FX reserves tumble on currency intervention

By Kim Tong-hyung

Korea’s foreign exchange reserves sustained their sharpest decline since the 2008 global financial crisis as the authorities apparently spent billions of dollars defending the risk-sensitive local currency, according to the Bank of Korea Wednesday.

The latest data will add sparks to the debate on whether the country has enough ammunition to defend against another full-blown financial turmoil, which looms as a real possibility as the world struggles to cope with the eurozone debt crisis and a sluggish U.S. economy.

Korea’s benchmark stock index, the Korea Composite Stock Price Index (KOSPI), slipped 2.33 percent, or 39.67 points, to close at 1,666.52 Wednesday as the heightened uncertainty surrounding the global economy continued to bite into confidence. The won closed at 1,190.4 per dollar, up from 1,194 Tuesday.

The country’s foreign reserves were measured at $303.38 billion at the end of September, falling by $8.81 billion or 2.8 percent from the historic high of $312.19 billion a month before. This represented the severest monthly shave since the $11.75 billion loss in November 2008, when the world was withering in fresh pain from the collapse of Lehman Brothers.

Shin Jae-hyuk, a BOK economist, attributed the fall in foreign reserves to the weakness of the euro and British pound against the U.S. dollar, which ate into the value of non-dollar assets. The euro depreciated 6.8 percent to the dollar last month and the pound declined 4.1 percent against the greenback. The Japanese yen inched down 0.6 percent to the dollar.

However, the central bank declined to comment about government officials reaching deeper into their war chests to defend the sharply declining Korean won.

The won lost more than 9 percent in September against the dollar, its worst monthly fall since early 2009, suggesting that BOK’s attempt to halt the bleeding, if there was one, failed to work as prescribed. The KOSPI dropped around 6 percent last month as the problems in Europe threatened to take another lurch toward the worse.

Observers say the new foreign exchange tally provides a firm grasp of the obvious that the BOK waded into the market last month in an attempt to halt damage to the won. Traders suspect currency authorities spent around $9 billion to $12 billion last month in attempting to prop up the won.

Although denying speculation that they are defending any specific exchange rate, policymakers here have repeatedly expressed alarm over the pace and extent of the won’s decline. However, there is criticism that the BOK is risking depleting its foreign exchange reserves in a losing battle to support the local currency as investors continue to flock to safer assets amid heightened uncertainty surrounding the global economy.

Officials from both the BOK and the strategy and finance ministry claim that the country’s reserves are adequate to deal with the current rockiness in global markets, but some private-sector analysts would beg to differ.

It’s impossible to explain the near-$9 billion loss in foreign reserves with just the weaker value of non-dollar assets, experts say, especially when the BOK announced last month that profits from foreign-exchange operations exceeded the benchmark rate set by the Morgan Stanley Capital International (MSCI) index.

“The $8.8 billion decline in foreign reserves clearly shows the country has less maneuvering room in dollars,” said Ahn Seung-gwon, an economist with the Korea Economic Research Institute (KERI).

“The won-dollar exchange rate touched 1,200 before coming down on Tuesday, which suggests that the authorities intervened again. Government officials are facing a difficult quandary — allowing the won’s value to slide dramatically would jolt the retreat of foreign investors, but using the country foreign exchange reserves to defend the won would be sowing the seeds for financial instability.”

While government officials are desperate for measures to defuse the threat to the local currency, critics like Shinhan Bank economist Cho Jae-sung claim the intervention efforts might actually fan the flight from the won by doubling as a confession of fear.

“Intervention could become prove to be a double-edged sword. The massive foreign-exchange holdings may allow authorities to wield a significant influence in the foreign exchange markets, but should the interventions become too frequent, market players could take it as a hint that the value of local currency is about to take a sharp dip,” Cho said in a recent report.

The country has scrambled to bulk up its foreign-reserve holdings in past years, which was at around $200 billion when the last financial crisis erupted in 2008.

While government officials are doing their best to downplay worries about a potential currency-related crisis, but admit there is no easy way to settle the debate on what would be the adequate level of foreign reserves for the country.

The International Monetary Fund (IMF) recommends that emerging economies should hold three months’ worth of current payment requirements, and according to this criteria, Korea’s adequate level of reserves would be around $132.8 billion.

But Ju Won, an economist from the Hyundai Research Institute (HRI), counters that while the country may have enough dollars to avert a possible default, the reserves still come woefully short of giving authorities a meaningful shot at restoring stability in foreign-exchange markets.

According to Ju, the country needs at least $384.8 billion to be safe. The number is reached after combining the $132.8 billion needed to meet the IMF recommendation, $149.7 billion the country has in short-term debt and another $100 billion, standing for 20 percent of foreigners’ investment in Korean shares, which Ju believes could match the level of the worst-case capital flight.