The Background of current re-surge of exchange rate and its implications

- Importance of risk management on future exchange rate fluctuation –

 Survey & Forecasting Department, International trade institute Kim Jaehong, Chief researcher

Amid the Korean government’s effort to maintain high won-dollar exchange rate, the Won surged to \1,040 caused by excess demand of dollar prompted by high oil prices. High exchange rate is expected to stay for a while, but it is required to prepare for possibility of strong won in the future. So, the risk management of volatile exchange rate is necessary.

1. Current trend of exchange rate

Ϛ; Modest increase of dollar

o The current weak dollar because of US economy downturn is slightly on the rise.

o Euro and Japanese yen were strong against dollar but is now on the adjustment period (on the weak side).

o But, China has maintained strong yuan, so far against dollar as capitals have been flowing into China.

Ϛ; Won especially has been far weaker against dollar than other currencies.

o Won/dollar exchange rate soared to \1,049.6 on May 8, since it dropped to \970 in early April after surging up to \1,029.2 on March 17.

o Won/yen exchange rate went down after mid-March, but it has soared substantially because of increase of yen/dollar exchange rate and surge of won/dollar exchange rate.

[Major exchange rate fluctuation, the year end]]

Note: 1) Won/dollar exchange rate is basic rate, so there is some difference with fluctuation rate of closing prices.

2) Numbers in the parentheses are increase and decrease rates compared to 2007 figures.

2. The recent background of Won exchange rate increase

Ϛ; The re-surge of won exchange rate is mainly caused by excess demand for dollar because of high oil prices amid the support of the government on high exchange rate.

1) Increase of the amount of settlement in dollar thanks to high oil prices: Expansion of dollar demand

▪ The recent oil price hike has led domestic oil import companies to pay more dollars to settle the amount.

2) Buying spree of US dollar with an expectation of high exchange rate: Expansion of dollar demand

▪ Expansion of forward exchange of investment trust companies and offshore investors with an expectation of high won/dollar exchange rate

▪ Government officials’ support for high exchange rate and expectation on strong dollar prompted by freeze on interest rates indicated by FRB spurred high expectation on exchange rate increase.

3) Outflow of foreign capital: Expansion of dollar demand (But, net selling has recently been reduced.)

▪ The volume of net selling of foreigners (\ trillion): -8.5(08.January) → -2.0(February) →-3.0(March) → -1.2(April) → -0.3(May 1~7)

4) Continued trade/current account deficit: Reduction of supply of dollar

▪ The trade and current accounts have recorded deficit of $6.9 billion and $6 billion for fifth and fourth consecutive months respectively since last December, leading to reduction of dollar supply to Korea.

5) Deteriorated condition of dollar supply: Reduction of dollar supply

▪ The supply of dollar into Korea has not been improved substantially.

▪ But, the situation is getting improved as the international financial market gets stabilized.

3. Future prospects and implications

Ϛ; Many institutes expect that high won/dollar exchange rate is maintained for a while.

o High oil prices is expected to continue, so dollar demand of domestic oil import companies would increase in settlement of oil.

o If dollar becomes stronger because of the Fed’s freeze on interest rates, it will help increase won/dollar exchange rate.

Ϛ; But Korea should prepare for possibility of strong won as well.

o Many expect high won/dollar exchange rate will continue, but some expect otherwise.

o If the international financial market becomes stabilized, won can become stronger against dollar.

▪ Make reference to table of「 Major financial institutions’ expection on Exchange rate 」

Ϛ; The risks of future exchange rate volatility should be managed in advance.

o Export companies highly reliant on raw material imports need to secure stable profitability.

o Efforts to secure raw materials are important for exporting companies amid inflation hike.

o The future exchange fluctuation can lead to cause losses, so the purpose and scope of foreign exchange risk management should be clarified.