Concerns rise over volatile exchange rate

The won-dollar exchange rate has shown sharp fluctuations in recent months, raising concerns over the possible negative impact of such volatility on the country’s economy, which is struggling with deteriorating conditions both at home and abroad.

Last week saw it rise by 18.8 won in the first three trading days to reach 1,219.3 won per dollar -- the highest level in five years and eight months -- before falling by 21.9 won over the following two days to close at 1,197.4 won on Friday. The foreign exchange market here was closed through Wednesday this week due to the Lunar New Year holiday.

The Korean currency began showing large fluctuations in the wake of a decision by the U.S. Federal Reserve in December to hike its key interest rate for the first time in nearly a decade.

The move, coupled with worries about the slowing Chinese economy and lower oil prices, has prompted foreign investors to sell shares in Korean companies. Foreign investors have remained net sellers of Korean shares since early December, marking their longest selling streak here.

Monetary policies being pursued by China and Japan to help boost growth also seem to have added up to amplify the volatility in the won-dollar exchange rate.

The average gap between the intraday highs and lows of the rate hit a five-month high of 7.9 won in January, according to data from the Bank of Korea. So far this year, there have been six trading days when the daily trading range went beyond 10 won.

The average daily change from the previous trading session’s close price came to 6.1 won last month, the highest since October when the corresponding figure amounted to 6.8 won.

Economists here note the recent volatility in the value of the won may fuel concerns over the stability of the Korean currency regardless of the country’s actual economic fundamentals.

“It seems that the currency fluctuation remains in the range that our economy can endure but there is the need to calm down the worrying sentiment,” said Lee Seung-ho, an expert on international finance at the Korea Capital Market Institute.

Some have raised concerns that the increased volatility in the won-dollar exchange rate may lead foreign speculators to target the Korean currency. An influx of hot money into the local currency market could rattle the country’s financial stability, they say.

This concern has drawn attention to the question of whether the country has enough currency reserves to cope with a possible emergency like the 1997-98 foreign exchange crisis that hit Korea and other developing Asian economies.

A report released by the Korea Economic Research Institute last month suggested the country needs nearly $80 billion more in forex reserves to guard itself against a possible global dislocation. The suggestion cast a shadow on what has been perceived as a robust aspect of the Korean economy.

The country’s currency reserves, which stood at $367.9 billion -- the seventh-largest in the world -- as of the end of last year, decreased slightly to $367.2 billion in January.

Policymakers in the government and the central bank have refuted the argument by the research institute, saying Korea’s foreign exchange reserves are large enough to serve as a buffer against another global financial crisis. They dismiss the possibility that the country will be hit by a massive capital outflow down the road despite growing volatility in the global economy.

Many economists seem to doubt the wisdom of Korea making intentional efforts to further increase its currency reserves when it has piled up large current account surpluses. With imports declining at a steeper pace than exports, the surplus amounted to a record high of $105.9 billion last year.

Still, they note that a cautionary stance should be differentiated from excessive pessimism, calling on policymakers to strengthen measures to prepare against the possibility that the flow of foreign capital will become more volatile.

The growing prospect that the U.S. Fed may refrain from further rate cuts in the coming months amid global market turbulence may help reduce fluctuations in the won-dollar exchange rate.

But economists say efforts should not be spared to preempt possible risks from market volatility by redressing the macro-prudential regulatory system, including tightening rules on holdings of forward exchange positions at banks and taxing foreign bond investments.

By Kim Kyung-ho (khkim@heraldcorp.com)