Posted by: Ihlwan Moon on March 5, 2009
It’s hard to understand why the South Korean won is the worst performing major currency if you listen to the country’s policymakers explaining about the current economic predicament. Finance Minister Yoon Jeung Hyun said on Mar. 5 that Korea has enough foreign exchange reserves of more than $200 billion, the sixth largest in the world, its national debt amounts to 33% of its GDP, a lot lower than OECD countries’ average of 75%, and the corporate debt-to-equity ratio has fallen to one-fourth the level during the 1997-98 Asian financial crisis. Moreover, the country has managed to curb the housing price bubble prevalent elsewhere, he argues.
So why the recent dive in the Korean won and market jitters that Korea may face a liquidity crisis? According to Yoon and his fellow policymakers, Korea has become a victim of speculations because it is a “small and open economy.” He declares: “I will put a top priority on gaining market confidence based on honesty.”
Well, Yoon and his ministry have failed to do so, at least so far. The best evidence is the country’s currency, which has lost nearly 20% of its value against the dollar so far this year after losing another 26% in 2008. If players at Seoul’s foreign exchange market are convinced that the Korean economy will be among the first to recover from the global recession — as Yoon says — and if they have confidence in Korean mandarins’ ability to forestall a liquidity squeeze, they would not have sold down the won to the current level.
Such a weak currency won’t help Korea’s economic recovery, particularly when demand in export markets has collapsed. It makes Korean products cheaper overseas but consumers are in no mood to buy. On the other hand, it is a recipe for stopping imports of capital goods needed for upgrading and expanding production facilities. Sure a double-digit fall in exports seriously undermined industrial production but a 16% plunge in facility investment was an important factor for a 5.6% contraction in Korea’s GDP in the last three months of 2008 from the previous quarter.
The government stresses that Korea has sufficient foreign exchange holdings to pay back foreign debt. It says foreign debt maturing within a year amounts to 77% of its foreign exchange holdings. In fact, no other Asian nation that investors care about has such a high ratio of short-term external debt (on a remaining maturity basis) to foreign exchange reserves. Few expect Korea to default on debt payment but many worry that it might run into a liquidity crunch if exports keep falling sharply.
What’s clear is that the won won’t be so weak unless Korea suffers from a shortage of the greenback. The best way to start winning market confidence is to explain exactly why there has been such an acute dollar shortage and show what specific steps Seoul is taking to end worries of market players. Until the won begins gaining its strength again, few investors would think Korea’s economic fundamentals are sound as Yoon states.