Bank of Korea: "Foreign Exchange Authorities in Korea Do Not Participate in Market with Specific Exchange Rate Targets... Responding to Short-Term Shocks" (Comprehensive)

Bank of Korea BOK Economic Research
Exchange Rate Volatility Eased by 0.003 Percentage Points with $100 Million Intervention

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] South Korea's foreign exchange market operations (participation) were found to be driven more by the purpose of responding to temporary exchange rate shocks rather than targeting a specific exchange rate to maintain export price competitiveness. Although the U.S. Treasury continues to keep South Korea on the watchlist due to its current account and trade surplus with the U.S., in reality, most of South Korea's foreign exchange market participation was carried out to ensure financial stability. The government maintains the principle of 'smoothing operation,' which means leaving exchange rate fluctuations to the market but making fine adjustments only when there is a sharp skew.

According to the report titled "The Behavior of South Korea's Foreign Exchange Market Operations and Their Effect on Exchange Rate Volatility Mitigation" published on the 3rd by the Bank of Korea Economic Research Institute in 'BOK Economic Research,' South Korea's foreign exchange market participation generally aimed to mitigate sharp exchange rate fluctuations rather than pursue a specific target exchange rate.

Senior Research Fellow Park Junseo of the Bank of Korea Economic Research Institute said, "Empirical analysis shows that South Korea's foreign exchange market operation behavior was of the 'leaning against the wind' type," adding, "Especially during periods including financial crises, it is estimated that there was a sensitive reaction to won depreciation, while during non-crisis periods, there was a more sensitive reaction to won appreciation." Park further stated, "Foreign exchange market participation was flexibly executed according to market conditions, without a biased purpose to reverse the direction itself."

Foreign exchange market participation was also analyzed to have a significant effect on mitigating exchange rate volatility. The study found that when approximately 100 million USD worth of foreign exchange market participation occurred, the exchange rate volatility was reduced by 0.003 percentage points. Particularly, in the 80th to 99th percentile range of highest volatility, the exchange rate stabilization effect increased to about 0.01 percentage points. This means that when the won-dollar exchange rate surged to the 1,200 won level or plunged to the 900 won level, the foreign exchange authorities' selling or buying of dollars helped reduce exchange rate fluctuations. Exchange rate volatility refers to an index showing how much the closing won-dollar exchange rate has fallen compared to the previous day. The duration of the foreign exchange market participation effect was also short-term (1-2 months), indicating that this measure was effective in resolving market imbalances caused by temporary exchange rate shocks.

This study was conducted by estimating the scale of authorities' market intervention based on data on South Korea's foreign currency reserves, interest rate spreads, goods balance, and foreign portfolio investment, and then analyzing its effects.

Park said, "The finding that foreign exchange market participation mitigated won-dollar exchange rate volatility seems to reflect that the authorities' intention to reduce exchange rate volatility was well communicated to economic agents," adding, "Going forward, it is necessary to pay more attention to clearer signal transmission and trust management by the central bank." Meanwhile, to increase transparency, the foreign exchange authorities have been disclosing net foreign exchange market intervention amounts quarterly since the end of December last year.

This content was produced with the assistance of AI translation services.