S Korea: no place to hide

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S Korea: no place to hide

September 20, 2011 11:16 am by Song Jung-a

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South Korean officials are worried. Concerned about the country’s long-standing vulnerability to external shocks, they have in the past year tried to protect its economy from sharp swings in external financing.

They have succeeded in limiting gyrations in the high short-term external debt. But, with global conditions deteriorating and the won falling sharply in the past 10 days, the real test is still to come.  

The country has introduced a series of measures since last year to protect its economy from sharp capital swings by limiting the currency forward positions of banks, re-imposing taxes on foreign bond holdings and imposing a levy on banks’ foreign debt.

Such measures have been effective in reining in short-term external debt.  But the country still remains vulnerable to global capital flows due to its open capital markets and its high dependence on exports.

With the European debt crisis escalating and the US economy slowing fast, the Korean won has fallen since August 1 by about 9 per cent against the dollar to its lowest level for the year while the country’s stock market has dropped about 15 per cent since August 1.

The moves have sparked fears of capital flight and prompted the authorities to intervene in the currency market to prop up the currency in recent days. Traders suspect the authorities have sold dollars in recent weeks, although government officials kept saying that the foreign exchange rate should be determined by the market.

Finance minister Bahk Jae-wan told lawmakers on Monday that the government was not pursuing a weaker won policy to boost exports and he was worried about the weaker won’s negative impact on inflation.

“I think the won has been reacting too excessively [to the global instability] and would eventually face a correction,” his deputy Choi Jong-ku told reporters on Tuesday.

The stock markets in South Korea and Taiwan were among the hardest hit by foreign fund outflows last week, Citigroup said, as foreign investors continued to withdraw funds from emerging Asian markets on growing risk aversion in the past few weeks.

Foreign funds sold US$1bn more of the nation’s stocks than they bought this month through Monday.

Foreign investors may be over-reacting to negative news from Europe and the US but they have reasons to be sensitive about their Korean holdings. South Korean banks still rely heavily on wholesale financing from European banks although their foreign currency liquidity conditions have improved.

The country has boosted its foreign reserves to a record $310bn from around $200bn in late 2008 but its short-term overseas debt amounts to half its reserves, making the country vulnerable to any credit squeeze in global markets.

Most of all, the large presence of foreign investors, who take up more than 30 per cent of the stock market, increases the market’s volatility especially when the global financial markets are in turmoil.

Kwon Young-sun, an economist at Nomura, says South Korea stands the lowest chances of a currency crisis in Asia in terms of economic fundamentals, given its strong current account surplus and abundant international reserves, but its open capital markets make it vulnerable to short-term market volatility. “Korea is Asia’s most open economy, apart from Hong Kong and Singapore. It’s a high-beta market, which is highly vulnerable to external risks.”

Bu he predicts the weaker won will help the economy recover fast next year even if the worsening debt problems in Europe and slowing growth in the US dent its economic growth this year.

Especially, the won’s weakness against the Japanese yen is a boon for Korean exporters, boosting their price competitiveness against Japanese rivals, he adds. The won has fallen to its lowest level against the yen in two and a half years with the yen trading at Won14.64 on Tuesday. “If the global economy slips into a double-dip recession, it will bring big initial shock to Korea but the weaker won, coupled with lower oil prices, will enable Korea to stage a V-shaped recovery next year,” says Kwon.

Related reading:
South Korea intervenes in market rout, beyondbrics
S Korea: growth matters, not inflation, beyondbrics
Rise of emerging markets currencies falters, FT

http://blogs.ft.com/beyond-brics/2011/09/20/s-korea-no-place-to-hide/#