Swap Agreement to Enhance South Korea’s Credit Rating
By Kim Tae-gyu
Staff Reporter
A currency swap deal between the Korean and U.S. governments is expected to help stabilize the volatile domestic financial market and crank up the nation’s credit rating.
Experts point out that the bilateral contract will help weed out fear and uncertainty, which have devastated the financial markets and caused a dry-up of liquidity.
The U.S. Federal Reserve announced Thursday that it would sign a swap arrangement with the Bank of Korea (BOK), which enables the central banks to barter each currency up to $30 billion.
The BOK hopes that the temporary liquidity swap facility, which is to expire April 30 next year, will be extended beyond the expiry date.
``Basically, the currency swap enriches our $240 billion reserve by $30 billion. But more importantly, the step is about ensuring that the U.S. will come to our rescue if our economy faces a meltdown,’’ said Park Tae-keun, an analyst at Hanwha Securities.
``In this sense, the contract is insurance and it will help restore investors’ confidence in the Korean economy. People will think the worst-case scenario will not happen as there is a rescue and this is likely to improve things across the financial market,’’ he said.
Chang In-whan, founder and CEO of local asset management firm KTB Investments, concurred.
``Thus far, Seoul stocks and the local currency have been overly discounted due to apprehension that the economy might suffer,’’ Chang said.
``Such psychological factors will subside to cause a quick rebound of the financial market. The KOSPI will touch 1,200 and the Korean won will rocket to between 1,200 and 1,300 in the near term,’’ he predicted.
The financial markets responded to the news immediately. The benchmark KOSPI rose 11.95 percent Thursday and the Korean won also appreciated 12.4 percent against the dollar.
In the midst of the global financial storm, Seoul stock prices have halved this year to a three-year trough and the won has tumbled to a 10-year low against the greenback.
Credit Default Swap Premium
Another good aspect of the swap contract is that it will increase Korea’s credibility as amply demonstrated by the falling credit default swap (CDS) premium.
A CDS is a vehicle for trading credit risk. The buyer of a CDS deal pays a spread to its seller in exchange for getting a par value of specified bonds or other instruments when they default.
For example, a bondholder can sign a CDS contract with a bank at a given premium. When the bond defaults, the bank is required to pay the par value of the bond.
The CDS spread is regarded as a barometer to measure risks of any bond or instrument. Hence, the treasury bond of a country is a gauge of its sovereign risk.
The CDS spread of the Korean five-year currency stabilization bond, which was less than 1 percent last year, skyrocketed to over 5 percent this month amid the financial crisis while peaking at 6.7 percent Oct. 24.
However, the news of currency swap took down the CDS premium by more than 100 basis points Thursday from 5.6 percent on the previous close.
``The CDS spread is predicted to head south further to around 3 percent in the near future thanks to the currency swap contract,’’ said Park Jong-youn, an economist at Woori Securities.
``This means our credibility will be substantially raised. Accordingly, chances are that foreign lenders will open their credit lines to local companies or banks to ease the dollar liquidity dry-up here,’’ he said.
No Panacea
But experts warn against any euphoria because the swap deal is not a panacea, which can deal with all lingering problems in the sagging economy.
In particular, the bilateral arrangement’s positive impact on the real economy is expected to be limited.
``The contract will deal with psychological hysteria in the economy. But it will not help much to deal with every fundamental problem,’’ said June Park, an analyst at Woori Securities.
``Liquidity problems will be sure to ease but they are unlikely to be addressed overnight. They will be solved 100 percent only when all fundamental hitches are tackled,’’ he said.
As the main headache, Park picked banks’ large short-term debts borrowed from overseas lenders, struggling construction companies that have heavy obligations and snowballing household debt.
KTB Investments President Chang has a similar opinion.
``The downturn of the real economy is inevitable in the coming years. The currency swap cannot fend off real-economy problems, which will weigh on our economy down the road,’’ Chang said.
``The agreement is just a starting point. We need to take the right direction afterward based on the currency swap deal. Otherwise, we will be in trouble,’’ he said.