Asian countries are increasingly looking to their currencies as a tool to fight inflation – and none more so at the moment than South Korea, where inflation last month hit a seven-year high of nearly 5 per cent — and the won on Tuesday recorded its largest one-day rise for three months.
The FT reports that the won rose 1.5 per cent on Tuesday to 1,023.20 against the dollar, its biggest gain since March, after Choi Jong-ku, head of the ministry’s international finance bureau, told reporters the government would strengthen the currency to ease inflationary pressures.
On Wednesday, the won was trading at 1,024 against the dollar and looked set to strengthen further — a big change from even last month, when the FT reported that the won has been one of the worst performers among the world’s most actively traded currencies this year, having lost 11 per cent of its value against the dollar.
But after appreciating 1.7 per cent against the dollar in the past month, Bloomberg reports Wednesday that the won now ranks as the best performer among the 10 most-active currencies in Asia outside Japan.
Why should global investors care about gyrations in the Korean currency? According to John Vail, chief global strategist and head of global asset allocation at Nikko Asset Management, continued won weakness would greatly reduce other Asian countries’ desire for currency appreciation — not least because Korean exporters have been able to cut export prices and outdo their regional rivals.
Vail has long said that the won is much too weak given South Korea’s relatively strong economic performance: Consider, he says, Korea’s “GDP growth of 5 per cent, current account at only moderately negative, exports growing an annual 20 per cent and a real policy interest rate that remains positive.”
The won’s strong performance this week brings it close to 2004 levels against the dollar, when the country was in a semi-crisis involving excessive consumer debt, notes Vail. Against the euro, the won has been at a record low, 10 per cent weaker than its previous low in early 2004. Versus the yen, barring the 1998 plunge, the won is nearly as weak as it has ever been, and twice as weak as the mid-1980s. Even against the renminbi, the won has depreciated by 15 per cent in 2008 and is very weak against almost every other Asian currency as well.
With $260bn of forex reserves, which surely seems excessive, both the Korean finance ministry and central bank have plenty of ammunition, especially given the fact that international speculators have minimal influence on the currency. Korea’s inflation would soar even further if the won does not depreciate, which is the major reason for Wednesday’s announcement of currency action.
In sum, a stronger won is appropriate for a strong country and will help to contain inflation in the whole region by allowing other Asian countries to feel more comfortable letting their currencies appreciate.”
Bloomberg, meanwhile, reports that currency experts predict that if the won weakens to around 1,030 versus the dollar, the government may come out again to prop up the currency. “But if it stays around 1,010, the government may stand aside”, Ko Yun Jin, a currency dealer at Kookmin Bank in Seoul, told Bloomberg.
The next big focus for investors in Korea, then, may well be bonds, which climbed for a third day after the central bank said, after the market closed on Tuesday, that it would buy back 500bn won ($488m) of government debt next week. The yield on the 5.5 per cent note due June 2011 fell 5bp to 5.62 per cent, according to Korea Exchange.