[OUTLOOK]Manage exchange risk in-house

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[OUTLOOK]Manage exchange risk in-house

The won-dollar rate has been falling sharply. The psychological barrier of 950 won has been broken and the won has even fallen below 940 against the dollar.
The won-dollar rate has been falling faster than other Asian currencies.
This appreciation of the won against the dollar can be seen as a positive forecast by foreigners of the future of the South Korean economy. South Korea’s market is certainly attractive to foreigners as it has gone through successful restructuring since the 1998 financial crisis and a comparatively high growth rate is expected.
The problem is, however, South Korea’s chronic disease ― imbalance in the exchange market.
A sharp fall of the won-dollar rate is caused by two factors: Speculators conducting a massive sellout of the dollar in the non-deliverable forward market and some major Korean exporters selling on the forward exchange market.
Drastic changes of the exchange rate worsen instability in the foreign exchange market, which will hurt mostly small- and mid-sized companies who are not prepared to react accordingly.
If this imbalance is regarded as a failure of the market, direct intervention by the authorities can be justified. However, the authorities’ intervention has often increased the imbalance in South Korea’s foreign exchange market. Therefore, they need to move carefully.
Fortunately, the currency authorities showed little intent of market intervention. An emergency case, such as a drastic fall of the won-dollar rate, will surely call for intervention to curb the appreciation.
However, to intervene over temporary changes of the exchange rate can eventually cause even bigger changes in the rate.
The authorities should instead focus on preparing mid- and long-term measures to stabilize the foreign exchange rate.
Our domestic exchange market’s imbalance is mainly because of its small size.
The volume of our trade between countries accounts for only 25 percent of foreign exchange trade, far below the 63 percent average of industrialized countries.
To curb any sharp fall or rise in the won-dollar rate, proper infrastructure is needed, such as making the South Korea won a hard currency.
Regulations on foreign currencies should be lifted and overseas investment should be increased.
We need to provide export financing and exchange rate insurance or support companies’ overseas marketing in an attempt to protect our small- and mid-sized exporters.
These companies are seriously hurt by any drop in the won-dollar rate because this fall worsens their profitability.
As the exchange rate drastically changes, financial companies’ roles are becoming more important. These firms should devise financial instruments for clients to avoid exchange rate attacks and the firms should also enhance their roles as market makers.
By doing this, they can offer methods to avoid the exchange rate risk and stabilize the foreign exchange market. Businesses should know clearly about the exchange rate risk and prepare ways to avoid this risk on their own.
It is suicidal to set up a special rate as a specific barrier and to sell off when the won breaks that line. When the exchange rate bounces back, businesses that do so could see even larger losses.
Most of all, companies should admit that we’ve passed the time when the government deliberately protected the exchange rate. They should be prepared for possible exchange rate risk.
They should also know that the flow of currencies has risks in both directions and that there are costs to avoiding exchange rate risk.
Foreign exchange rates are hard to forecast and change drastically. Without proper management of exchange rate risk, a company’s profitability can only be weakened, no matter how hard it works to lower the cost and to develop high technology.

* The writer is the president of the Korea Institute of Finance.

by Choe Heung-sik
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