Intervention likely to curb fallout of falling yen

The government said it now recognizes there is a need to intervene in the local foreign exchange market as concern continues to grow about the weakening yen and strengthening won.

Since early this year, market watchers and industries have been urging the government to take action, criticizing it for leaving the foreign exchange market untouched despite the fast appreciation of the won and growing losses among local businesses.

Finance Minister Bahk Jae-wan hinted on Wednesday what policy measures the government may adopt in response to an announcement by the Bank of Japan one day earlier that it would raise its target inflation rate to 2 percent by maintaining quantitative easing.

Earlier, Japan’s central bank announced $116 billion of quantitative easing with the inauguration of the new Shinzo Abe administration.

Although Bahk didn’t unveil what the measures will be or when they will be implemented, he said, “the government is prepared for action to contain the won’s appreciation.”

According to experts, the most plausible package of measures would be lowering the ceilings on foreign exchange positions at banks, imposing taxes on foreign investments in Treasury bonds and adding a levy on banks’ offshore debt.

Even though Bahk stopped short of saying the government will resolutely embrace the three measures, experts believe they are the most realistic options at this time.

“The country’s forex authorities shouldn’t leave the market as it is, because the won’s appreciation is caused by major countries’ monetary and forex policies,” said Ko Deok-kil, a senior researcher at Samsung Economic Research Institute.

Inflows of foreign capital surged significantly because of aggressive quantitative easing by the U.S. and Japan, Ko explained.

“There are growing potential risks in the local market as speculative sell-offs of the won are starting to increase, too,” he added.

As of October, foreign currency deposits at home hit $39.39 billion, up from $29.93 billion in 2011 and $23.28 billion in 2010, according to the Bank of Korea.

“There is a need to tighten market regulations to ease volatility,” Ko said. “One method could be imposing taxes on financial transactions, temporarily and conditionally.” Such taxes are considered when foreign capital inflows exceed a certain level designated by the authorities.

There has been a debate about the taxation issue, but no conclusion has been reached as the government is treading carefully.

After Vice Finance Minister Shin Je-yoon remarked that the government is seeking another measure besides the aforementioned three-pronged counter-attack last week, market observers have begun speculating about this may be.

Some believe a Tobin tax will be introduced, which would levy taxes of 0.1 to 0.5 percent on all kinds of forex transactions.

But Shin dismissed the idea by saying that such a tax could affect the real economy. He also said it’s not effective in detecting speculative foreign capital.

According to a government official at the Ministry of Strategy and Finance, the first likely action by the forex authorities is likely to be further lowering the ceilings on foreign exchange positions.

A bank’s net foreign exchange position measures the extent to which future inflows of a currency exceed or fall short of future outflows. Lowering the ceilings is considered the first step to restraining foreign capital flows.

In November, several authorities - the Finance Ministry, the Bank of Korea and the Financial Services Commission - agreed to restrict the local branches of foreign banks to holding currency forward deals equivalent to 150 percent of their equity capital, down from 200 percent from Jan. 1. The ceiling for domestic banks has been lowered to 30 percent from 40 percent, the government said.

The last time the government slashed the ratio was June 2011.

Another possible measure being discussed is regulating non-deliverable forwards (NDFs), which are mostly composed of speculative funds, according to the official.

Others are calling to cut the key interest rate to hold the won in check if the government cannot carry out large quantitative easing like Japan.

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