ed Curbing currency volatility

The Korean government appears to have reached a consensus on adopting a Korean-style Tobin tax to regulate ``speculative’’ capital inflows.

Deputy Finance Minister Choi Jong-ku proposed taxes on foreign exchange transactions and bonds at a seminar organized by the Korea Institute of Finance in Seoul last week. The proposal represents a sharp U-turn from the government’s hitherto skepticism about imposing taxes on "hot money," cross-border speculative funds seeking short-term gains.

Few will dispute the need for new tax measures "tailored to domestic market conditions," given the rapid revaluation of the Korean currency and extreme volatilities in the foreign exchange market. Nevertheless, policymakers need to take a cautious approach in consideration of possible side effects.

The Tobin tax was suggested by Nobel laureate economist James Tobin in 1972 to curb exchange rate fluctuations by levying small taxes on foreign exchange trades. The Tobin tax is back in the limelight after 11 eurozone nations, including Germany and France, got the go-ahead from the European Commission last month to introduce the financial transaction tax (FTI), a modified type of the Tobin tax, from next year at the earliest. Brazil began to levy taxes on cross-border financial transactions in late 2009 but the initiative has only been partly successful because the South American country’s initial goal to weaken its currency fell short of expectations.

Korea currently has three basic tools to control its foreign exchange market: lowering the ceiling on foreign exchange positions at banks, charging taxes on foreign investments in Treasury bonds and adding a levy on banks’ offshore debt. But these measures are deemed insufficient, in general.

The Korean-style Tobin tax is primarily focused on regulating capital inflows, but policymakers need to pay attention to capital outflows, taking into account that the massive exodus of foreign capital left indelible marks here in the previous two crises.

We can’t overemphasize the importance of the stable financial market, given the painful experiences in the 1997 Asian financial crisis and the 2008 global economic crisis. In this regard, introducing the new tax can be considered.

The key is to minimize the anticipated side effects. More than anything else, levying taxes on financial transactions could put a damper on trading itself, which would enlarge market volatility and impose unnecessary burden on businesses.

Therefore, the government can introduce the system but shelve its implementation so it can be applied in times of crisis. What is needed most, however, is for the government to study and prepare thoroughly.