Tag Archives: South Korea

South Korea worries over interest rate hike

Following from a recent news about South Korea’s exchange rate and its record high appreciation since 2008, I want to talk about the general threat that Korea may face in the near future.

According to South Korea Finance Minister Hyun Oh Seok, interest rate rise might pose great threat at home. South Korea have generally fared well despite 2008 financial crisis and Euro zone debt crisis. Just to see few data on inflation control and interest rate;

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We see that there was a huge drop in nominal interest rate from above 5% down to 2%, and at the same time inflation dropped at about the same rate. As a result, the real interest had little influence. This abled Korea to control capital in/outflow and thusly export. Because of lack of much natural resource endowments, Korea is quite dependent on its exports. one of the characteristics that Korean economy shows is that many exports are highly value added items with high technology. To name a few, cell phones, TV’s, naval engineering goods and automobiles.

As a result, in order for South Korea to be really stay on its competitive edge requires favorable financial conditions, especially those regarding exchange rates and interest rates. So, what happened to Korea in the past few months? There has been a huge appreciation in Korean currency Won and many worry that this will be a head wind against its growth.

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Another big concern for Korea right now is climbing household debt level reaching its record high (see graph below) at a wrong time. The Fed is continuing to taper quantitative easing programs, and the talk of whether interest rate will increase sooner than anticipated will also play a role in markets other than that of US. Why Korea should really be worried is that most of household debt is tied to mortgage in floating interest rate. Consequently, if interest rate hike around the world could bring back up the interest rate in Korea, burden on household could cause a series of default.

High debt level and high interest rate are something that Korea is not so fond of with harsh memory of defaulting less than two decades ago. There has been government measures to mitigate mortgage loan by directly bailing out some of highly distressed households, but this has not been so popular for many people on the ground of moral hazard. These kind of approach is also very costly in political games.  Although current level of debt is of course not as bad as the level during the Asian financial crisis in 1996, but it is something to keep in mind over time.

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Another thing I would like to point out briefly is the recent low level of inflation. With target band between 2.5% and 3.5%, the 1.3% Korea has right now may be not so satisfying. Yes, Korea have endured quite well the recent financial crises around the world, but with inflation rate going down, monetary policy instrument may be eroding its power, at least less than it could fully have. I don’t think it is at a worrisome level just yet at nominal interest rate still at 2.5%, but this is another side that Korea should really keep in mind for the next few years.

Although Korea is number four economy in its geographical region of East Asia, it should be still considered as a “small economy.” Yes, it experienced very high growth and despite hardships in the past had came out of its crises at a record speed, the economy is still very vulnerable to financial market around the world. After having such a bitter experience in 1996, Korea’s financial market is one of the most heavily regulated market in East Asia. However, I think in order for Korea to truly grow, it should allow financial sector to grow organically.

 

Government Intervention in Bubbles

Upon completion of Burton G. Malkiel’s A Random Walk Down Wall Street, I was thinking about the various bubble scenarios listed throughout the first part of the book, where investor’s were betting on “castles in the air” hoping that a greater fool would come along to pass their overpriced stocks to. At one point when discussing the “tronics bubble” in the 60’s, Malkiel quips that the SEC never got involved in the massive speculation because they couldn’t force people not to throw their money into these overpriced stocks.

When I read that, I remember wondering if there are any other countries where outrageous speculation is curbed by regulators. The only example I could think of is the KRX in South Korea, where there is a daily price limit. Since 1998, a stock traded on the KRX is not allowed to fluctuate by more than 15 percentage points on any given day. Before that, there were even stricter limits. While this doesn’t force investors to make sound investment decisions, it does prevent the “castle in the air” from crashing to the ground before they can do something about it. While Malkiel mentioned stocks fluctuating over 50 percent a day during some bubbles, it would take 3 or 4 days before an asset could fluctuate that much on the KRX exchange.

While this obviously puts a limit on daily volatility, I was wondering if this kind of regulation would cause the stock prices to fluctuate less when looking at a longer time horizon. I checked google finance (which for some reason, only gives data on the KRX since mid 2005). The KRX actually dropped more during the 2008 financial crisis, although it also recovered quicker and the returns in the KRX index have been greater than any of the three major U.S. exchanges’ indexes.

This also led me search for other countries that have similar regulations on assets. I found examples where there are daily price limits on futures and options, but none for the securities themselves. Whatever the case, I thought the book was very easy to read and provided good, memorable examples. If I took anything away from the book, it is that I hope to hold assets in the future that don’t need daily price limits to not fluctuate more than 15 percent per day and that slow, boring, steady returns are much more desirable. From the litany of bubbles in the past, it also aptly demonstrates that human’s desire for rapid wealth creation will ensure that bubbles are not something that will go away.

(Revised): South Korean Exchange Rate

My brother and I both study in United States, therefore it costs more than $100,000 per year to pay for college in my family. As a result, I am very conscious about Korean won-US dollar exchange rate. Korean Won-US dollar exchange rate was as low as 900 Won per dollar in early 2008, but it rose rapidly to 1400 won per dollar by end of year 2009 due to financial crisis in 2008. When I started studying at the University of Michigan in 2008, my father sent me approximately 45million won, corresponding to $50,000 for tuition and living expenses. However, by the end of 2009, he had had to send over 77million won (corresponding to $55,000 – as tuition and living expense increased as well during 18 months), almost twice (in fact, 171%) compared to the amount he sent me a year ago. Thinking that 77 million won is “too much”, I decided to go back to Korea in order to fulfill my mandatory military service obligation for two years and wait until exchange rate settles down.

