Time to take aggressive, preemptive action
Korea was again hit by financial turmoil triggered by the U.S.' aggressive monetary tightening. The Korean currency plunged to its lowest level against the U.S. dollar in 13 years and six months last week after the U.S. Federal Reserve raised its key interest rate by 75 basis points for a third straight time.
The local currency market felt more shock than had been expected. The Korean currency closed at 1,409.7 won per dollar Thursday, 15.5 won down from the previous day. It marked the first time since March 2009 for the Korean unit to fall below 1,400 won against the greenback.
Yet, the won's tumbling value should not come as a surprise. It is natural for the won to become weaker as the Fed's benchmark interest rate now stands at the range of 3 percent to 3.25 percent, far higher than the Korean central bank's rate of 2.5 percent.
As far as interest rates are concerned, the dollar has become much more valuable than the won. Thus investors have rushed to sell the won and buy the dollar in order to minimize their losses or maximize their profits. That's the way cookie crumbles and the money flows.
The problem is that Korean financial authorities have not fared well in preparing for the Fed's hawkish move to tame inflation, which has soared to a four-decade high. The onus is on the Bank of Korea (BOK) which has failed to take preemptive action. BOK Governor Rhee Chang-yong has so far maintained a moderate position of raising the key rate by 25 basis points despite the Fed's aggressive hike of 50 to 75 basis points.
Now, Rhee has belatedly hinted at taking a "big step" of a half percentage point hike as Fed Chair Jerome Powell clarified that the U.S. central bank will continue to push up the rate to bring runaway inflation under control. It is clear that the BOK can no longer prop up the value of the won by taking a moderate, defensive step.
It is necessary to figure out why the weakening won poses a serious threat to the export-oriented Korean economy. The depreciation of the won is not a boon to exports anymore. It could increase import prices, stoking more inflationary pressure and resulting in higher interest rates. Then it could expand the country's trade deficit.
Korea recorded a trade shortfall for the fifth consecutive month in August when it widened to $9.47 billion. In the first 20 days of this month, the imbalance snowballed to $29.21 billion, exceeding the annual record high of $20.62 billion posted in 1996. The widening shortfall is highly likely to cause a deficit in the current account, a broad measure of the nation's global trade in goods and services as well as net earnings on cross-border investments. If that happens, Korea will suffer a twin deficit together with the fiscal deficit.
It is imperative for the BOK to shift to an aggressive and preemptive stance. Much higher interest hikes will be inevitable in order to fight inflation, shore up the local currency, prevent capital outflows, and stabilize the people's livelihoods. The central bank should not miss out on a rare opportunity to take timely action.
Korea was again hit by financial turmoil triggered by the U.S.' aggressive monetary tightening. The Korean currency plunged to its lowest level against the U.S. dollar in 13 years and six months last week after the U.S. Federal Reserve raised its key interest rate by 75 basis points for a third straight time.
The local currency market felt more shock than had been expected. The Korean currency closed at 1,409.7 won per dollar Thursday, 15.5 won down from the previous day. It marked the first time since March 2009 for the Korean unit to fall below 1,400 won against the greenback.
Yet, the won's tumbling value should not come as a surprise. It is natural for the won to become weaker as the Fed's benchmark interest rate now stands at the range of 3 percent to 3.25 percent, far higher than the Korean central bank's rate of 2.5 percent.
As far as interest rates are concerned, the dollar has become much more valuable than the won. Thus investors have rushed to sell the won and buy the dollar in order to minimize their losses or maximize their profits. That's the way cookie crumbles and the money flows.
The problem is that Korean financial authorities have not fared well in preparing for the Fed's hawkish move to tame inflation, which has soared to a four-decade high. The onus is on the Bank of Korea (BOK) which has failed to take preemptive action. BOK Governor Rhee Chang-yong has so far maintained a moderate position of raising the key rate by 25 basis points despite the Fed's aggressive hike of 50 to 75 basis points.
Now, Rhee has belatedly hinted at taking a "big step" of a half percentage point hike as Fed Chair Jerome Powell clarified that the U.S. central bank will continue to push up the rate to bring runaway inflation under control. It is clear that the BOK can no longer prop up the value of the won by taking a moderate, defensive step.
It is necessary to figure out why the weakening won poses a serious threat to the export-oriented Korean economy. The depreciation of the won is not a boon to exports anymore. It could increase import prices, stoking more inflationary pressure and resulting in higher interest rates. Then it could expand the country's trade deficit.
Korea recorded a trade shortfall for the fifth consecutive month in August when it widened to $9.47 billion. In the first 20 days of this month, the imbalance snowballed to $29.21 billion, exceeding the annual record high of $20.62 billion posted in 1996. The widening shortfall is highly likely to cause a deficit in the current account, a broad measure of the nation's global trade in goods and services as well as net earnings on cross-border investments. If that happens, Korea will suffer a twin deficit together with the fiscal deficit.
It is imperative for the BOK to shift to an aggressive and preemptive stance. Much higher interest hikes will be inevitable in order to fight inflation, shore up the local currency, prevent capital outflows, and stabilize the people's livelihoods. The central bank should not miss out on a rare opportunity to take timely action.
