Taiwan could face a destabilising influx of "hot money" if China lets its currency appreciate, a government study showed.
China has come under heavy international pressure to allow its yuan currency to appreciate, with the United States saying the pegged currency gives China an unfair trading advantage.
According to the study by the government's Council of Economic Planning and Development, seen by Reuters on Friday, an appreciation of the yuan and booming trade ties could see Chinese "hot money" flow into Taiwan, causing problems for financial stability.
The report did not elaborate and a council official declined to explain the thinking but analysts said Tawian's currency <TWD=TP> and stocks could be used as a proxy for the yuan, which is not freely traded.
"It's either the Taiwan dollar or Taiwan stocks as a proxy for the appreciation of the RMB (yuan), anything that has a large exposure to the Chinese economy."said Joseph Lau, economist, Credit Suisse.
Taiwan's central bank has waged a campaign against what it calls hot money after introducing some capital controls late last year, fearing speculators could create asset bubbles and push the currency to levels that undermine exports.
The report also said that Taiwan's exporters could gain from a stronger yuan as Chinese exports lose competitiveness, but a firmer currency would also raise the costs of labour and raw materials for Taiwan firms operating in China.
The $390 billion export-led economy has benefited from China's rapid economic growth after the island's government adopted a pro-China business policy, and the two former political foes are seeking to sign a free-trade deal that would further open their economies.
China will probably let the yuan strengthen after foreign governments take the pressure off, allowing Beijing its dignity, said Hu Chung-ying, a council deputy minister.
He said the Taiwan dollar would appreciate in tandem with the yuan and exceed the central bank's preferred range. Taiwan's central bank keeps the currency in a managed float, frequently intervening in the market to control the price.
(Reporting by Ralph Jennings