Cheong Wa Dae is back in crisis mode. President Lee Myung-bak instructed his aides Monday to switch the presidential office into emergency mode as global financial instability stemming from the fiscal woes in the eurozone has risen sharply in recent weeks.
During the past two months, volatility in domestic financial markets has increased significantly, threatening to hurt Korea’s economic growth. In this short span of time, the Korean won depreciated by 12 percent against the U.S. dollar, the sharpest drop among the 21 major currencies around the world.
On Monday, the Korean currency fell to a 13-month low, threatening to breach 1,200 per dollar, as investors panicked and fled to safe havens. The won’s plunge would have been steeper had the government not intervened in the market. But the currency gained the next day as market sentiment improved.
The downward pressure on the Korean won was triggered by foreign investors who dumped their Korean stock holdings. In August, they net sold local stocks worth 5.1 trillion won. This month to Monday, they again offloaded stocks worth 2.2 trillion won. This selling spree caused Korean stock prices to tumble by 22 percent during the short period.
Reflecting the unease in financial markets, Korea’s credit default swap spread, the premium that the nation has to pay to insure against the default of its sovereign debt, broke through the 200 basis points mark last week, nearing the level that Korea reached in June 2009.
Given the high degree of Korea’s openness to the global economy, it is inevitable that domestic markets experience fluctuations when global financial uncertainty increases. But the latest movements in Korea’s exchange rates and stock prices were excessive in light of its strong economic fundamentals.
When it comes to economic fundamentals, few countries can beat Korea. Among other things, Korea is fiscally sound, with its government debt to GDP ratio remaining in the 30 percent range, much lower than the OECD average of above 70 percent.
Korea has also accumulated large foreign exchange reserves. At the end of August, its reserves exceeded $310 billion, much larger than the $240 billion it had when Lehman Brothers collapsed. The reserves have kept rising on the back of the nation’s strong export performance.
Korea’s foreign debt structure has also improved in qualitative terms. Its total short-term foreign debt stands below $150 billion, less than half of its foreign exchange reserves.
Citing these and other indicators, government officials sought to assure investors that Korea would be able to withstand any crisis on its own. But their assurances have failed to give confidence to investors.
To boost investor confidence, President Lee himself should be in crisis-fighting mode. In this regard, it was timely that he decided to revive the emergency meetings he had presided over at an underground war room at Cheong Wa Dae from January 2009 to September 2010.
Top policymakers attending the meetings need to step up monitoring of the global and domestic financial markets. More importantly, they need to explain to the public as well as investors how the present eurozone turmoil differs from the 2008-09 global crisis. Such explanatory efforts would ease excessive concerns.
Three years ago, few expected the collapse of Lehman Brothers. As a result, governments as well as financial institutions around the world were caught off guard. But the ongoing turbulence in the eurozone is unlikely to play out in such a fashion.
Currently, the worst-case scenario is a Greek default on its debt. But even when a default becomes inevitable, eurozone countries are highly likely to take steps to ensure that it takes place in an orderly fashion without inflicting unbearable damage on financial institutions.
This week, eurozone officials, under pressure from leaders in other parts of the world, began work to boost the firepower of the region’s rescue fund to a level sufficient to bail out not only Greece but Spain and Italy. This move has eased concern about a Lehman-style financial tsunami sweeping the world again.
Yet this is not to say that the eurozone crisis would end without adversely impacting the global economy. Even under the best-case scenario, the long drawn-out crisis will put a significant drag on global economic growth. This means the Korean economy will face strong headwinds going forward. Top policymakers need to prepare for the growing downside risks to the national economy.
