New forex controls may backfire

This is the second in a series of articles regarding the reaction of foreign banks to the government’s latest effort to bring short-term borrowing under control ― ED.

By Kim Jae-won

Staff reporter

The latest regulations on the currency market is totally the “wrong prescription based on a misdiagnosis,” according to financial experts and foreign bankers here.

They said that the rules are just a stopgap measure and they will not help stabilize the market in the long-term because it will only drive foreign banks to a non-deliverable forward (NDF) market, which they believe will eventually cause the local market to shrink.

The NDF market is where foreigners trade the local currency over the counter. It sets the tone for the spot market here.

Kim Ki-hwan, chairman of the Seoul Financial Forum (SFF), said that the government’s new regulations may backfire, increasing volatility further, contrary to the will of policymakers.

“(The Korean government) tries to cure what it can see, however, it needs to get rid of problems deep down inside. The root cause of the volatility is the non-convertibility of the Korean won.

“In that regard, the government should come up with measures to enable the Korean won to be traded overseas through future deregulations on capital flow.”

The former OECD ambassador said that Korea needs to broaden the foreign exchange market to be more resilient to outside factors.

“For example, if a pool is small, it can be affected by a tiny stone. However, a big lake is not bothered from such a movement.

“It is the same with the foreign exchange market. If it is large enough, it cannot be disturbed by capital flow both inside and outside,” said Kim.

A local researcher at a private think tank also echoed his view.

“Korean GDP was ranked 13th in 2007, but the size of its FX market was 18th at the time. In contrast, Singapore and Australia were fifth and seventh respectively in size of FX markets, though their GDP ranked only 40th and 15th,” Kim Jae-min, an economist from the Korea Capital Market Institute (KCMI) said in a recent report.

Kim of the KCMI added that the nation needs to further deregulate the capital flow.

“Foreign investors should change the won into foreign currencies because they are not allowed to take the won out of the nation. It automatically downgrades its value and discourages stability in the market.”

Another analyst from a foreign bank said that he cannot find any case of a government setting a ceiling on currency forward.

“Not a single country in the world has ever imposed regulations for currency forward. It has occurred naturally through demand. If the government tries to dampen such a trade, Korean customers, such as local shipbuilders may suffer from that,” the analyst said on condition of anonymity.

However, executives from foreign banks were cautious to comment on the issue. HSBC Korea, the largest branch of foreign banks here, said it cannot say anything on the issue at this time.

Korea said Sunday that it will tighten regulations on currency transactions in the local foreign exchange market in a bid to ease financial volatility and prevent abrupt capital outflows from causing the economy to suffer in chaos.

The Seoul government will also step up efforts to improve the soundness of foreign currency liquidity held by banks by restricting their use and calling for stricter debt control, according to the Ministry of Strategy and Finance in a joint press release with the central bank and other financial regulators.

Under the latest measures, the ministry said that it will restrict the amount of currency towards and other currency-related derivatives held by Korean banks to 50 percent of their equity capital, while the ceiling for local branches of foreign banks will be set at 250 percent, the ministry said.