Interest in Exchange Rate Direction Following Trump's COVID-19 Diagnosis... What Is South Korea's Appropriate Foreign Exchange Reserve?

[Image source=EPA Yonhap News]

[Asia Economy Reporter Eunbyeol Kim] Following the news of U.S. President Donald Trump's positive diagnosis for the novel coronavirus infection (COVID-19), the Bank of Korea and other foreign exchange authorities are closely monitoring the potential impact of this event on exchange rates and financial markets. The prevailing reaction is that President Trump's COVID-19 diagnosis will increase financial market uncertainty, acting as a factor strengthening the U.S. dollar. Consequently, discussions about South Korea's appropriate level of foreign exchange reserves may resurface.

According to the Bank of Korea on the 3rd, as of the end of August, foreign exchange reserves stood at $418.95 billion (approximately 497.2936 trillion won), an increase of $2.42 billion from the previous month ($416.53 billion). The increase in foreign exchange reserves was attributed to returns on foreign currency asset management and the rise in the dollar-equivalent value of foreign currency assets denominated in other currencies due to the weakening of the U.S. dollar. Compared to the depletion of foreign exchange reserves during the 1997 foreign exchange crisis, the current level of reserves amid the COVID-19 crisis is sufficiently serving as a protective barrier.

However, there is considerable debate among experts about what constitutes an appropriate level of foreign exchange reserves. While countries like the U.S., which can print dollars, face fewer issues, countries of South Korea's scale must consider factors such as external openness, export dependence, and geopolitical risks.

The International Monetary Fund (IMF) suggests an appropriate level of foreign exchange reserves to be 100-150% of the sum of four items: ▲5% of annual export volume ▲5% of money supply (M2) ▲30% of short-term external debt ▲15% of the balance of foreign securities and other investment funds. By IMF standards, South Korea's foreign exchange reserves meet the appropriate level.

However, the reserves fall short of the appropriate level suggested by the Bank for International Settlements (BIS) in 2004. The BIS recommends an appropriate level of foreign exchange reserves as the sum of three months' import payments, short-term external debt, and one-third of foreign equity investment funds. According to this standard, South Korea's appropriate foreign exchange reserves are estimated to be around $600 billion. Those advocating for stronger foreign exchange reserves often cite the BIS standard as their basis.

Choi Jin-ho, a research fellow at KB Financial Group Management Research Institute, stated in "KB Knowledge Vitamin - Understanding Appropriate Foreign Exchange Reserves," "Considering the heterogeneous characteristics between advanced and emerging countries, although countries that do not meet the IMF criteria do not immediately face foreign exchange or financial crises, it is possible to interpret that there is a latent risk of expanding instability if unexpected external shocks persist over the long term."

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