Korea May Face End of Dollar Carry Trade
By Lee Hyo-sik
Staff Reporter
South Korea is bracing for the possible end of the dollar ``carry trade'' ― a development that could destabilize the financial sector here ― as the greenback has been gaining strength of late.
Analysts here say the dollar's recent gain against the Korean won and other currencies will likely be short-lived, but cautioned that if the U.S. raises its key interest rate sooner than expected, the dollar could strengthen further, bringing the carry trade trend to an abrupt end.
They suggested that Korea should beef up its monitoring of short-term speculative money movements in and out of the country, and take preemptive measures to minimize its possible fallout on the local financial market.
Carry trade refers to the investment strategy of borrowing money in countries with low interest rates and investing it in high-yielding currencies and assets elsewhere. It takes place when there is an interest rate gap between countries.
Before the worldwide financial crisis, the Japanese yen was considered a popular borrowing currency for carry traders as its policy rate was at rock bottom, near zero percent. But now investors are engaged in carry trade involving the dollar.
With the easing of the global credit crisis, many international investors and hedge funds borrowed money from U.S. financial institutions this year to invest in stocks and other assets in emerging markets for larger returns.
But if the borrowing costs of the dollar go up or the global financial sector is hit hard by another crisis, the greenback will strengthen against other currencies. In this case, carry trade may end abruptly, causing investors to take money out of emerging markets and potentially destabilizing foreign exchange and other financial sectors.
The South Korean currency closed at 1,176.2 won against the greenback Friday, up 1.7 won from the previous trade. But on Thursday, the local currency lost ground sharply against the greenback, closing at 1,177.9 won, down 13 won from Wednesday.
On Friday, the benchmark KOSPI inched down 0.8 points, or 0.05 percent, to 1,647.04, falling for the third consecutive session.
On Wednesday, the U.S. Federal Open Market Committee (FOMC) hinted at ending the Federal Reserves' record-low interest rate policy earlier than previously expected, shoring up the value of the dollar across the globe. Also, its decision to end a currency swap arrangement with the Bank of Korea (BOK) and 13 other central banks further boosted the greenback.
A growing number of European countries, including Greece and Austria, are suffering from ballooning fiscal deficits and falling sovereign credit ratings, putting pressure on the euro against the greenback.
``The dollar has been gaining ground over the past week due to a range of factors, including the U.S. Federal Reserves' indication of a sooner-than-expected rate hike and the growing financial market jitters in some European countries. But the greenback's recent strengthening will not likely last long, given the snowballing fiscal and trade deficits in the U.S. It is too early to raise the possibility of the end of the dollar carry trade,'' LG Economic Research Institute senior economist Shin Min-young said.
But Shin said if the international financial market falls into turmoil again and the U.S. increases its key rate at a faster pace, the value of the dollar will go up, prompting many global investors to take money out of Korea and other emerging economies.
``If that happens, it would increase the volatility in the nation's foreign exchange and stock markets. But the sluggish equity market and the rising won-dollar rate this week is largely due to debt problems facing Dubai and Greece, and other short-term downside risks, not the growing fear that the dollar carry trade may come to an end,'' the economist said.
In light of the U.S. decision not to renew a currency swap agreement with the BOK, Shin suggested the government increase its monitoring of short-term money movements in and out of the country, and send a consistent signal to the market that Korea is in a much better position now than a year ago to deal with a reoccurrence of the global credit crunch or other outside shocks.