Soaring won puts forex authorities in a bind

By Lee Kyung-min

The rapid appreciation of the won continues to spell trouble for the foreign exchange authorities in Korea, a repeated dilemma over whether market intervention is needed to “rein in” the fast-soaring local currency that saps the competitive edge of the export-reliant economy.

The concern is growing since Korea can look only to exports, which have had a better-than-expected performance amid the COVID-19 pandemic, as the only reason for optimism given the sharp tightening of consumption set to worsen due to a third wave of coronavirus infections.

Market intervention via buying U.S. dollars to weaken the won will entail an immediate warning from the U.S., drawing attention to Korea that is already on the list of countries under close monitoring for currency manipulation.

Economists and market analysts say the local currency will continue to strengthen as the U.S. dollar is highly likely to weaken following a massive stimulus package pledged by U.S. President-elect Biden.

The local currency closed at 1090.30, Dec. 11, continuing an uptrend defined by it passing the psychologically significant 1,100 won level Dec. 3 after more than two-and-a-half years.

The currency hovered as high as 1,080 won thereafter, driven by a lack of intervention and no related signals by the forex authorities.

Currency manipulation

A country is subject to scrutiny by the U.S. if it is designated as a currency manipulator, defined under three conditions.

The designation applies to a country that has a reported trade surplus with the U.S. of over $20 billion in the past 12 months; if it logged a current account surplus of more than 2 percent of gross domestic product (GDP); and if its net foreign currency purchase exceeds over 2 percent of GDP for more than six consecutive months.

Upon the designation, the U.S. requires the country involved to correct its currency undervaluation. No subsequent corrective actions within the following 12 months will be followed by limiting U.S. investment in that country, restricted contracts with the U.S. federal government, and additional monitoring from the International Monetary Fund (IMF).

Korea as of June 2019 was classified as a country under monitoring, as the first two of the three conditions were met.

The repercussions of being designated a currency manipulator notwithstanding, the authorities should promptly intervene to limit any unreasonable spike in the local currency, according to Seoul National University economist Kim So-young.

“The manipulator status will lead to tightening in trade conditions mostly to materialize through tariffs, but that is a concern for later. A timely and moderate smoothing operation is needed to keep wild currency swings under control.”

Implications for local firms

The soaring won bodes ill for local export firms, especially top growth driver industries including manufacturers of chips and displays as well as automakers.

This is because their earnings in dollars converted to Korean won will lead to substantial losses.

But other big industries such as steelmakers and petrochemical firms will see a limited impact, since a stronger won can help them reduce purchase costs of raw materials, while final products will be sold at higher-than-usual prices.

Increasingly unsettled are small- and medium-sized enterprises (SMEs), which account for 99 percent of companies here.

Unlike large conglomerates that have a variety of measures to hedge against currency risks, SMEs without such costly measures in place are more vulnerable to currency fluctuations.

According to a November survey by the Korea International Trade Association survey of 801 export firms, the break-even exchange rate was 1,133 won for SMEs and 1,126 won for large firms.

“This means the current exchange rate level of below-1,100 won has already begun to hurt their profitability, a reason why action by the authorities is needed,” Kim said.