[FORUM]The overvalued won is worrisome

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[FORUM]The overvalued won is worrisome

The won is appreciating too quickly. This is probably good news for companies that have large debts in foreign currency or that purchase raw materials; or for parents whose children are studying abroad and domestic travelers going abroad. But it is nothing but a disaster for exporters. In a country that is highly dependent on exports, the won's appreciation is not a blessing but a curse. It would be desirable if the exchange rate stayed at a reasonable level, but it is not clear where that reasonable level is. In order to judge whether a currency is overvalued or undervalued, analysts came up with a real effective exchange rate, but calculating a real effective exchange rate is complicated, and a different conclusion can be derived depending on years or price indexes.

Thus, a "Big Mac Index," which has been appearing in The Economist, a British magazine, since 1986, is often used as a reference. The index was devised to evaluate different currencies by comparing prices of hamburgers sold at McDonald's in different countries. The Economist announced this year's results in April, but domestic analysts and policymakers did not pay much attention to it. There could be a couple of reasons behind the lack of attention.

First, since the price of a hamburger does not represent a consumer price level of a respective country, many analysts tend to consider the index as something invented to kill time. Second, because the won turned out to be undervalued by 5 percent, according to the index, analysts must have concluded that the won was valued at an appropriate level.

However, we should take the Big Mac Index more seriously. The announcement in April particularly emphasized that the dollar was estimated to be the most overvalued since The Economist started calculating the index. The indication that the dollar could become devaluated in a short period of time has actually come true. The index had also warned that the won was overvalued for eight years, beginning in 1989, but domestic firms and the government ignored the warning and the companies' profitability worsened, which eventually led to the 1997-98 financial crisis.

Even before the financial crisis we experienced a crisis because of the won's overvaluation. In mid-1970, the government-pegged won-dollar exchange rate was 484 won to $1, despite double-digit inflation. Because of the won's overvaluation, the competitiveness of entire industries weakened, and after the second oil shock, the Korean economy and politics crashed together.

Since the won was undervalued, according to April's Big Mac Index, some people may argue that it is far-fetched to discuss an economic crisis just because the exchange rate recently fell. However, there are two reasons why we should worry about the falling exchange rate.

First, the won is relatively overvalued compared to currencies of competing exporting countries, except the United States. According to the index, the won is 14 percent more overvalued than Japanese and Taiwanese currencies; 37 percent to 44 percent more than Chinese, Hong Kong, Thai and Malaysian currencies.

Another reason for the overvaluation is that the recent economic trends are similar to the trends just before the financial crisis. Before the financial crisis, high interest rates, wages, the overvalued won and high real estate prices hurt domestic firms' profitability and led to large losses for the firms and for other financial institutions.

After the financial crisis, there were various reforms, but now wages and real estate prices are at a relatively high level, and interest rates and the won's value are rising, which is worrisome. The government should consider these facts and approach the exchange rate issue more carefully.

The government should not overlook the issue by saying that a weakening dollar against other currencies is a worldwide trend. Instead, the government should come up with countermeasures to deal with the won's overvaluation compared with currencies of competing nations. Though the won's appreciation against the dollar is unavoidable, the speed of appreciation should be slower than the appreciation of currencies of competing countries against the dollar.


The writer is director of the JoongAng Ilbo Economic Research Institute.

by Ro Sung-tae

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