By Cho Jin-seo
Staff Reporter
South Korea has become so vulnerable to the mercurial cross-border capital flow, that its stock market was the second most exposed to the risk of global volatility among 22 emerging economies, a recent study showed.
The data warns that the country should not be complacent about its financial soundness, and should seek a more active role in global discussions on regulating the international capital flow.
“The fluctuation of capital inflow and outflow is large in South Korea because both its real and financial economies are wide open,” researcher Lee Yun-seok of the Korea Institute of Finance said in his report published on Saturday.
“Our nation is depending on international trade and energy import more than most other nations are. So the amount of foreign investment and foreign debt tends to change rapidly in line with changes in global economic conditions such as the exchange rate and commodity prices.”
Lee also said that Korea’s foreign exchange regulations are too weak to protect the market.
The statistics show that it was only in the past few years that South Korea’s vulnerability has become a serious problem. In 2005, it was placed 21st among 22 emerging nations on the vulnerability score card on the overall capital market, including foreign exchange, shares, bonds, and derivatives markets. This means Korea was relatively a safer place from the wake of global volatility compared to its peers.
In 2008, however, it was found to be the sixth most vulnerable among the same group.
The data looks at the relative size of capital flow compared to the country’s gross domestic product. International capital flow helps the economy secure necessary capital more easily not only from domestic investors and lenders but also from foreign institutions. So, scoring high on the list does not necessarily mean that the economy is in bad shape. Actually, Korea’s risk exposure was still lower than some wealthy and small-sized countries such as New Zealand and Luxembourg.
But the sheer size of daily cross-border financial transactions by hedge funds and others seeking short-term gains also mean they can easily destabilize the country’s economy by creating asset price bubbles in good times and exploding them in bad times. A prime example is Ireland, which was hit hard by the recent global financial crisis.
The research also showed that it is the stock market and the banking sectors where the international capital flow can be the most deadly. Korea was ranked second to last in this area.
The bond market was also rated to be the third most vulnerable among emerging nations.
There has been a surprising development of financial liberalization in the past two decades ― the stock market was prohibited to non-residents until 1992, and the domestic bond market until 1996.
Foreign ownership of listed companies was limited to 20 percent until 1997. Only the Asian financial crisis of 1997 triggered the liberalization of the financial market to international capital. Nowadays, foreign shareholding often exceeds that of domestic investors in many major listed companies.
The problem of short-term cross-border capital flow is recognized by many governments and academics, and countries like the United States are now considering setting up a regulatory system such as the international transaction tax.
The G-20 countries will be discussing the issue in its summit in November in Seoul. Lee said Korea should take the initiative. “We have to make our position clear, considering our condition on this capital flow issue,” he said.