The currency swap between South Korea and Japan will likely resume in the coming months as the two countries’ finance ministers reached a consensus on Saturday to promptly start negotiations on the bilateral financial pact.
The two countries’ previous currency swap deal expired in February 2015. The new swap is designed to prepare for currency volatility arising from negative external factors - effectively acting as a buffer against sharp currency swings.
A currency swap is an accord between two parties to exchange one currency for another at a specific rate in a bid to use the foreign currency to ease volatility in the market.
The Seoul-Tokyo currency swap, which continued from 2001 to 2015, has been regarded as an effective tool to minimize volatility in the won-yen exchange rate. Trading currencies at a designated rate for a certain period was allowed under the pact.
Irrespective of political or diplomatic conflicts with Japan, it is laudable for the Korean government to push for a resumption of the pact given the benefits it gives local exporters in terms of currency hedging on the global stage.
Some critics say the currency deal with Japan was not urgent, citing Korea’s current account surplus for the 52nd consecutive month so far and solid foreign exchange reserves worth $371.3 billion as of July, ranking No. 7 in the world.
Some criticize the government for allegedly agreeing to the swap deal in exchange for the wartime sex slavery deal, which was signed between the countries in late 2015.
Whether this allegation is true or not, international economic deals need to be approached separately from political strife. Many local economists also share the view that it is necessary for Korea to sign currency swap accords with as many countries as possible for the stability of its currency.
A desirable way for the government should be clarifying in front of the public that the sex slavery deal was not a prerequisite for negotiation of the currency swap resumption.
Korea is a country that is heavily dependent upon exports -- which account for about 50 percent of gross domestic product -- for its economic growth. Considering Japan has seen its exports account for just 15 percent of its GDP, the deal could benefit Korea much more.
At the present stage, a crucial factor surrounding the foreign exchange market is the U.S. Federal Reserve’s move to raise its benchmark interest rate. With the rising possibility of the Fed conducting another hike later this year following its previous hike in December 2015, Korea has no choice but to be alert to likely massive capital flight.
In that scenario, the swap deal with Japan, whose yen is one of the few reserve currencies in the world, could to some extent prevent the Korean won from sharply losing ground against the U.S. dollar and major currencies, including the euro and Chinese yuan.
In the wake of reopening talks with Tokyo, it would also be better for Seoul to push for resumption of the currency swap pact with Washington if possible, which took effect between 2008 and 2010.
South Korea has signed currency swap pacts with countries including China, Malaysia and the United Arab Emirates. And its Finance Ministry has recently agreed with its Chinese counterpart on extending their currency swap worth 64 trillion won ($57 billion), which expires in 2017.
