Korea takes action to stabilize foreign exchange volatility

Tension is increasingly building up for Korean financial authorities as the Korean won to dollar exchange rate is growing closer to 1,400 won. Last week, government authorities were known to be verbally involved in the situation, releasing foreign reserves to protect the exchange rate. This starkly contrasted to the government's lack of action last week when the government referred to the situation as a "global situation caused by a strong dollar." The change in action is also reflected in Deputy Prime Minister Chu Kyeong-ho's remarks that "we cannot simply sit on our hands in this situation." South Korean financial authorities have increased the level of intervention as the weaker won impacted import prices and widened trade deficits. Despite such efforts, experts in the foreign exchange market still say that the Korean won to dollar exchange rate of 1,400 won is likely to break soon and go beyond 1,450 won.

The Presidential Office hinted last week at the possibility of a Korea- U.S. currency swap agreement to tackle foreign exchange volatility. "There is likely to be discussions on subjects of joint interest (such as foreign exchange rates, etc. at the Korea-US summit this week)," said Chief Presidential Secretary for Economy Choi Sang-mok on Friday. Currency swap agreements are likened to overdraft protection, where a country's local currency can be entrusted to the other party to lend to the other country's currency. The U.S. maintains permanent currency swap agreements with five key currency economies, including the E.U. and Japan, but the currency swap agreement with Korea terminated shortly after the outbreak of the Covid-19 pandemic. As foreign exchange volatility and anxieties escalated, however, the need for the contract surfaced, which had been considered unfeasible due to a lack of interest by the U.S. 　

Moreover, the Federal Open Market Committee is considering raising key interest rates, currently at 2.25-2.5 percent, by a giant step of 0.75 percentage points or an ultra-step of 1 percentage point this week. If the U.S. key interest rates go above that of Korea, which currently stands at 2.5 percent, the dollar will become stronger, raising a higher risk of foreign funds leaving the country. There is even a risk of the won becoming even weaker if international foreign exchange speculation occurs.

As central banks are responsible for currency swap agreements, an immediate agreement is unlikely to be reached at the upcoming Korea-US summit. An agreement at the leader level could certainly help stabilize volatile exchange rates. We must prepare ourselves for the worse if expectations cannot be met. 　

At the summit in May, Seoul and Washington agreed to strengthen relations by driving closer ties in diversified fields, moving beyond military and national security alliance to economic and technology relations. Korea is dealing with severe challenges driven by the strong dollar, triggered by the U.S. quantitative tightening measures. Korea must convince the U.S. that a currency swap is needed for a closer and stronger alliance.