Gov`t, Capable of Unlimited Intervention in Foreign Exchange Market?

Amid escalating pressures of a strong won due to the inflow of foreign capital into the local stock market, it is noteworthy to what extent the nation’s foreign currency authorities could intervene.

As an official of the authorities announced ‘unlimited intervention’ Monday, the government and the Bank of Korea (BOK) are capable of providing an unlimited amount of won to buy dollars by issuing foreign exchange stabilization bonds (FESB) and currency notes. In reality, however, it is hard for the authorities to raise more than 3.8 trillion won, the maximum issue of FESBs, given the current financial state of the government and the balance of the BOK.

The Ministry of Finance and Economy (MOFE) issues FESBs to deposit won in the BOK. Then the BOK intervenes in the foreign exchange markets with the money. Currently, the situation is the other way around: the interest of FESBs is higher than that on deposits. Accordingly, the net loss of interest, which the government should make up, reaches 1.1 trillion won. This is why it is extremely difficult for the government to issue more FESBs.

In addition, the central bank will have trouble achieving the minimum target of call rate (3.65 percent) due to falling call rates in the market, unless it absorbs increased amounts of currency by issuing currency stabilization bonds.

Foreign capital that flowed into the local stock market amounted to 480 billion won on Aug. 21 and 22 or 7.1 trillion won from June. If this trend persists and the authorities are incapable of taking more defensive measures, their capacity to manipulate the foreign exchange market will be depleted. Moreover, the widespread perception of a strong won may lead to ‘leads and lags,’ which means accelerated and decelerated foreign trade payments and receipts, usually associated with exchange rate speculation. Companies’ foreign exchange deposits of residents reached 15.63 dollars or 18 trillion won, as of Aug. 20. If the won is obviously strong, companies will sell a considerable amount of their dollars, accelerating the fall of foreign exchange rates. The exchange rate between the won and the dollar remained stable on Aug. 25 and 26 since foreigners bought less stock, the yen, which has a crucial influence on the won-to-dollar exchange rate, stopped gaining against the dollar, and the Finance and Economy Ministry made clear its plans for intervention in the market.

Yong-Ki Kim ykim@donga.com