ED Won's downward march

Take preemptive action to avoid looming woes

The Korean currency tumbled 14 won Friday from the previous day's close to end at 1,326.10 won per U.S. dollar, which was the lowest seen since April 29, 2009. The won has lost about 10 percent in value so far this year, driven by global monetary tightening amid soaring inflation. Fears of an economic recession have also put downward pressure on the local currency.

The problem now is that the won's weakness will persist for the time being as the U.S. Federal Reserve is expected to raise the federal funds rate further after taking a “giant step” of a 75-basis-point hike in June to tame inflation. Market watchers cannot rule out the possibility of the Fed ramping up the rate by as high as 100 basis points this month as consumer prices skyrocketed by 9.1 percent last month, a steepest rise in 41 years.

The Bank of Korea (BOK) increased its benchmark interest rate by an unprecedented margin of 50 basis points to 2.25 percent last Wednesday. However, the U.S. interest rate will soon be higher than Korea's as the Fed is certain to raise its key rate sharply next week. In that case, the Korean won is likely to lose its value further against the greenback. This could prompt capital outflows from Korea as foreign portfolio investors are sure to sell their Korean stocks and bonds to avoid foreign exchange losses.

In a nutshell, Korea is in trilemma: higher interest rates, a weakening local currency, and runaway inflation. These downside risks will continue to weigh on the export-oriented Korean economy. There are growing fears of stagflation, a simultaneous phenomenon of economic stagnation and high inflation. A possible global recession is likely to deal a severe blow to Asia's fourth-largest economy.

Exports, the country's growth engine, have begun to dwindle due to surging prices of energy and commodities as well as supply chain disruptions in the wake of the Russian invasion of Ukraine. Overseas shipments posted a single-digit increase in June, ending 15 months of double-digit growth. Korea suffered a trade deficit for the third consecutive month with the shortfall standing at $10.3 billion in the first half of this year.

China's economic slump is making matters worse. The world's second-largest economy grew a mere 0.4 percent in the second quarter of the year, the lowest since the same period in 2020 when it suffered a contraction of 6.8 percent amid the outbreak of the COVID-19 pandemic. This is a cause for concern as China is Korea's largest trading partner. A quarter of Korean exports usually go to China, the so-called factory of the world.

Against this backdrop, the weakening value of the Korean won is taking its toll on the economy. According to the BOK, the import price index surged by 33.6 percent year-on-year in June. This sharp rise means that Korea has to pay much more for its imports, including oil, gas, raw materials and parts.

Stabilizing the foreign exchange rate is crucial to regaining financial and economic soundness. Top financial officials are expected to discuss with U.S. Treasury Secretary Janet Yellen, who is to visit Seoul on Tuesday, how to ease currency volatility. One option is for Seoul to strike a currency swap deal with Washington to cope with a potential shortage of U.S. dollars here. The Yoon administration should take preemptive action to prevent a financial and economic crisis.