Time for a contingency plan

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Time for a contingency plan

The prospects for the world economy seem to be growing ever darker. U.S. economist Nouriel Roubini has warned of another global economic contraction and a financial crisis likely to wreak more havoc than that which followed the collapse of Lehman Brothers in 2008.

The credit crisis in the euro zone is quickly spilling over to the real economy. Fiscal dilemmas are also growing more complex. Italy has become the latest country to suffer a downgrade of its sovereign credit rating, and its reduction was by three notches. Greece declared that it cannot attain the target for deficit reduction that was a key condition for a bailout package and is now on the verge of bankruptcy.

The troubles in the euro zone have now deeply impacted financial sectors around the world. European and U.S. banks with substantial holdings in government bonds of risky economies are in danger. Bank of America, Morgan Stanley and Belgian bank Dexia look set to face restructuring. Equity markets in Asia suffered sharp losses because troubled U.S. and European banks pulled out their funds.

As the growing fiscal and financial crisis affects the globe, U.S. and European economies are quickly losing steam due to the credit crunch and reduced government spending. Many predict the U.S economy will shrink in the final quarter. China, which has so far sustained the global economy, is also slowing due to weak consumption overseas.

The risks for the export and foreign-capital dependent Korean economy are multiplying. The sharp drop in the value of the won and the shortage of key currencies may grip the economy as it did in 2008.

But the government insists it is better positioned to keep a lid on the situation this time. The nation’s foreign currency reserves exceed $300 billion, while short-term debt is at $150 billion. However, if the euro zone crisis continues, the country will run out of ammunition with which to defend itself.

Some $100 billion would be needed to prop up the economy, with $200 billion set aside for contingencies. As such, Korea needs a contingency plan to hedge against a worst-case scenario.

Emergency meetings will simply not suffice. The government may have to reconsider taxing foreign capital, despite fears that this could hurt Korea’s credibility and scare away foreign investors.

Either way, new methods to guard against sudden capital exits must be sought.
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