Tailored Tobin tax may help control forex trade

To curb the won’s fast appreciation and control the volatile foreign exchange market, the Ministry of Strategy and Finance said yesterday that the government may launch a form of Tobin tax by introducing a foreign exchange tax tailored to domestic market conditions, as well as a new tax on bond sales.

Choi Jong-ku, deputy minister for international economic affairs at the ministry, described recent quantitative easing programs by major economies as “unprecedented.” He said the massive influx of foreign capital into the local financial market is making it increasingly vulnerable to a mass exodus of foreign capital.

“Movement in the foreign exchange market has remained worrisome since the fourth quarter of last year,” Choi said. “The three traditional measures we use to control it are limited in what they can do vis-a-vis global market conditions, and there is a need to tax forex transactions [a Tobin tax] or bond sales.”

The vice minister’s remarks came during a seminar covering the issue of the growing volatility of foreign capital in and out of the country. It was hosted by the Korea Institute of Finance and comes against a backdrop of a strengthening won and weakening Japanese yen, a combination that has hammered Korean exporters’ profitability.

According to the Korea Center for International Finance, the Japanese currency saw the steepest depreciation against the dollar last year, dipping 11.3 percent on-year. This is the steepest since it shed 12.8 percent in 2005. The Korean won rose 7.6 percent against the greenback last year.

The government has three basic recourses when it comes to controlling the foreign exchange market: Lowering the ceilings on foreign exchange positions at banks, charging taxes on foreign investments in Treasury bonds and adding a levy on banks’ offshore debt.

The Tobin tax, named after Nobel laureate in economics James Tobin, refers to the idea of levying taxes of between 0.1 and 0.5 percent on all kinds of foreign exchange transactions.

“It would not be desirable to introduce the Tobin tax in its original form, as this would apply a uniform rate to all forex spot transactions. But [the government] needs to consider whether to control foreign exchange transactions in a manner appropriate to the local environment,” Choi said.

On the possible introduction of a bond transaction tax, Choi said the government will decide after closely monitoring 11 euro zone nations which are looking into adopting similar measures.

As for foreign exchange transaction taxes, France and Belgium introduced them in 2001 and 2004, respectively, but they have temporarily suspended the regulations until other euro zone nations embrace similar measures.

Choi said the government will tighten its regulations on non-deliverable forwards (NDF), which are mostly composed of speculative funds that add volatility to the local financial market.

“Possible measures include mandating NDF transactions cleared through the central counter party, and charging and tightening a levy on banks’ nondeposit offshore debts,” he said.

Kim Jung-han, a senior researcher at the institute, warned that embracing both taxes could help tackle volatility in foreign capital flows but also shrink the entire financial market.

Shin Se-don, a professor of economics at Sookmyung University in Seoul and a mentor for President-elect Park Geun-hye, said he agrees on the need to take additional measures to curb market volatility, but said the government must study the side effects properly first. Using the case history of Sweden, he said this shows how the Tobin tax can add to uncertainties in the forex market.

“The Swedish government imposed a 0.5 percent tax on foreign exchange transactions in 1984 and raised the rate to 1 percent in 1985,” Shin said. “Five years later, this caused the country’s stock market to plunge.”

“If the government wants to introduce a Tobin tax, it needs to specify whether it will be levied on won-dollar exchanges, or dollar-won exchanges, or both. For the bond transaction tax, it needs to determine whether this will affect Treasury bonds, circulating currency bonds, or triple A bonds issued by private companies,” Shin added.

“Years ago, the Korean government thought about weakening the Korean won as it was busy cleaning up the mess after the Asian financial crisis, but it’s never really had cause to think seriously about strengthening the won,” said an expert who attended the seminar.

By Kim Mi-ju [mijukim@joongang.co.kr]