Government now moving to control forex market

The government finally decided to intervene in the foreign exchange market yesterday, making the first move toward regulating foreign currencies.

The Ministry of Strategy and Finance, Bank of Korea and the Financial Supervisory Service announced yesterday that they will lower ceilings on banks’ foreign exchange forward positions in order to reduce volatility in capital flows at home.

A bank’s net foreign exchange position measures the extent to which future inflows of a currency exceed or fall short of future outflows.

At foreign and domestic commercial banks, the share of foreign currency forward positions to total capital will be reduced by 25 percent, the Finance Ministry said.

The move will restrict local branches of foreign banks to holding currency forward deals equivalent to 150 percent of their equity capital, down from 200 percent at present. The ceiling for domestic banks will be lowered to 30 percent from 40 percent, the government said. The regulatory move will take effect from Jan. 1.

“There is a growing chance of increased volatility in cross-border capital flows due to the country’s relatively sound economic fundamentals and ample global liquidity,” the Finance Ministry, the central bank and the financial regulator said in a joint statement.

It is the first time the government has slashed the ratio since June 2011.

The announcement came after the BOK and FSS wrapped up their inspection of local banks’ handling of foreign exchange forward positions amid the local currency’s ascent against the dollar - as exporters increased their dollar sales, foreign capital inflows have become more abundant.

After dipping below the 1,100 won mark on Oct. 25 for the first time in 13 months, the local currency closed at 1,082.00 won against the greenback on Nov. 21, reaching a new high this year. The lowest was 1,184.00 on May 24.

Cutting the ratio helps limit the supply of dollars, making the Korean won weaker. It is one of three macro-prudential measures by the government to intervene in the currency market to curb rising short-term foreign external debt and to stem excessive cross-border capital movements.

The other two measures are imposing a tax on foreign investment in local bonds and a levy on banks’ offshore debt.

The Finance Ministry said the government judged it needs to take preemptive action.

A report by the Bank of Korea said yesterday that a 1 percent (10 won) rise in the won-dollar exchange rate would spur private consumption to decline by 0.21 percent (204.1 billion won) and domestic investment by 0.49 percent (96.6 billion won).

“As a result, the ascending won leads to a contraction in both consumption and investment, because consumers get less purchasing power while companies see increasing costs due to increasing import prices,” the report said.

“The regulation would be effective in blocking in- and out-flows of speculative funds, but this doesn’t directly affect the stock market,” said Bae Sung-young, a researcher at Hyundai Securities.

By Song Su-hyun [ssh@joongang.co.kr]