar (TWD).

While a stronger currency often signals investor confidence and macroeconomic strength, in Taiwan’s case it may trigger consequences that undermine its export model, strain monetary policy, and heighten financial market volatility.

Export-Led Growth Meets Exchange Rate Fragility

Taiwan’s economic structure leaves it especially sensitive to foreign exchange movements. More than 60% of GDP comes from exports, with a heavy concentration in high-value-added sectors like semiconductor fabrication and electronics manufacturing. Flagship firms such as TSMC and Foxconn operate under tight global pricing constraints. Margins are highly sensitive to currency fluctuations, particularly when competitors in South Korea, Vietnam, and China maintain more favourable FX conditions.

For years, the Central Bank of the Republic of China (CBC) has informally managed the TWD to maintain competitiveness without attracting accusations of manipulation. However, current macroeconomic forces are making this balancing act harder to sustain.

What’s Driving Appreciation Pressure?

Several overlapping forces are now pushing the TWD upward:

1. Surging Capital Inflows

Global investors, drawn by Taiwan’s dominance in the semiconductor supply chain, are pouring capital into equity and bond markets. The post-pandemic boom in AI-related infrastructure has boosted investor appetite for firms like TSMC, driving foreign portfolio inflows. These inflows naturally increase demand for TWD.

2. US Dollar Weakness and Policy Divergence

As the US Federal Reserve approaches the end of its tightening cycle, the dollar has shown signs of softening against Asian currencies. Meanwhile, Taiwan maintains a sizable current account surplus, and its domestic inflation has remained relatively contained. This mix adds upward pressure on the TWD, especially as traders begin to anticipate interest rate differentials closing in 2025.

3. Central Bank Caution

The CBC has historically preferred minimal, non-disruptive interventions in FX markets. It uses sterilised operations and reserve accumulation rather than aggressive rate moves. But in the face of persistent appreciation pressure, this approach has limited effect. Unlike more interventionist peers, Taiwan’s central bank does not operate with the same policy latitude.

Consequences of a Stronger TWD

A sustained or rapid appreciation of the Taiwan dollar carries a range of economic consequences:

1. Erosion of Export Competitiveness

A stronger TWD makes Taiwanese exports more expensive in USD terms, reducing price competitiveness. With key rivals like South Korea maintaining a weaker won, Taiwanese manufacturers risk losing market share, especially in commoditised tech sectors. Small and medium-sized exporters are particularly vulnerable, lacking the pricing power or operational scale to absorb FX losses.

2. Monetary Policy Dilemma

The CBC is caught in a bind. Cutting rates could ease domestic borrowing conditions, but it would likely accelerate capital inflows and add to TWD appreciation. Conversely, raising rates to defend the currency could hurt consumer demand and small businesses already facing weak post-pandemic recovery. Imported disinflation from a stronger currency further complicates the inflation outlook, creating a risk of premature tightening or policy inaction.

3. Financial Market Volatility

Taiwan’s equity markets are sensitive to export earnings, especially in tech. A stronger currency compresses profit margins, lowering earnings expectations and increasing volatility. Bond markets also face rising hedging costs as international investors seek protection against FX swings. These factors can create sudden reversals in capital flows, amplifying instability.

Learning from History

Taiwan has faced similar challenges before. In the late 1990s and again after the 2008 financial crisis, the TWD experienced sharp bouts of appreciation that tested the CBC’s credibility. In both cases, the central bank opted for gradual, reactive policies rather than front-loaded intervention. While these measures helped avoid full-blown currency crises, they did little to address the deeper issue: Taiwan’s economic dependence on externally driven demand and its exposure to currency risk.

What makes today’s situation more difficult is the sheer scale of Taiwan’s role in global supply chains and the heightened geopolitical risk associated with cross-Strait relations. Any market perception of instability in China tends to drive safe-haven flows into Taiwanese assets—even if those flows ironically increase Taiwan’s exposure to external shocks.

Policy Dilemmas and Strategic Uncertainty

The CBC is now faced with a difficult choice: intervene more decisively in FX markets, risking diplomatic scrutiny (particularly from the US), or tolerate further appreciation and accept the potential consequences for Taiwan’s export sector.

Capital controls are politically and economically unviable, given Taiwan’s integration into global financial markets. At the same time, reorienting toward domestic demand or pursuing a services-led growth strategy would take years and considerable structural reform.

In the short term, Taiwan may seek to expand regional trade ties to diversify demand and reduce dependence on the US-China corridor. However, without a more flexible and coordinated approach to currency management, Taiwan remains highly exposed.

Conclusion

Taiwan’s current predicament illustrates the paradox of currency strength in an export-led economy. While capital inflows and a robust trade surplus suggest macroeconomic health, they also mask growing vulnerability. If the TWD appreciates sharply—and policymakers fail to respond with a clear and credible strategy—the very foundations of Taiwan’s economic success may be at risk.

For now, Taiwan’s double-edged exposure to global capital and foreign demand remains unresolved. The window for pre-emptive action is narrowing.

Author: Ricardo Goulart