[Viewpoint]A domestic stigma

A paradox is taking place in the Korean economy these days. Korea has the largest foreign currency reserves in its history, but lack of access to foreign currency is causing big problems for domestic banks.
Korea’s foreign exchange holdings as of the end of March was $263.8 billion. As the country has established the Korea Investment Corporation to invest its foreign holdings efficiently, there seems to be a consensus that we have a foreign exchange overflow.
However, ever since the sub-prime mortgage crisis in the United States, Korean banks, unable to borrow enough foreign currency in the United States or Japan, have even gone to Malaysia in search of dollars, euros and yen.
A Korean banker I met here said that an increasing number of foreign banks and investors have expressed concern over the rapid increase in short-term loans being taken out by Korean banks.
One of the reasons for the situation lies in the government’s overly conservative approach to the use of foreign currency holdings. After the financial crisis in 1997, the government stopped lending foreign currency to domestic financial companies. The logic is that the government has to store the foreign exchange holdings as liquid assets because foreign currency holdings are emergency funds to be used in extreme situations.
This is a reasonable approach when we have an appropriate amount of foreign exchange holdings. However, the situation changes when our foreign reserves become excessive.
There is no reason to apply the same rules to amounts that are needed and amounts that go beyond what is needed. It is better to use the excess in a way that produces greater profits or in areas that help develop the Korean economy.
However, the government has only made it possible to use excess foreign currency holdings through the Korean Investment Corporation. In a questionable move, the corporation invested $2 billion with Merrill Lynch, but it does not lend foreign currency holdings to Korean financial companies nor invest them domestically.
This could be considered rational if overseas investment was less hazardous and domestic investment or loans were more risky. However, we cannot find any special reason for the policy except that the government is trying to prevent the repetition of problems it had in 1997. After the financial crisis, the country drained its foreign exchange holdings by making them available to domestic financial companies.
The problem this time around for Korean financial companies is not insolvency. They need large amounts of foreign currency because the current account surplus is falling and they have to purchase shipping and heavy industry futures. It is a totally different situation from the one that was created by the financial crisis, when bad loans accumulated as businesses went bankrupt and foreign banks withdrew their investments. There is also no reason to worry about a foreign currency crisis because Korea’s foreign currency holdings are bigger than ever.
In the writer’s view, it would be a win-win situation and would also help the economy if part of the nation’s foreign reserves or KIC funds were lent to Korean banks. It would raise the profitability of foreign exchange holdings and reduce the need for Korean banks to buy foreign currency at a high price overseas.
It would also reduce the interest burden of Korean businesses or individuals because domestic financial companies will be able to charge lower rates if they have more access to foreign exchange.
Especially in the cases of banks that borrow foreign currency to establish a position in preparation for the purchase of futures, there is no need to worry about tied-up money because the risk is low and the date of expiry is set.
It is not desirable that the government, without looking at the situation realistically, unconditionally prohibits the use of foreign exchange holdings only because the companies that need them are domestic.
Most sovereign wealth funds invest overseas because the countries that manage the funds are small and they have no other choice. But in a country like Korea, where foreign currency and investment demands are high in the domestic market, it is better to utilize foreign exchange holdings by making appropriate use of them at home.
The government and the Bank of Korea have now accumulated a large amount of foreign exchange holdings, and they use them only to buy U.S. Treasury bonds that provide low interest rates. Otherwise they give responsibility for its management to foreign investment banks and pay high commission fees for doing so. Meanwhile, Korean banks must travel overseas to borrow foreign currency. Isn’t it ridiculous and pathetic that we have to borrow money from others when we have plenty of our own?

*The writer is a professor of economics at the National University of Singapore. Translation by the JoongAng Daily staff.

by Shin Jang-sup