'Korea-US Currency Swap' Boosts Market... Not a Cure-All (Comprehensive)

Currency Swap Effect Causes Sharp Exchange Rate Drop and KOSPI Surge
Similar to 2008 Financial Crisis... Short-Term Effect May Fade
Exchange Rate Could Surge Again if COVID-19 Root Issues Remain

US Rapid Response Differs from Past
Lee Ju-yeol "Thankful to Chairman Powell for Showing Leadership as Key Currency Nation"

[Asia Economy Reporters Eunbyeol Kim and Sehee Jang] The domestic financial market, which had been weighed down by the COVID-19 pandemic, is finally showing signs of recovery. The news of the agreement to establish a currency swap between South Korea and the United States has alleviated concerns over foreign currency liquidity, acting as a much-needed relief for the domestic financial market. The KOSPI recovered the 1500 mark during trading hours, and the won-dollar exchange rate, which had threatened the 1300 level, sharply declined. For the first time since 2011, a KOSPI sidecar was triggered.

As of 11:56 a.m. on the 20th in the Seoul foreign exchange market, the won-dollar exchange rate stood at 1,254.40 won per dollar, down 31.33 won from the previous day. The rate started at 1,253.7 won, down 32 won, and maintained its decline. The agreement on the Korea-US currency swap the previous day appears to have calmed the surge in the exchange rate.

The Korean stock market, which had been plunging continuously, is also showing signs of stabilization. As of 12:02 p.m., the KOSPI was trading at 1,520.81, up 4.33% (63.17 points) from the previous trading day. Earlier, the Korea Exchange activated a buy-sidecar in the KOSPI market for the first time since 2011. The KOSDAQ index also rose 5.09% (21.79 points) to 450.14 compared to the previous trading day. However, foreign selling pressure remains. Foreign investors have net sold 131.1 billion won on the KOSPI so far today, continuing their selling streak for 12 consecutive trading days. Institutions also net sold 8.1 billion won, while individuals net bought 110.2 billion won.

In the bond market, foreign investors’ demand for cashing out appears to be easing. As of 9:35 a.m. in the Seoul bond market, the yield on 3-year government bonds fell 6.6 basis points (1 bp = 0.01 percentage point) from the previous day to 1.127% per annum.

The Bank of Korea announced the previous day that it had agreed to a bilateral currency swap contract worth 60 billion dollars with the U.S. Federal Reserve (Fed). The contract period is at least six months (until September 19, 2020). This is twice the size of the swap agreement made during the 2008 global financial crisis.

Lee Ju-yeol, Governor of the Bank of Korea, told reporters on his way to the Bank of Korea headquarters that day, "We expect the Korea-US currency swap agreement to contribute to easing instability in the domestic foreign exchange market." Governor Lee added, "The agreement with the U.S. Fed is on the contract conclusion, and now we will proceed with drafting the contract. Once the contract is drafted, we plan to supply dollars to the market immediately." He also noted that extending the currency swap is possible if necessary.

[Image source=Yonhap News]

Kim Yong-beom, First Vice Minister of Strategy and Finance, also said at the Innovation Growth Strategy Review Meeting and Policy Review Meeting that day, "The Korea-US currency swap agreement is twice the size of that during the 2008 global financial crisis," adding, "It will serve as a strong safety net to stabilize the domestic foreign exchange market, which was affected by global financial instability."

Although the market has temporarily breathed a sigh of relief, there are concerns that the effect may be short-lived, and the 'Korea-US currency swap' should not be regarded as a panacea. This is because the fundamental problem cannot be considered resolved unless COVID-19 is contained.

◆ Like the 2008 Financial Crisis... The Effect May Be Short-Term = "Just because the Korea-US currency swap agreement has been made does not mean all problems are solved." This is a statement from a foreign exchange authority official regarding the current currency swap agreement. When the Korea-US currency swap was concluded on October 30, 2008, the won-dollar exchange rate, which had been around 1,400 won, dropped sharply to the 1,250 won level. However, the exchange rate gradually started to rise again and returned to the pre-swap level within about 20 days. In December of that year, the Bank of Korea made three withdrawals from the currency swap, calming the exchange rate again, but by April of the following year, the exchange rate soared to nearly 1,600 won per dollar.

At that time, concerns about the global real economy persisted even after the currency swap agreement, which pushed the exchange rate back up. As major countries such as the U.S., Japan, and Europe recorded negative growth rates, risk-averse behavior emerged, leading to renewed demand for the dollar.

Even now, amid the COVID-19 pandemic, the world is desperate to secure dollars. The Dollar Index, which shows the value of the dollar against six major currencies, remains above 100 despite the currency swap announcement. Ultimately, if the fundamental problem is not resolved, the Korean foreign exchange market is likely to be seen as a place where foreigners can freely exchange dollars. Especially compared to China, Hong Kong, Singapore, and Malaysia, Korea’s openness is higher, which could accelerate dollar outflows.

Yumi Kim, a researcher at Kiwoom Securities, said, "The decline in the won-dollar exchange rate may be short-lived," adding, "For the won to remain strong, the dollar’s strength must be limited and there must be signs that COVID-19 is calming down." She further evaluated, "Ultimately, confirming the containment of COVID-19 is most important for exchange rate stability, and until specific countermeasures for credit risks related to bad assets in the U.S. emerge, volatility in the won-dollar exchange rate is inevitable."

Governor Lee Ju-yeol also told reporters on his way to work that day, "This currency swap is intended to alleviate the dollar shortage, and it is a different issue from a financial crisis." He said, "While the currency swap can block the spillover of financial market instability caused by dollar shortages in emerging markets to the U.S., the Fed is handling the financial crisis caused by the real economy through other means."

◆ This Time Led by the U.S... Differences from 2008 = However, the situation is not exactly the same as in 2008. During the financial crisis, Korea requested the currency swap from the U.S., and the U.S. initially showed reluctance, but this time the U.S. took the initiative. As COVID-19 spread worldwide, a dollar shortage emerged, and if this situation prolonged, the U.S.’s position as the key currency country could be shaken, prompting the U.S. to act quickly. The shortage of dollars and the rise in the dollar’s value caused market instability in the global financial market, limiting the dollar’s function as the key currency. The financial market instability in one country kept spreading to others, leading to international financial market instability, so the U.S. decided it must alleviate the dollar shortage as the key currency country.

Governor Lee said, "The most prominent phenomenon in the international financial market right now is risk aversion, and the shortage of dollars in the international market is causing constraints from the perspective of the key currency country, which is why the U.S. stepped in." He added, "This case shows the leadership of the central bank of the key currency country, with the U.S. acting quite swiftly. I am very grateful for Fed Chair Jerome Powell’s prompt decision-making."

Jerome Powell, Chair of the U.S. Federal Reserve (Fed) [Image source=Reuters Yonhap News]

Separately from the currency swap, Governor Lee emphasized that the domestic foreign exchange reserves are at an appropriate level. He assessed, "Even when applying several criteria to evaluate the adequacy of foreign exchange reserves, the current level is generally considered appropriate."

Yun Yeo-sam, a researcher at Meritz Securities, said, "Blocking external shocks with the currency swap was a good choice," advising, "The next task is to control government bond yields and corporate bonds, and since large companies’ financial conditions are also not good, liquidity in this area should be monitored." He also added, "Some level of safety net is needed for securities companies, which have grown larger than insurance companies."

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