Korea’s weak currency strategy
The value of the Korean won continues to fall and is soon likely to breach the threshold of 1,200 to the U.S. dollar. Hail to the almighty weak won.
Countries once took great pride in having strong currencies. It was seen as a symbol of national vigor. That is no longer the case. Now many nations prefer to see their currencies decline as a means to boost economic growth. A weaker currency usually means bigger sales of their products overseas and more jobs at home.
In this regard, Korea has been no different than from most of its Asian neighbors, such as China. Despite its public denials, the Korean central bank has frequently intervened in the foreign exchange markets to keep the value of the won low. Seoul’s currency policy has been an important reason why companies like Samsung Electronics and Hyundai Motor have taken business away from Sony and Toyota since these Japanese companies are burdened by the high value of the yen.
The recent fall of the won has been due to other factors as well. Foreign institutional investors who have invested in the Korean stock market have been selling their shares and repatriated their money home as they seek to protect themselves from possible global financial turmoil stemming from the eurozone debt crisis. That is putting further downward pressure on the won.
Korea has been among the emerging markets hardest hit this year by capital flight, with the benchmark stock index tumbling by 12 percent since mid-March. The won has fallen by 5.5 percent against the dollar during the same period.
While a weak currency benefits exports, the sudden descent of the won also poses a potential threat to Korea because it exacerbates inflationary pressure as the cost of imports rise.
Fortunately, Korea has beefed up its defenses against the effects of sudden capital outflows since the 1997 financial crisis, when the rapid withdrawal of foreign funds set the won plunging to around 2,000 to the dollar. The country’s reserves are now at record levels and it has established currency swaps with China and Japan.
In the coming months, we are likely to see another factor causing the won to weaken further: a cut in interest rates.
Korean industries are starting to feel the effects of the financial turmoil in Europe and the economic slowdown in China. The sluggish global economy also means that inflationary pressure in Korea is on the decline. This will allow the Bank of Korea to loosen monetary policy in order to stabilize the economy.
Korea’s recent economic data has been generally poor, although the country remains one of the best performers among the world’s advanced industrial economies. Industrial production is flat, exports are down, and business confidence is slipping. But the price of key imports, such as oil and other commodities, is also falling because of the weakening global demand.
When the Bank of Korea holds its monthly monetary policy meeting tomorrow, it is likely to keep the benchmark policy rate at 3.25 percent for a 20th straight month. The central bank has been cautious in cutting interest rates because of inflation concerns, but those worries now appear to be misplaced.
Consumer inflation held steady at 2.5 percent in May, which is at the low end of the central bank’s target range of 2 percent to 4 percent inflation. Korea now has one of the lowest inflation rates in Asia. If the economy starts stumbling as the financial crisis in the eurozone intensifies, the Bank of Korea will face growing pressure to prune interest rates
In an effort to support growth, a fall in the interest rate to 2.75 percent by the end of the year does not seem unreasonable if inflation remains tame. The central bank may wait another month or so to monitor inflationary trends and the growth outlook before starting to slash interest rates in August. Any such move would keep the won weak for the foreseeable future.
A weak won and lower interest rates would certainly help the Korean economy, at least in the short-term. They would contribute to stimulating the domestic demand. A weak currency would discourage Koreans from traveling abroad and to spend their money at home instead, while encouraging Japanese and Chinese tourists to come to Korea. Lower interest rates would also lead to increased consumer spending in the coming months since it would ease the high household debt burden.
Of equal importance, Korea would gain further competitive advantage over Japan in export markets because of the weak won. The yen is likely to remain overvalued since it is seen as a safe haven currency by international investors. When it comes to currencies and exports, the weak almost always triumph over the strong.
John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant.