Time to liberalize Korean currency
By Tony Michell
Among the economic plans for 2014, there is a missing element which threatens the concept of restarting and sustaining growth. This is a plan for the liberalization of the won which is held captive by the frontiers of Korea.
Unlike most other currencies in the world, including many countries with a much weaker economic situation and lower per capita GDP, Korea has a set of capital controls which are best suited to a Third World country with a chronic current account deficit ― not to the 15th largest economy in the world, the seventh largest trading nation, 7th largest capital reserves, Asia’s fourth largest economy, and the country with a largest current account surplus in 2013 of $70 trillion ― about 5 percent of GDP which was the agreed G20’s over-valued threshold.
The year 2014 is when action is needed as a result of the tapering of the U.S. Federal Reserve Bank’s $1 trillion a year injection of bond buying funds into the global economy. As economists consider the impact of the taper ― they believe that the economies that will suffer most are those who exhibit “original sin.” This started with the “fragile five” economies, India, Indonesia, South Africa, Brazil and Turkey and three EU countries, but it is Argentina ― not on the list ― which has had the worst meltdown. Original sin was a term created by Barry Eichengreen of USC Berkeley ― a leading monetary economist ― and describes economies which cannot raise debt in their own currency, but have to borrow in someone else’s currency ― normally the U.S. dollar.
But “original sin” also describes Korea, which puts itself in this situation not through a weak economy but by creating internal chains on its currency. There can currently be no “Gimchi” (denominated in won) bonds in London unlike the Samurai bonds (in yen) and now the Dimsum bonds (in renminbi). When the tourist tries to change won at London Heathrow or JFK in New York, he finds that while he can exchange baht, Indonesian rupiah, Singapore dollar, the won is not quoted at any normal foreign exchange office. The won was to be liberalized in 2012 according to the road map agreed on joining the OECD, Kang Man-soo threw away this plan when he became finance minister in 2008.
Imagine what a range of new jobs, new activities and new economic opportunities freeing the won would create for small- and medium-sized enterprises, for overseas construction companies, for NGOs and for the Korean financial industry. Here are some pointers:
(1) Loans for non-residents, as in Singapore, greatly increase foreign direct investment.
(2) The development of won Gimchi Bonds frees the guardians of the won from worry about foreign debt (Today’s Gimchi bonds are in U.S. dollars).
(3) Korean banks could hold won off-shore and use those deposits as collateral for foreign investment and finance.
(4) Korean companies can hold off-shore won deposits in those Korean banks.
(5) The Korean financial industry blossoms in a new international environment.
(6) The large NDF (non deliverable forward) market denominated in won moves on shore from Singapore and Hong Kong.
What about the risks?
Generally the refusal to release the won has been based on three types of fear: fear of capital flight, fear of hot money and fear of collapse of the value of the won.
While some in the government see the upside, most including most members of the National Assembly, see only the downside. How can they be convinced that the upside outweighs the risk many times over?
The choice of policy methods open to Korea to control the risks is considerable, depending on which step is taken first. There are two steps required, the liberalization of won markets internally in Korea (following the Singapore model), and the internationalization of the won (perhaps following the Chinese model.) China is steadily moving its renminbi toward full convertibility, with about 18 percent of global transactions now being conducted in renminbi. The Chinese central bank and other monetary authorities are moving in two directions, both encouraging the settlement of trade accounts in renminbi and the authorizing of renminbi denominated loans in selected financial centers. Hong Kong, London and other financial centers are fighting to be allowed to hold deposits of renminbi.
Of Singapore it has been said recently by the Asian Development Bank that “It is the overall package of policies ― including strong economic fundamentals and a robust financial system ― that serves to increase Singapore’s resilience toward disruptive swings in capital flows.” Unlike larger economies that have used interest rates to direct market led capital movements, Singapore has used a trade weighted index exchange rate policy. This might work well for Korea, so the won would no longer float against the dollar, but against a basket of currencies with a heavier weighting toward the renminbi than the U.S. dollar. Korea could avoid prematurely raising interest rates following the growing emerging market crisis spreading from Argentina’s meltdown.
Making the won valuable for the entire world, not just Koreans, will allow more flexibility in monetary policy, reduce the volatility of the won, develop the financial system and make overseas investment by Korean firms and banks much easier. It is the missing ingredient in the government’s economic reform strategy.
Tony Michell first came to Korea in 1978 and worked for the Economic Planning Board. He teaches at KDI School of Policy and Management and directs an influential consultancy at Korea Associates Business Consultancy.