BOK sounds alarm over snap flight of foreign funds

The central bank warned yesterday of an increase in the volatility of cross-border capital movements as the prolonged economic slowdown could spark a reversal of inflowing foreign funds.

A series of credit rating upgrades on Korea and quantitative easing by major central banks around the world are luring more foreign capital into Asia’s fourth-largest economy and leading the won to appreciate more than 5 percent to the U.S. dollar so far this year.

The warning came as risks of a sudden reversal of foreign capital persist because any deterioration of external conditions like Europe’s debt crisis could hurt the Korean economy.

The Bank of Korea (BOK) said in a semi-annual financial stability report that the volatility of cross-border foreign capital flows could increase if the impact of the euro zone debt woes spills into the real economy in full swing. “If so, Korea would face a sharp deterioration in its foreign exchange soundness as short-term speculative money, as well as massive long-term funds, could fly out of the country,” the report showed.

The Korean currency became highly volatile while the country saw a sharp decline in its foreign exchange reserves at the height of the 2008 global financial crisis, as foreign investors pulled their money out of the Seoul markets en masse.

Mindful of risks from such capital flows, the government has taken a set of steps to smooth out cross-border capital flows since 2010, including a bank levy and tighter rules on banks’ FX derivative positions. The central bank and financial watchdog plan to inspect banks’ handling of currency forward positions from next month amid the won’s ascent.

Yonhap