[Editorial] Gov’t Ability to Manage Forex Reserves

The amount of foreign exchange reserves fell 10.6 billion dollars last month. Certainly, a sharp fall in forex reserves had been expected since the government declared war on the exchange rate July 7 and sold dollars. The amount of reserves, however, has plummeted more than expected. July’s fall was the biggest since 1971, when Korea began recording the statistic. After the government began intervening, the won-dollar exchange rate seemed to stabilize slightly higher than the 1,000 level. As state intervention prolonged, however, the Korean won grew weaker. Critics say the only result of this action was a fall in foreign exchange reserves.

In certain aspects, it is understandable for the government to try easing inflation by injecting dollars into the market and strengthening the won. This, however, is a stop-gap measure since dollar demand is much bigger than supply. Late last month, Korea had the world’s sixth-largest foreign exchange reserves of 247.5 billion dollars. Given the growing current account deficit, however, it is not enough to clear all worry. The Korea Institute of Finance says more than 290 billion dollars in foreign exchange reserves is needed considering the amount of import and short-term foreign debt and recent foreign investment patterns.

The amount of foreign liabilities in late March surged more than 30 billion dollars to 412.5 billion dollars. Short-term foreign debt with maturity shorter than a year accounted for 42.8 percent (176.5 billion dollars) of the foreign debt figure. Even Strategy and Finance Minister Kang Man-soo said, “Korea will be a net debtor nation as early as August.” The country must not underestimate the advice of global credit rating agency Standard & Poor’s, which said Korea should be very careful in dealing with short-term debt.

President Lee Myung-bak’s economic team has lost confidence in the market. The team has sent mixed signals after changing the focus of fiscal policy from growth to stability. Rumors have spread that Korea will face another financial crisis in September due to distrust in economic authorities. The government needs an effective financial policy to prove its risk management capability and ease market uncertainty. A good starting point is control of forex fluctuations while smoothly running the foreign exchange market, and prevention of a plunge in foreign exchange reserves. These measures could restore market confidence.