Prolonged won weakness weighs on Korean firms, banks

An employee sorts U.S. dollar bills at Hana Bank's foreign currency counterfeiting response center in Seoul, July 3. Yonhap

Corporate and financial sectors are facing mounting pressure from the won's prolonged weakness, with the won-dollar exchange rate remaining at elevated levels for more than two months.

According to the Seoul foreign exchange market, the won has hovered around the 1,500-per-dollar level since mid-May, fluctuating around the psychologically important threshold as foreign equity outflows offset strong stock market gains and a large current account surplus. This lifted the second-quarter average exchange rate to 1,501.6 won, its highest quarterly level since the Asian financial crisis in 1998.

The won briefly strengthened on Friday, with the won-dollar exchange rate ending onshore trade at 1,478.5 per dollar, its lowest close since May 11, when it finished at 1,472.4. The rate saw little change on Monday, closing at 1,478.4.

A weaker won is creating winners and losers across industries. Manufacturers that rely heavily on imported raw materials and components are facing higher production costs, while companies with foreign currency-denominated debt are shouldering heavier repayment burdens and greater exposure to translation losses.

The airline industry is especially vulnerable because key costs such as aircraft leases and fuel are denominated in U.S. dollars. Shipping companies are similarly exposed because vessel purchases and charter fees are largely settled in dollars.

Financial institutions are also under growing pressure to manage dollar liquidity and meet rising corporate demand for foreign exchange hedging.

In the past, a weaker won was widely viewed as a guaranteed boost for exporters, but that relationship has weakened.

While exporters may benefit from favorable exchange rate movements, profitability ultimately depends on cost structures and input costs. Companies with high dollar-denominated sales and substantial domestic production continue to benefit from a stronger dollar. Those benefits, however, are more limited for firms with extensive overseas production or a heavy reliance on imported raw materials.

"With volatility in oil prices, exchange rates and logistics costs expected to remain high in the third quarter, companies need to review and manage their contract terms with extra care," said Lee Gwan-jae, a senior researcher at the Korea International Trade Association.

Small and medium-sized enterprises (SMEs) are under even greater strain. In a survey of 635 firms conducted by the Korea Federation of SMEs late last year, respondents said they needed an average exchange rate of 1,362.6 won per dollar to meet their target operating profit. The won was already trading in the 1,470 range at the time.

Among companies engaged in both exports and imports, 40.7 percent said the won's sharp depreciation had hurt their business, compared with just 13.9 percent that reported gains. Rising prices for imported raw materials and components were the most commonly cited source of pressure, followed by higher foreign-currency settlement costs and increased ocean and air freight charges.

"Even if raw material prices and foreign-currency payment costs rise, small manufacturers cannot immediately reflect those increases in selling prices or supply contract rates because of existing contracts and long-term business relationships," a Korea Federation of SMEs official said.

Export containers are piled up at Busan Port, Wednesday. Yonhap

The won's prolonged weakness is prompting companies to adjust their foreign exchange risk management strategies, with one of the clearest shifts emerging in foreign currency liquidity management.

Bank of Korea data showed corporate U.S. dollar deposits fell from $81.93 billion in January to $72.71 billion in March before rebounding to $82.99 billion in May.

The rebound suggests companies have increased dollar holdings amid elevated exchange-rate volatility. Market participants said firms were building up dollar liquidity in preparation for a prolonged period of won weakness.

"Corporate demand for foreign currency has continued to grow for import payments, overseas investments and hedging purposes," a commercial bank official said. "As exchange-rate volatility rises, companies are also seeking to maintain larger dollar liquidity buffers."

The weaker won is also influencing companies' longer-term business strategies.

Firms facing rising import costs are reassessing procurement plans and supply chains, while businesses with heavy import dependence are looking to diversify settlement currencies and expand long-term supply contracts to reduce foreign exchange risks.

Companies with substantial overseas production, meanwhile, are placing greater emphasis on improving earnings stability rather than relying on short-term foreign exchange gains.

Experts say the government should step up policy support to help companies manage foreign exchange risks as elevated exchange rates are expected to persist.

"The government needs to focus its policy efforts on managing exchange-rate volatility and stabilizing the supply of raw materials," said Kang Min-jae, head of the economic policy team at the Korea Chamber of Commerce and Industry. "It also needs to devise measures to ease the burden on companies from fluctuations in energy and raw material prices."

Financial institutions are also facing mounting challenges, as banks, brokerages and insurers are required to secure adequate dollar liquidity during periods of exchange rate volatility while meeting growing corporate demand for foreign exchange hedging.

For commercial banks in particular, the strong dollar is complicating growth plans for the second half. A weaker won inflates the value of foreign-currency assets in local-currency terms, driving up risk-weighted assets (RWAs). That, in turn, weighs on common equity tier 1 ratios, a key measure of capital strength.

Combined RWAs at Korea's four major banks — KB Kookmin, Shinhan, Hana and Woori — already rose 2.9 percent to 886.5 trillion won ($599 billion) at the end of the first quarter, an increase of 24.3 trillion won from three months earlier.

Analysts said the recent strength of the dollar reflects a structural shift rather than a temporary trend. They said financial institutions should strengthen foreign currency liquidity and capital management instead of expecting the won to quickly return to the 1,100-1,200 range.

"With the exchange rate likely to remain above historical averages, domestic financial institutions need to closely monitor the impact of sustained won weakness on profitability and capital adequacy," the Korea Institute of Finance said in a recent report.