As the world economy recovered, so did Korea won-US Dollar exchange rate settled down. By the end of 2013, Korean won fell below to 1,050 won per dollar, recording lowest in more than two years. According to an article from Korea Herald (Korea keeps watch on won volatility), the main reason for the strengthening of Korean Won is due to economy recovery and United States’ quantitative easing. As more amount of US dollar is circulating in the market, relative strength of Korean won compared to US dollars grow naturally. For students like me, who needs to convert large amount of Korean won to US dollars, stronger currency is a big plus. However, as Korea has an export-driven economy with large sales of electronics and automobiles worldwide, a strong currency can hinder the export and act negatively in terms of economic growth.

Korean government and the central bank are well aware of it, and hinted that they are ready to intervene to curb the currency’s strength, according to the Wall Street Article (South Korea’s Won Falls After Officials Hint of Intervention). As Korean won hit a two-year high against the dollar (one possible cause being US quantitative easing) and five-year high against the Japanese yen (similarly, Abenomics being a reason), the Korean stock market ended at a four-month low, with Samsung Electronics stock decreasing by 5.5%. Korean central bank intervened last October by bringing $2 billion to slow gains, and it hinted that they are monitoring market flows closely to protect the economy against exchange rate volatility.

Recently, won-dollar rate has rose to 1080 won per dollar. Part of the reason might be tapering of US quantitative easing. According to Wall Street Journal in January 22nd (IMF Calls Out South Korea on Its Currency Policy), IMF told Korea that it should only intervene in exchange-rate markets to prevent volatility that might damage the economy. The Wall Street Journal highlighted the fact that “although countries can devalue their currency by buying foreign currency, the move puts upward pressure on other countries’ exchange rate and can fuel trade and political tensions between governments.”

For me personally, won-dollar rate of 1080 is too high and hope it goes back to 900 back in “good, old days.” However, I am aware that Korean economy is depending heavily on export on electronics and automobiles. From my memory, I remember Samsung electronics and Hyundai Motors still performed well in world market when currency rate was around 900 won per dollar. If they continue to make fine, quality products, I believe that they can still perform well globally regardless of exchange rate. Furthermore, companies should continue their best to cut down the cost and also manage their exchange rate risks by “hedging” it. So should Korean government try to manipulate the exchange rate? I think the market should decide what exchange rate should be.

South Korean Exchange Rate

My brother and I both study in United States, therefore it costs more than $100,000 per year to pay for college in my family. As a result, I am very conscious about Korean won-US dollar exchange rate. Korean Won-US dollar exchange rate was as low as 900 Won per dollar in early 2008, but it rose rapidly to 1400 won per dollar by end of year 2009 due to financial crisis in 2008. When I started studying at the University of Michigan in 2008, my father sent me approximately 45million won, corresponding to $50,000 for tuition and living expenses. However, by the end of 2009, he had had to send over 77million won (corresponding to $55,000 – as tuition and living expense increased as well during 18 months), almost twice compared to the amount he sent me a year ago. Thinking that 77 million won is “too much”, I decided to go back to Korea in order to fulfill my mandatory military service obligation for two years and wait until exchange rate settles down.

As the world economy recovered, so did Korea won-US Dollar exchange rate settled down. By the end of 2013, Korean won fell below to 1,050 won per dollar, recording lowest in more than two years. According to an article from Korea Herald (Korea keeps watch on won volatility), the main reason for the strengthening of Korean Won is due to economy recovery and United States’ quantitative easing. For students like me, who needs to convert large amount of Korean won to US dollars, stronger currency is a big plus. However, as Korea has an export-driven economy with large sales of electronics and automobiles worldwide, a strong currency can hinder the export and act negatively in terms of economic growth.

Korean government and the central bank is well aware of it, and hinted that they are ready to intervene to curb the currency’s strength, according to the Wall Street Article (South Korea’s Won Falls After Officials Hint of Intervention). As Korean won hit a two-year high against the dollar (one possible cause being US quantitative easing) and five-year high against the Japanese yen (similarly, Abenomics being a reason), the Korean stock market ended at a four-month low, with Samsung Electronics stock decreasing by 5.5%. Central bank intervened last October by bringing $2 billion to slow gains, and it hinted that they are monitoring market flows closely to protect the economy against exchange rate volatility.

Recently, won-dollar rate has rose to 1080 won per dollar. Part of the reason might be tapering of US quantitative easing, but according to Wall Street Journal in January 22nd (IMF Calls Out South Korea on Its Currency Policy), IMF told Korea that it should only intervene in exchange-rate markets to prevent volatility that might damage the economy. The Wall Street Journal highlighted the fact that “although countries can devalue their currency by buying foreign currency, the move puts upward pressure on other countries’ exchange rate and can fuel trade and political tensions between governments.”

For me personally, won-dollar rate of 1080 is too high and hope it goes back to 900 back in “good, old days.” However, I am aware that Korean economy is depending heavily on export on electronics and automobiles. From my memory, I remember Samsung electronics and Hyundai Motors still performed well in world market when currency rate was around 900 won per dollar. If they continue to make fine, quality products, I believe that they can still perform well globally regardless of exchange rate. So what is the most “adequate” exchange rate? The one driven by the market, or the one government tries to set?