ED Fears of a weakening won

Korea needs to revive currency swap deal with US

The Korean won is likely to become weaker against the U.S. dollar, raising concerns about its devastating effects on the financial markets and the economy. On Tuesday, the local currency hit a two-year low of 1,250.8 won per dollar, down 0.9 won from the previous day.

The won's close marked a depreciation of more than 9 percent from last year's average won-dollar exchange rate of 1,144. Its weakness was caused by the U.S. move toward monetary tightening and fears over China's COVID-19 lockdown.

It seems inevitable for the won to depreciate further as the U.S. Federal Reserve is set to take a big step to raise its interest rate by 0.5 percentage points next month to tame inflation. Some even predict that the next rate hike could be as high as 0.7 percentage poinst.

South Korea's domestic situation is also putting greater pressure on the won to remain weak. The country posted a trade deficit of $5.2 billion in the first 20 days of this month due to high oil prices. It faces a high possibility of suffering a trade shortfall for the second straight month in April, if the trend continues.

The declining value of the local currency brought about a surge in import prices. In March alone, import prices skyrocketed 35 percent from the same month last year. Foreign investors have sold off more than 10 trillion won ($8 billion) worth of Korean shares so far this year in a bid to minimize their losses arising from the weakening won. If the “sell Korea” phenomenon accelerates, this will destabilize the local stock and financial markets further.

However, financial authorities have limited policy tools to shore up the value of the won. It is almost impossible for policymakers to intervene in the Seoul currency market to stop the won from falling further. Thus, it is necessary to take fundamental and comprehensive measures to raise interest rates, keep the country's current account surplus, and speed up an economic recovery.

Stabilizing the won-dollar exchange rate is also crucial to fighting inflation. Consumer prices reached a 10-year high of 4.1 percent in March from a year earlier due to soaring oil and gas prices amid the Russian invasion of Ukraine and global supply disruptions.

The incoming Yoon Suk-yeol administration needs to revive a currency swap deal with the U.S. to cope with a potential foreign currency shortage. Korea was able to stabilize its currency by using such a deal in the 2008 global financial crisis and in the 2020 global health crisis arising from the COVID-19 pandemic. The most recent swap deal worth $60 billion expired at the end of last year.

There is no doubt that a currency swap deal with major global economies will act as a safety valve. It could also help the incoming government deepen economic and financial cooperation with the U.S. as well as strengthen Seoul's security alliance with Washington.