Korea Adopts Strong Currency Policy
Market Intervention Is to Tame Inflation but Morgan Stanley Warns of Backfire
By Kim Jae-kyoung
Staff Reporter
Financial authorities announced Monday that they will directly intervene in the currency market to curb a further slide of the won against the dollar, but many are skeptical over whether the move will achieve its intended goal.
Some critics say that the government's intervention will end in failure, as continuing depreciation of the won is a natural phenomenon reflecting the current economic fundamentals, such as the widening current account deficit and rising demand for the dollar caused by increasing oil prices.
The move comes as a means to put a lid on rising inflation.
In a joint statement, the Ministry of Strategy and Finance and the Bank of Korea (BOK) said they will take strong measures to curb market volatility if the imbalance in supply and demand is considered excessive. The announcement came one day after Finance Minister Kang Man-soo and BOK Governor Lee Seong-tae met in Seoul.
``We are concerned about the currency market being skewed in one direction, and we will keep a closer watch on the movement of the foreign exchange rate,'' the statement said.
In a press conference, Choi Jong-ku, head of the ministry's international finance division, said the government will use foreign exchange reserves to curb further weakening of the local currency.
``Our top priority is to tame inflation. We have plenty of foreign exchange reserves and are ready to sell our dollar holdings whenever necessary,'' Choi said.
The nation's foreign reserves reached $258.1 billion in May, down $100 million from the previous month. They are the world's sixth largest behind China, Japan, Russia, India and Taiwan.
Responding to the announcement, market analysts raised questions over the effectiveness of the government's direct intervention policy.
They said that given the soaring inflation, market intervention is understandable, but too ``frequent'' or ``excessive'' intervention will do more harm than good.
Bloomberg quoted Morgan Stanley as saying that the pledge of stern action to stabilize the won will ultimately fail to halt the declines because Korea's economy is slowing and its trade deficit is widening.
The U.S. investment bank added that Korea's interest rate and exchange rate policies are not internally consistent for currency intervention to be regarded as credible.
Citigroup economist Oh Suk-tae also said that the local currency market is somewhat overshooting but it is not desirable for the government to step in too often.
``Frequent intervention can weaken the effect of government policy and hurt its credibility,'' he said. ``If the government steps in over and over, chances are high that it will waste a huge amount of foreign reserves without achieving its intended goal.''
The joint efforts by the government and the central bank come as the rapid depreciation of the won against the greenback is stoking inflation expectation and destabilizing the financial market.
``In the market, there have been increased expectations for the won to lose additional ground against the dollar. We think that it is urgent to dispel such expectations,'' Ahn Byung-chan, head of the central bank's international bureau, said.
``The market has misunderstood that there is a specific won-dollar range the financial authorities want to maintain, but there is no such range,'' he added.
The won has dropped 10.5 percent against the greenback this year despite several interventions by the government. The won closed at 1,042.90 won per dollar Monday, up 7.5 won from the previous session.
The government had favored a weaker won policy to sustain high economic growth by boosting exports, but soaring inflation has recently made the government shift this policy.
Experts say that an interest rate hike would be a better tool to keep inflation in check, noting that frequent market intervention will make the currency market more vulnerable to speculative investors.
The ING Group's chief economist also said that interest rates would be a better way to intervene because higher rates would cure what ails Korea.
``I think the authorities should make a clear statement rejecting the weak-won policy and backing it up by saying they want the won-dollar rate to go back to the 915-940 level of 2007 and intervening to drive it back there,'' Tim Condon said.
``That would slow inflation expectations and halt the U.S. dollar buying,'' he added.
Oh said the government should let the market determine the exchange rate, adding that interest rates are what the authorities should touch to tame inflation.
In the meantime, Cheong Wa Dae ousted Strategy and Finance Vice Minister Choi Joong-kyung Monday for mismanaging the foreign exchange policy.