Will the COVID-19 Triggered Currency War Reignite...Resembling the 2008 Financial Crisis (Comprehensive)

Countries Successively Announce Liquidity Supply Measures
Possibility of US Zero Interest Rate and China Reserve Requirement Ratio Cut

Bank of Korea Also Expected to Cut Interest Rates
Concerns Over Emerging Markets Hit in Currency War

[Asia Economy Reporters Eunbyeol Kim, Hyunjin Jung, Beijing Correspondent Sunmi Park] There are growing concerns that the novel coronavirus disease (COVID-19) could trigger a global currency war. As countries roll out economic measures to combat COVID-19 and inject liquidity, these policies appear to be sparking a competitive devaluation of currencies. This situation resembles the pattern seen during the 2008 financial crisis. Although South Korea's exchange rate fluctuations are not as pronounced compared to major countries, there are worries that if a currency war breaks out, international capital could rapidly flow in and out, destabilizing the market. The market has largely priced in the expectation that the Bank of Korea will cut its benchmark interest rate next month.

On the 12th, key players in the foreign exchange market diagnosed that "regardless of the United States' intentions, a currency war-like situation is currently unfolding." In fact, the U.S. implemented an emergency rate cut of 50 basis points (1bp = 0.01 percentage points) on the 3rd (local time), after which a weak dollar trend has continued. Since late February, the U.S. dollar has steadily weakened. The dollar index, which was threatening the 100 mark at 99.86 on the 20th of last month, recently dropped to around 96. On the 9th, it fell further to 94.895.

Meanwhile, the currencies of major countries have relatively appreciated. The dollar-yen exchange rate, which was 112.10 on the 20th of last month when the U.S. weak dollar trend began, dropped to 104.54 the day before. This means the yen appreciated by about 6.74%. The Swiss franc rose by 4.63%, and the offshore Chinese yuan also increased by 1.10%. The won-dollar exchange rate rose after COVID-19 spread in January but fell nearly 15 won (won appreciation) from the 1200 won level to around 1185 won following the U.S. rate cut.

[Image source=Reuters Yonhap News]

◆ Competitive Monetary Easing Among Major Countries Amid Possibility of U.S. Zero Interest Rate = On the 11th (local time), the Bank of England (BoE) surprised markets by cutting its benchmark interest rate by 0.50 percentage points. It also lowered the countercyclical capital buffer ratio, which banks hold as reserves at the central bank, from 1% to 0%. The BoE's significant rate cut appears to be aimed at aligning with the U.S. and Canada. Earlier, the Bank of Canada (BOC) followed the Fed's rate cut by lowering its benchmark rate by 0.5 percentage points to 1.25% the next day.

The European Central Bank (ECB), which held a monetary policy meeting on the 12th, is also expected to slightly cut its current deposit rate of -0.5% and announce measures to support small and medium-sized enterprises. The Fed expanded its repurchase agreement (RP) transaction limit from $100 billion to $150 billion, and then from $150 billion to $175 billion. The New York Federal Reserve explained that this was a measure to ensure banks maintain sufficient reserves and to ease pressure on financial markets. However, this also fueled the competition for liquidity easing.

At first glance, it seems that the world is cooperating through rate cuts. The problem is that the U.S. has much more room to cut rates down to zero compared to other countries. The ECB and the Bank of Japan (BOJ) already have benchmark rates at 0% and negative (-0.10%), respectively. Ultimately, major central banks are facing a situation where rates are at the floor, forcing them to seek other tools to maintain the effectiveness of monetary policy. The BOJ's purchase of exchange-traded funds (ETFs) is a representative example. Since the recession has already progressed, advanced countries find it difficult to aggressively conduct asset purchases.

[Image source=Yonhap News]

◆ China May Join... Emerging Markets Like South Korea Could Be Hit = The trade war with China, which had quieted due to COVID-19, could resurface. The People's Bank of China (PBOC) is highly likely to implement liquidity supply measures as early as this week. On this day, the Communist Party's official newspaper, the People's Daily, reported on its front page that Premier Li Keqiang presided over a State Council executive meeting on the 10th, urging policies to expand support for small and medium-sized enterprises by commercial banks and reduce financing costs. It also reported that a special discounted loan of 800 billion yuan had already been allocated to companies involved in COVID-19 prevention efforts to enable them to resume operations quickly.

Since the State Council executive meeting mentioned the government's financial support policies for normalizing corporate activities, experts are focusing on the possibility that the PBOC will soon unveil a cut in the bank reserve requirement ratio (RRR), which would have an additional liquidity effect. Expectations for stimulus measures from the Chinese government have risen since the COVID-19 outbreak, and the direct mention of reducing corporate financing costs at the State Council executive meeting is interpreted as a signal that the PBOC's announcement of an RRR cut is imminent. Li Daxiao, chief economist at Yingda Securities in China, said, "The PBOC will take follow-up measures immediately after the State Council executive meeting. An RRR cut announcement is expected within the next few days, possibly as soon as this week."

Economic experts expect the PBOC to cut the bank RRR by 50 to 100 basis points. This would inject liquidity of about 300 billion to 700 billion yuan into the market.

If a currency war scenario unfolds, South Korea and other emerging markets are also expected to be affected. Theoretically, a stronger won would be disadvantageous for exports. Additionally, increased exchange rate volatility and market instability are concerns. Professor So-Young Kim of Seoul National University's Department of Economics said, "If a currency war leads to increased liquidity and faster capital inflows and outflows, South Korea's financial market, which relies heavily on foreign investors, could be hit."

For this reason, there are calls for South Korea to establish a global cooperation system in advance through currency swap agreements with the U.S. and others before a crisis hits. The sequence could be competitive currency devaluation → instability in emerging market financial markets → renewed instability in advanced countries. The Wall Street Journal (WSJ) editorial on the 10th titled "Fed's Market Stabilization Measures" stated that the Fed needs to establish currency swap agreements with South Korea, China, Taiwan, Hong Kong, and Australia. Currency swaps are agreements that allow countries to deposit their own currency with each other and receive the other's currency or dollars in emergencies such as foreign exchange crises.

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