South Korea Takes Action to Stem Financial Turmoil

To help stabilize the won and prop up local banks in a currency crunch, Korea's central bank will supply them with U.S. dollars

By Moon Ihlwan

Workers install a new signage of Korea Exchange Bank in Seoul on September 19, 2008. Korean banks are at the heart of Korea's currency crisis. KIM JAE-HWAN/AFP/Getty Images

South Korea's central bank on Oct. 17 announced it will provide U.S. dollars to local banks suffering from a foreign currency liquidity crunch, in a step analysts say could eventually help stabilize the country's currency. The move, coming a day after the won plunged 9.7% against the dollar, the worst daily fall in a decade, is designed to send a message to the world that Korea will use its ample foreign exchange reserves to avert a crisis, Bank of Korea officials said.

The plan to supply the banks with dollars will begin next week in the form of auctions for currency swaps. Korean banks in need of dollars could offer better terms for the swaps in which the Bank of Korea will provide the greenback in exchange for the won. "The authorities are determined to remove uncertainties over Korean banks' foreign currency funding," said Bank of Korea Deputy Director Lee Hee Weon.

The swap arrangement is the first measure released after Korea's top policymakers and regulators held emergency talks aimed at calming jitters on the local financial markets. The meeting was arranged after both the won and the benchmark Kospi index on the Seoul bourse plummeted by nearly 10% on Oct. 16. The day before, credit rating firm Standard & Poor's placed Kookmin Bank (KB), Korea's largest lender, and six other Korean banks on its watch list with negative implications, citing potential difficulties the banks may face in foreign currency funding.

Recalling the Asian Crisis

An Oct. 15 statement by S&P, like BusinessWeek a division of The McGraw-Hill Companies (MHP), warned that unless Seoul offers sovereign support for Korean banks, their liquidity risks could be exacerbated "in a process of reverse discrimination." Seoul's inaction (BusinessWeek.com, 10/15/08), it says, contrasts with the efforts of many other nations, which have recently drawn up comprehensive financial support schemes, including blanket deposit guarantees and underwriting of interbank lending risks.

"It is time for all policy authorities to join forces in one direction to stabilize financial markets," declared Korea's chief regulator, Jun Kwang Woo, in a parliamentary hearing. Jun, who heads the Financial Services Commission, said he expected the global financial turmoil to persist until at least mid-2009. Seoul could come up with more relief measures if the continuing financial meltdown threatened banking stability, says Lee at Bank of Korea.

The sense of crisis has been roused after a growing number of investors and media began drawing parallels between the storm hitting Korea and that in 1997 when the Asian financial crisis pushed the nation to the brink of sovereign default. A trigger was the won, which has lost some 30% of its value against the dollar since the beginning of this year, the world's worst-performing major currency (BusinessWeek.com, 10/8/08).

Indeed, some key economic indicators show disturbing similarities. Apart from the sharp currency depreciation, which also occurred during the Asian crisis, Korea's short-term debt has nearly tripled, to $176 billion, in the past two-and-a-half years. A decade ago, in the two-and-a-half years before the Asian crisis, Korea's short-term debt soared 2.2 times.

Health Balance Sheets

Another troubling sign is Korea's current account, which measures trade in goods and services. In the first eight months of this year, Korea posted a $12.6 billion current account deficit, and although the overall annual deficit is expected to be smaller, Korea is expected to post a big shortfall this year after reporting nine consecutive years of surplus. That smacks of Korea in the 1990s, when it piled up deficits in the runup to the meltdown.