Foreign exchange authorities prioritize market imbalances over exchange rate level

A staff member sorts U.S. dollar bills at Hana Bank’s currency counterfeiting response center in Seoul, July 3. Yonhap

As the won-dollar exchange rate remains at unusually elevated levels despite record-high exports fueled by strong semiconductor demand, market attention has increasingly turned to the question of how much ammunition foreign exchange authorities have.

Typically, stronger exports lead to increased dollar inflows, which support the won and push down the exchange rate. This time, however, the exchange rate has remained in the psychologically significant 1,500-won range for about two months. The won has fallen about 8 percent against the dollar this year, while the dollar index has risen about 3 percent during the first half. On Monday, the won also traded in the 1,500-won-per-dollar range before closing at 1,503.4 won in onshore trading, down 2.0 won.

A prolonged period of won depreciation could fuel higher import costs, squeeze corporate margins and erode households' real purchasing power.

Following the 1997 Asian financial crisis, Korea adopted a free-floating exchange rate system in which the won's value is driven by market demand and supply rather than government-set levels. More buyers of the won push the currency higher, while more sellers put downward pressure on it.

According to multiple government and financial sector sources, authorities are more concerned with market volatility and one-way market moves than with the exchange rate level itself when deciding whether to intervene, in line with their long-standing policy of avoiding interventions based on specific exchange-rate thresholds.

The approach reflects their view that a sharp, short-term surge in the exchange rate can be driven not only by supply and demand factors but also by shifting market expectations and sentiment, which can amplify volatility.

"We are not entering the market to defend any particular exchange-rate level," a senior foreign exchange official said. "While traders are attaching significance to the 1,500 or 1,600 mark, what matters to authorities is whether market functions are operating properly, rather than the level itself."

The emphasis on volatility rather than the exchange rate reflects concerns that treating a particular level as a policy target could distort market expectations.

Officials worry that any perception of defending a specific level would give traders a focal point for speculative bets, ultimately fueling rather than containing volatility.

Authorities' recent messaging has reflected that stance. When the won weakened beyond 1,550 per dollar in intraday trading on June 8, the Bank of Korea (BOK) and the Ministry of Finance and Economy stepped in with a joint verbal intervention, warning they would "never tolerate excessive volatility and one-way market moves" that diverge from economic fundamentals.

At the time, officials believed the volatility was being exacerbated not only by underlying market flows but also by speculative trading, particularly in the offshore nondeliverable forward market.

Foreign exchange authorities have already spent more than $30 billion to stabilize the currency market through direct intervention using the country's foreign exchange reserves.

According to the BOK, the authorities were net sellers of $13.63 billion in the foreign exchange market in the first quarter of 2026. Combined with $22.47 billion in net dollar sales during the previous quarter, they injected $36.1 billion, or about 50 trillion won, into the market over the past two quarters.

The won, however, has shown little sign of rebounding. Analysts say that while massive dollar sales can slow the pace of the won's depreciation, they are unlikely to reverse the underlying supply-and-demand dynamics driven by broad dollar strength, foreign investors' selling of Korean assets and geopolitical risks.

"The authorities have helped ease upward pressure on the won-dollar exchange rate through dollar-selling intervention and by encouraging the National Pension Service to increase its currency hedging," said Wi Jae-hyun, an analyst at Kyobo Securities. "But their capacity to respond is limited and could come under greater strain if foreign investors continue selling Korean equities in the second half of the year."

If foreign exchange volatility persists and one-way market moves intensify, authorities may deploy additional macroprudential tools targeting banks' foreign-currency transactions and cross-border capital flows.

Rather than directly influencing the exchange rate, such measures are typically used to temper market expectations and ease demand for dollars, helping safeguard financial stability.

Korea introduced a package of macroprudential measures in 2010 after the global financial crisis to reduce foreign exchange market volatility caused by sharp cross-border capital flows.

The measures included limits on banks' foreign exchange forward positions, a withholding tax on foreign investors' bond holdings and a levy on banks' nondeposit foreign currency liabilities.

Unlike today, the policy focus at the time was on curbing excessive capital inflows during periods of won strength.

With the currency now under pressure, authorities are expected to focus instead on managing financial institutions' foreign currency demand and transaction patterns, rather than reinstating the previous measures in their existing form.

Bank of Korea Gov. Shin Hyun-song speaks before the National Assembly in Seoul, Thursday. Yonhap

Attention is also turning to currency swaps, often viewed as the foreign exchange market's ultimate safety net.

Markets broadly expect Seoul and Tokyo to renew their $10 billion currency swap agreement, established in December 2023, before it expires in November. Japan is currently the only country with which Korea maintains a dollar-based swap line.

By contrast, the chances of Korea securing a new swap line with the United States, which would carry greater weight in the foreign exchange market, remain unclear.

Currency swaps allow central banks to exchange liquidity in their respective currencies at predetermined rates. They serve as a vital backstop during financial crises, effectively allowing countries to borrow foreign currency to stabilize domestic markets.

Historical data underscores the immediate stabilizing effect of bilateral swap lines with Washington, which Seoul has tapped twice in the past.

Korea signed its first $30 billion swap line with the United States on Oct. 30, 2008, during the global financial crisis. On the day of the announcement, the won strengthened 12.4 percent against the dollar, with the exchange rate closing at 1,250 won. The arrangement expired in February 2010 after two extensions.

A second, $60 billion facility was established in March 2020 during the COVID-19 pandemic. According to a paper by the Korean Economic Association, the won strengthened 3.3 percent on the day of the announcement and posted an average gain of 2.1 percent over the following two weeks. The arrangement expired in December 2021 after three extensions.

Analysts argue that temporary intervention by local authorities is not enough to offset long-term capital outflows, making a currency swap with the United States an important tool for stabilizing the market.

"Considering the structural pressures driving dollar outflows, Korea needs a joint exchange-rate stabilization mechanism with the U.S., such as a currency swap, to ensure stable dollar liquidity," said Jeon Kyu-yeon, an analyst at Hana Securities.

Asked about the possibility of a currency swap with the United States, BOK Gov. Shin Hyun-song told a parliamentary committee on Thursday that discussions are ongoing within the framework of central bank cooperation. However, he emphasized that liquidity conditions remain ample, downplaying concerns over an immediate shortage of dollars.

"Arrangements like currency swaps can have a substantial symbolic and psychological impact," Shin said. "However, they are primarily designed to inject liquidity when it dries up, and under current market conditions, liquidity is not lacking."