Bracing for a deluge

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Bracing for a deluge

China plans to add more currencies from emerging countries to its swelling foreign exchange reserves - which currently total $2.5 trillion - as a part of the nation’s efforts to move its holdings away from the U.S. dollar.

“We can diversify our foreign reserves by considering currencies of not only smaller countries but some emerging-market economies as well,” Zhou Xiaochuan, governor of the People’s Bank of China, said during a meeting of the International Monetary Fund in Washington D.C.

Capital from China has already started to flood into the Korean market. Chinese investors have bought 2.9 trillion won ($2.6 billion) worth of Korean bonds and 76.6 billion in Korean stocks so far this year, according to the Financial Supervisory Service.

The deep-pocketed China Investment Corp. and China’s largest pension fund have both taken an interest in the Korean market. While that should be good news for Korea, many observers are more worried about the trend than excited.

The cascade of Chinese capital has already sent the value of the Korean won sharply higher. In fact, the won recorded the largest gain verses the greenback among major Asian currencies. The U.S. dollar has tumbled 4.59 percent versus the won in recent weeks, compared with a dip of 1.64 percent against the Chinese yuan, 2.23 percent against the Japanese yen and 2.59 percent against the Thai baht. Concurrently, China’s shopping spree in Korea has sent bond yields to record lows, even though the Bank of Korea raised the benchmark interest rate last month.

Chinese money is starting to contribute to volatility in the Korean market. We can’t predict if and when China will turn hostile against South Korea, using its hefty investment as a weapon. A sudden exodus of Chinese capital would wreck havoc on the Korean economy. We cannot discriminate against certain types of capital simply because of its owner. A liberalized capital market like ours also does not have any mechanisms in place to restrict inflows and outflows of a certain currency anyway.

But China’s foray into the Korean stock and bond markets may only have just begun. It’s a double-edged sword. It can enrich the capital market, increase jobs and help stimulate the economy. But in the long-run, we have to worry about the risk of an asset bubble.

The Korean stock market is hovering near the 1,900-mark and the bond markets are already inundated with Chinese money. We must now ready a contingency plan. Whether the influx of Chinese money benefits or poisons the economy depends on how our economic and government officials prepare for and react to the situation.
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