The won recorded its steepest monthly gain in 17 years in July, amid reports that the foreign exchange authorities of Korea, the United States and Japan launched an unprecedented "first-ever three-way exchange rate coordination." The won-dollar exchange rate fell 8.81% in July, the largest monthly drop since March 2009 (10.88%), when the fallout from the global financial crisis was still unfolding. Funds from SK hynix's issuance of American Depositary Receipts (ADRs), dollar inflows earned by exporters, and a shift by foreign investors to net buying in the domestic stock market pushed up the won's value. In particular, foreign media reported that the foreign exchange authorities of Korea, the US and Japan jointly intervened for the first time ever on the 30th of last month to halt the weakening of the won and the yen.
While it is fortunate that the won has escaped a phase of excessive undervaluation, it is too early to feel reassured. In fact, the won-dollar exchange rate fell to 1,418 won on the 31st of last month before rising to 1,446 won on the 2nd, showing that the effect of the three-nation exchange rate coordination did not last long. Above all, there is concern that if the likelihood of a rate hike by the US Federal Reserve rises toward the end of the year, foreign capital outflows and upward pressure on the won-dollar exchange rate could grow. In addition, if the yen strengthens, yen carry trade funds could flow out, triggering a decline in the won's value. Another risk is that dollar demand could rise in the US stock market due to mega initial public offerings (IPOs). Shin Hyun-song, Governor of the Bank of Korea, said last month, "A currency swap is a liquidity provision mechanism, but there is no shortage of dollar liquidity right now." However, even if there is no possibility of a financial crisis, a rise in the exchange rate leads to inflation and interest rate hikes, delivering a shock to households, businesses and the real economy.
The government and the Bank of Korea should use the Korea-US-Japan exchange rate coordination as a springboard to secure a Korea-US currency swap. The US maintains currency swaps with Japan, the eurozone, the UK, Canada and Switzerland. In October last year, it signed a $20 billion currency swap agreement with Argentina. Korea, by contrast, has failed to make progress in restoring a Korea-US currency swap despite pledging $350 billion in investment in the US last year. Korea must devote all its efforts to persuading the US side, citing the fact that unstable exchange rates like the present will hamper investment in the US. It is also time to fully bolster the foreign exchange defense network by extending and making permanent the Korea-Japan currency swap set to expire in November, and by accelerating efforts to attract foreign direct investment (FDI).
