Risky Intervention

Let Market Determine Won-Dollar Exchange Rate

The government's decision to intervene on the Seoul currency market Monday to check a further slide of the Korean won against the U.S. dollar is designed to bring escalating inflationary pressure under control. There is little doubt that a weaker won will hike import prices of oil and other natural resources, including grain and food, adding fuel to inflation. In this regard, the policy of market intervention is seen as a desperate move to cushion the brewing oil shock.

The decision came one day after the Lee Myung-bak administration set in motion the first in a series of four-phase energy saving measures. The government said the country has virtually entered a third oil shock since crude prices are approaching $150 per barrel. In this situation, soaring oil prices are cited as the main culprit of inflation. South Korea is in a difficult position as 96 percent of its energy supply comes from imports from other countries.

From a global perspective, the continuing weakness of the greenback has also contributed to the stronger crude prices. The dollar is expected to remain weak against major currencies such as the Japanese yen and the euro for the time being. And growing demand for energy in rapidly growing economies, including China and India, are putting more pressure on oil prices. Many analysts at home and abroad predict that oil prices might surpass $170 per barrel by the end of the year. And some say they could hit $200 in the coming months.

Against this backdrop, a further depreciation of the won against the dollar may dictate stagflation. At the start of the Lee government, policymakers took a position to accede to a weaker won in an apparent move to boost the nation's exports and thereby speed up economic recovery. It was a mistake by the government to give more weight to higher economic growth than price stability. Belatedly, the government has realized that President Lee's growth-oriented policy is unrealistic and unattainable. What's more important is that sustainable growth should be achieved without triggering inflation.

We welcome a policy shift from higher growth to price stability. But a question is raised over the government's move to directly intervene in the currency market. The Ministry of Strategy and Finance and the Bank of Korea (BOK) have vowed to mobilize foreign exchange reserves to prop up the value of the won. This intervention could give the impression that South Korea is manipulating the exchange rate. It also might lead to distortion of the market, bringing about grave side-effects.

It is not only natural but also desirable to let the market determine the exchange rate. The won is now under growing pressure for depreciation on the back of an economic slowdown, a widening current account deficit and a selling spree by foreign stock investors. Financial authorities wasted about $10 billion last month trying to prevent the local currency from making further losses as it fell to 1,050 won per dollar. Intervention is a stopgap measure. Policymakers should keep in mind that intervention will do more harm than good to the economy.