[Why&Next] "Attractive due to low interest rates"... Government plans to cover tax revenue using even foreign exchange defense funds

A Clever Way to Cover Tax Revenue Without National Bond Issuance or Supplementary Budget
But It Deviates from the Purpose of Exchange Rate Defense

As the Korean won accumulated in the Foreign Exchange Equalization Fund is being considered as a means to cover the government's tax revenue shortfall, concerns are raised that, although it is an efficient method under the current circumstances, it does not align with the fund's original purpose. While it is currently highlighted as a 'clever solution' to improve the fund's balance and cover tax revenue without the government incurring national debt, the fund's fundamental role in defending the exchange rate could be compromised.

The government is contemplating utilizing the won liquidity in the Foreign Exchange Equalization Fund to cover the expected tax revenue shortfall of about 60 trillion won this year. The plan involves transferring the won funds to the Public Fund Management Fund (Gongja Fund) and then reallocating them to the general account for use as part of the general budget. Since the current administration emphasizes 'fiscal soundness,' this method is being devised as a measure to cover the tax shortfall without issuing government bonds or preparing supplementary budgets. Notably, up to approximately 30 trillion won can be allocated to the general account at the government's discretion without requiring parliamentary approval, which is attractive from the government's perspective.

The Foreign Exchange Equalization Fund was established for the government to intervene directly or indirectly in the foreign exchange market to maintain currency value stability. The concern about using the won funds is that it could become difficult to respond if the exchange rate suddenly falls. Hong Seong-guk, a member of the Democratic Party of Korea, recently issued a press release stating that Korea ranks second among 16 countries in exchange rate volatility. He warned, “With the Korea-US interest rate differential at an all-time high and the yuan, which the won follows, facing instability due to China's real estate risks and economic recession threats, caution is needed regarding volatility,” and argued that the Foreign Exchange Equalization Fund should not be touched.

However, at this moment of a high exchange rate phase, it seems practically unproblematic. To defend the soaring won-dollar exchange rate, the foreign exchange authorities have been conducting 'dollar sell interventions' by selling dollars from the Foreign Exchange Equalization Fund and buying won. A Bank of Korea official said, "In a situation where the exchange rate is rising like now, using the won accumulated in the Foreign Exchange Equalization Fund, which is not immediately needed, does not seem to be a big problem." Given the current situation where rising oil prices and sluggish economic recovery in China are fueling a strong dollar trend, it is calculated that there will be no sudden need for won.

The government views transferring won to the Gongja Fund positively from the perspective of improving the fund's balance. As of the end of last year, the Foreign Exchange Equalization Fund's asset size was 269.4 trillion won. Of this, 2.4 trillion won is net assets, and the remaining 267 trillion won is debt borrowed from the Gongja Fund. A Ministry of Economy and Finance official said, “The won accumulated in the Foreign Exchange Equalization Fund is not free money but borrowed from the Gongja Fund, so interest must be paid regularly,” adding, “Rather than holding it as debt, the decision was made to repay it to improve the balance.” The ministry also repaid about 4 trillion won to the Gongja Fund over three years from 2014 to 2016.

Regarding the government's recent plan to issue about 18 trillion won worth of won-denominated Foreign Exchange Equalization Bonds, it was explained as a “concept of refinancing at a low interest rate.” Assuming the Foreign Exchange Equalization Fund is used to cover the tax shortfall, this means issuing low-interest Foreign Exchange Equalization Bonds instead of borrowing high-interest funds again from the Gongja Fund for exchange rate defense. The Foreign Exchange Equalization Fund usually deposits funds with the Gongja Fund at the level of 10-year maturity treasury bond interest rates, averaging about 2.7% from 2010 to 2021. The won-denominated Foreign Exchange Equalization Bonds are issued at the level of 1-year Monetary Stabilization Bonds interest rates, about 2.1%. The 0.6 percentage point difference means saving at least 110 billion won in interest, according to the Ministry of Economy and Finance.

However, it is difficult to avoid the criticism that it is necessary to consider whether efficiency should be exchanged for the fund's essence. Lee Sang-min, senior research fellow at the Nara Salrim Research Institute, said, “Repaying borrowed money may seem rational and efficient,” but added, “The appropriate size of the Foreign Exchange Equalization Fund should be determined through foreign exchange policy, not used as a trick to adjust tax revenue size or bond issuance volume, which deviates from the fund's fundamental use.” He further stated, “Simply changing the pocket holding the money does not actually improve fiscal soundness, and it does not seem desirable to make it appear as if fiscal soundness is being promoted just because it is a method other than supplementary budgets or bond issuance.”

There are also concerns that utilizing the Foreign Exchange Equalization Fund could burden the foreign exchange market's external credibility and the central bank. If the fund is diverted due to government fiscal difficulties rather than foreign exchange policy principles, questions about Korea's principles could arise. Assemblyman Hong said, “The Bank of Korea could be perceived as bearing not only external variables but also government tax revenue deficits and fiscal problems.”

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