Analysis: S.Korea in FX dilemma

By JONG-HEON LEE, UPI Business Correspondent  |  Nov. 4, 2004 at 12:24 PM
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SEOUL, Nov. 4 (UPI) -- South Korea's financial authorities are in a huge dilemma over how to deal with sharply rising won against the U.S. dollar, which could determine the pace of the country's export-driven economy.

Concerns are growing as the local currency's sharp ascent against the dollar is eroding the profitability of export companies, thus undermining overall overseas shipments. Exporters are calling for the currency regulators to step in to stabilize the foreign exchange market.

But the government is not in an easy position to intervene in the market because it has already bought huge dollars to curb won strength. It is now under fire as it holds too much foreign reserve, the world's fourth largest.

The South Korean won steadied near its strongest level in four years in the wake of the dollar's weakness caused by concerns of widening U.S. trade and budget deficits and a economic slowdown due to record high oil prices.

The won currency already trimmed its 6.5 percent advance against the greenback this year, becoming the best performer in 2004 among 15 Asian Pacific currencies, according to local currency regulators.

Officials hoped the re-election of President George W. Bush would boost the dollar, but the won again rose on Thursday to 1,113.4 per dollar, its strongest finish since Sept. 27, 2000 when it ended at 1,113.6, and is now heading towards a seven-year high. The currency is just 20 won short of its highest level since the 1997-98 financial crisis, when the won's value more than halved in just a few weeks.

The absence of strong intervention by South Korean authorities to sell the won against the dollar has sparked a rush of stop-loss dollar sales in recent weeks. The prospect that the U.S. government would allow the weak dollar trend to boost exports also attributed to the sharp fluctuation in the foreign exchange rate, dealers said.

The won, along with other Asian currencies, has risen on speculation that China's surprise interest rate hike last week for the first time in nine years brought Beijing closer to adjusting its pegged exchange rate, allowing its currency to rise against dollar.

Businesses and research institutes warn that the won's sharp appreciation against the U.S. dollar would deal another blow to South Korea's exports, the main driver of the economy, which is already slowing down with overseas demand has cooled.

A higher won hurts price competitiveness in South Korea's export by making them more expensive in the international markets and cut into exporters' earnings. According to the commerce ministry, a 10-percent jump in the value of the won against the dollar could reduce the country's overall exports by 10 percent.

"The won's drastic appreciation could worsen exporters' profitability," said Jang Jae-cheol, a senior economist at Samsung Economic Research Institute. The think tank painted a gloomy picture of South Korea's exports next year, citing a slowdown in the global economy, high oil prices and the won's appreciation.

"Exports are expected to grow around 10 per cent next year, a sharp turnaround from a gain of over 30 percent this year," it predicted in a policy report. The forecast is based on an estimate that oil prices will reach $35 a barrel in 2005, the won will rise to 1,120 won to the dollar and the global economy will grow 3.2 percent.

The won's current value against the dollar is far higher than a level exporters think is optimal to make their exports price competitive. Citing a recent survey, the commerce ministry estimates the optimal value at 1,186 won to the greenback.

The Federation of Korean Industries, the lobby for the country's big businesses, asked for the government to step in the foreign exchange market to curb the rising won. "The government must conduct smoothing operations to ease currency market volatility and ensure stability I the broader financial market," it said in a statement.

The government must control fluctuations in foreign exchange rate to allow corporations to respond more effectively, the statement said. The won's rise against the dollar, along with higher oil prices, has also damaged the country's business sentiment, according to a survey report released on Wednesday by the central Bank of Korea.

The country's accumulated annual exports reached the $200 billion mark for the first time last month on the back of strong shipments of chips and mobile phones, but exports growth has slowed down. Its October export growth of 20.9 percent was the slowest in 11 months. The trade surplus slipped in the month to $2.5 billion from $2.8 billion in September.

Possible showdown of exports would deal a serious blow to the country's economy as they have been powering the economy's growth with domestic consumer spending and corporate investment in a prolonged slump. Exports account for over 30 percent of South Korea's gross domestic product.

Still worse, economists say the strong local currency would damage domestic consumption, to say nothing of exports. "The strong won against the dollar would erode the profitability of export companies, which prevent them from investing and hiring, which is additional blow to the domestic spending," said Lee Sang-jae, an economist at Hyundai Securities.

Government officials also expressed concerns that the strong won would further slow exports. Finance-Economy Minister Lee Hun-jai said the won's rise against the U.S. dollar was a concern for the exports-led economy. But he stopped short of making hawkish remark that the government would intervene in the foreign exchange market.

The central bank appeared to oppose heavy intervention because it considers that a higher won could help ease concerns about domestic inflation, which is being driven higher by rising oil import costs.

The country's soaring foreign reserves is another factor that prevents the financial authorities from dollar-buying intervention.

South Korea's foreign reserves rose to a new high of $178.39 billion as of the end of October, up $3.94 billion from the end of September, according to the Bank of Korea. South Korea was the fourth-largest holder of foreign reserves after Japan, Taiwan and China. The end-October reserve were 25 percent higher than a year earlier.

The increasing foreign reserves are a result of the government's intervention to keep the won weak. The financial authorities have heavily intervened in the currency market since last year to prevent dollar inflows from exporters and foreign share investors from pushing up the won.

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