IN Taiwan, the heat is on. The massed forces of the People's Liberation Army are flexing their muscles within spitting distance of Taiwan's coast and diplomatic sabre-rattling has gone beyond the rattling stage with China stating that a 'covert independence movement' is reason enough for an invasion. All this just three days before the island's parliamentary elections on Saturday, leading political commentators to the unsurprising conclusion that the mainland is deliberately ruffling Taiwan's feathers in an attempt to undermine the elections and destabilise the economy. But is it working? Opinion is divided. Those who prefer a political explanation reason that China's tactics are having a massive impact upon the stability of the breakaway island nation. Those who study economic fundamentals say they remain strong enough to override political ploys. Bob Broadfoot, managing director of the Political and Economic Risk Consultancy, which assesses risk associated with Asian nations for international clients, said: 'This is the biggest risk Asia faces today. There is an 80 per cent chance the two sides will end the situation positively, meaning there is a 20 per cent chance it will end disastrously. 'It is much more serious than people are giving it credit for. It could go in either direction. That kind of uncertainty makes businesses uncomfortable, and if it doesn't make them uncomfortable they should have their heads examined.' On the economic side, John Nelson, investment strategist at Jardine Fleming in Taiwan, argued that any doldrums experienced by the market were not attributable solely to the political situation, but reflected economic fundamentals as well. 'A lot of things that made Taiwan a high price-earnings market have gone,' he said. 'Earnings are not looking good; the property market is suffering from oversupply; and certain sectors are experiencing a range of difficulties. Obviously there is an element of political uncertainty, but that's not all.' On one point they are agreed, however. Both believe the 46-year stability between Taiwan and the mainland is ending, an event that will heavily influence market performance in the near to medium term. Mr Nelson said: 'The status quo is coming to an end, and until there is a new structure in place there will be a political overhang which will dampen the market.' Mr Broadfoot said: 'We are seeing both sides pushing themselves to the edge. Once they get to the edge they will have to decide how they can avoid going over the edge and act constructively. But the process of reaching that stand-off is necessary.' Taiwan is in the unusual situation of being a healthy economy plagued by uncertainty. This dilemma has got international institutional investors in a quandary. On one hand, the stock market is down about 35 per cent over the year, leading many international money managers to conclude that Taiwan must represent a buying opportunity. On the other, the escalating political tension and its possible ramifications are making investors hold back from moving in in any significant way. 'It's a difficult one to call,' said John Ross, general manager of HG Asia's Taiwan office. 'It is hard to divorce the fundamentals from the political issues. But we think it is a good time to buy. 'The market is down and the economy is still growing strongly. Clients are starting to come back in.' Peter Kurz, managing director of Barings' Taipei office, said: 'Our clients are relatively complacent. They have been through rough periods in Taiwan before and it has always bounced back. 'The feeling at the moment is that China is focusing on the elections, and once they are over, there will be less reason for the mainland to be so bellicose.' Most institutions had already discounted the political risk associated with Taiwan and factored a risk discount into their weightings. But while international attention centres on the invasion question, Mr Broadfoot said other global political factors needed to be taken into account. He argued that while the dispute stayed between Taiwan and China, the economic ramifications would remain relatively limited. However, he feared the row could take on far more serious proportions if the United States became involved in the debate. 'There are some loose cannons in Washington that could get looser as the US elections approach,' Mr Broadfoot said. 'Any incident between the two in the run-up to the US election could elicit a fiery response from America. It's an awkward time.' Assuming there is no overt US involvement in the fracas, the net result, as far as financial professionals in Taiwan are concerned, is that the market could be going nowhere until the issue has been resolved. Mr Nelson said: 'We don't think the market is going down much, but we don't think it is going up much either. Until a concrete unification strategy has been worked out there will always be uncertainty.' Nevertheless, international clients appear keen to exploit what they see as a potential buying opportunity in Taiwan, and brokerages are loath to turn down business. So, within the uncertain environment, they are having to assess which sectors and which individual stocks will best be able to weather the storms and reward investors. Mr Kurz said he favoured what were known as the 'styrene' stocks - the larger petrochemical companies such as Tai Ta Chemical and Grand Petrochemical. He said that despite their relatively high exposure to the mainland, their markets remained strong and there was no indication the political differences were about to impact on their operations too severely. On the downside, Mr Kurz said he was avoiding the electronics sector, which he said would suffer as companies tried to issue huge share placements which would dilute growth in earnings per share. He was also bearish on the textiles sector, which was suffering from rising costs, and the construction sector, which was still feeling the effects of the downturn in the property market. But recommendations from several other Taiwan-based houses crossed all sectors, with some heavily bearish on electronics and construction and others strongly bullish. This seems to indicate a degree of schizophrenia and confusion and in part explains the market's lack of direction as investors, politicians, economists and strategists try to decide which way to call the whole situation. 'There are a lot of people buying plane tickets,' Mr Nelson said. He added that many people were increasing the percentage of their assets that they kept offshore. This is Taiwan's problem. It might happen; it might not - but while uncertainty exists it is better to play safe. This should be enough to keep major international money quiet for a while longer - at least until the elections are over and done with.