[Insight & Opinion] Conditions for Exchange Rate Stabilization

As the exchange rate surges, concerns about the Korean economy are mounting. It was expected that the exchange rate would fall to the 1,300 won range if the Korea-US trade negotiations were concluded, but contrary to expectations, the rate is hovering above the 1,450 won level. While a rising exchange rate is positive for exports, it also leads to inflation and a slowdown in domestic demand, and incurs costs by prompting foreign stock investment funds to flow out due to concerns over foreign exchange losses. Above all, since the exchange rate serves as an indicator of a country's economic credibility, it is urgent for policymakers to come up with countermeasures.

The reasons for the rising exchange rate include the possibility of a delayed interest rate cut in the United States, which has strengthened the dollar, but domestic factors play a larger role. The demand for dollars has increased significantly due to the rise in overseas stock and direct investments, and foreign investors who have realized gains are selling stocks in large quantities out of concern for foreign exchange losses. Ultimately, the exchange rate can only stabilize when domestic investment by Korean investors increases and the selling pressure from foreign investors decreases.

First, industrial competitiveness must be enhanced. While semiconductors and automobiles have maintained their competitiveness, most industries, including petrochemicals, shipbuilding, and steel, are losing ground due to competition from China. Although liquidity expansion and changes in stock dividend-related systems may temporarily boost stock prices, with this year's growth rate expected to be below 1 percent, there are limits to sustained stock price increases. Only when industrial competitiveness is strengthened, leading to increased employment and higher growth rates, will overseas investments by Korean investors shift to domestic investments and foreign investment inflows rise, thereby stabilizing the exchange rate. Policymakers should actively support investments in new industries such as artificial intelligence (AI), enhance industrial competitiveness, boost growth rates, and stabilize the exchange rate.

Institutional reforms in line with global standards are also necessary. Due to capital liberalization and digitalization, the investment market has become globalized, unlike in the past. Excessive taxation or unreasonable labor systems that do not align with global standards increase overseas investments by domestic companies and decrease foreign investment in Korea. Unfair practices such as stock price manipulation are also factors that drive overseas investment. As a result, with domestic demand stagnating and employment declining, the country could fall into the trap of low growth and a high exchange rate. Policymakers must strictly crack down on financial crimes such as stock price manipulation, as is done in the United States, to establish fair trading practices. Lawmakers should also recognize the changing investment environment and revise tax and labor laws and systems closely related to corporate investment to align with global standards.

Finally, it is important to reduce uncertainty in the Korean economy. Recently, Korea has frequently changed laws and systems related to real estate, labor, and investment. Frequent policy changes increase economic uncertainty. In addition, the economy being influenced by specific political ideologies further heightens economic anxiety. This can increase both legal and illegal capital outflows and raise the exchange rate. To stabilize the exchange rate, policymakers must maintain consistent policies and overcome the politicization of the economy to reduce uncertainty in the Korean economy.

The Korean economy is facing both opportunities and challenges. With the US-China power struggle, the United States is restricting Chinese exports and promoting domestic manufacturing. The US export restrictions on China are similar to the semiconductor export restrictions imposed on Japan in the late 1980s. At that time, due to US trade restrictions, Korea and Taiwan were able to become semiconductor powerhouses as they are today. The current changes in the trade environment could also provide an opportunity for Korea's shipbuilding and steel industries, which are losing competitiveness to China, to make a comeback and stabilize the exchange rate. On the other hand, factors such as the progress of aging, increased liquidity due to declining employment, polarization of housing prices, and rising economic uncertainty are contributing to a higher exchange rate. The Korean economy must maximize opportunities and efficiently overcome challenges to stabilize the exchange rate.

Kim Jeongsik, Professor Emeritus of Economics, Yonsei University