Fed's earlier end to tapering prompts call for Korea to increase dollar reserves

Fed's earlier end to tapering prompts call for Korea to increase dollar reserves

Bank of Korea Governor Lee Ju-yeol speaks during a press conference at its headquarters in Seoul, Nov. 25. Yonhap

By Lee Min-hyung

Korea should increase its foreign exchange reserves amid escalating fears over the rapid rise of the won-dollar exchange rate, with the U.S. Fed sending repeated signals to put an earlier end to tapering its asset purchase program, economists said Tuesday.

As the world’s largest economy is expected to increase its key interest rate soon after the end of tapering, there is also a strong chance that the monetary tightening by the U.S. will end up hastening the exodus of foreign capital as early as the beginning of 2022, they added.

Some reports said that the Fed would complete tapering by the end of March next year, and the planned rate hike is scheduled to start sometime around the spring season.

This has prompted calls for Korea to brace for the worst-case scenario by increasing its foreign exchange reserve and extending a currency swap agreement with the U.S. The deal is worth $60 billion (70.89 trillion won) and is set to expire at the end of this year.

“Korea’s foreign exchange reserve is not sufficient to endure a possible post-pandemic crisis, so the country should increase the reserve by expanding the scale of the currency swap deal ahead of the beginning of the Fed’s tapering,” Sejong University economist Kim Dae-jong said.

Kim said Korea’s foreign exchange reserve-to-GDP ratio is below 30 percent, which is a worrying level, and the country should increase the ratio by a huge margin in line with other countries and regions that top 100 percent, citing the examples of Switzerland, Hong Kong and Singapore. “This is crucial amid the surging won-dollar exchange rate and a series of other looming financial uncertainties here and abroad.”

After hitting a three-year low of around 1,100-won per dollar late last year, the rate has been on the steep rise before touching the 1,200-won mark. As of Tuesday, the figure hovered around 1,180 won per dollar, but a prevalent outlook is that the exchange rate will soon touch the 1,200-mark by the end of 2021 on the Fed’s ever more hawkish turn.

Other external uncertainties ― such as escalating fears over the spread of the Omicron variant of COVID-19 ― also continue posing upward pressure on the exchange rate, so the economist advised the Bank of Korea (BOK) to extend the swap agreement with the U.S. as a preemptive move.

Recent data from the BOK also backed up the argument, as Korea’s foreign exchange reserves in November declined by $5.3 billion from the previous month. This was the first time in five months that the reserve level failed to set a new record high.

Despite such worries, BOK Governor Lee Ju-yeol remained optimistic saying that the economic circumstance here has “changed a lot” since March 2020 when the two countries signed the $60 billion currency swap agreement.

“It is a clear fact that the global economy has since recovered, and the economic circumstance also changed,” Lee told reporters during a press conference. “Back then, we expected a great crisis and recession. Both countries also understand the status quo and the BOK and the Fed are still in talks over the extension of the swap deal.”

Other economists expected the Korean won to lose more ground against the dollar in a near-term perspective on lingering uncertainties surrounding the Fed’s earlier tapering and the default crisis of China’s once-largest real estate developer, Evergrande.

“Even if the Korean stock market bounces back throughout this week, its impact on the won-dollar exchange rate will be limited,” IBK Investment & Securities analyst Jung Yong-jin said.

This is because the renewed concern over the spread of COVID-19 here will help the U.S. dollar strengthen its valuation against the Korean won, Jung added.

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