Headed toward the largest trade deficit

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Headed toward the largest trade deficit

The foreign exchange market has turned alarming. The U.S. dollar shot up to 1,340 won on Monday for the first time since 2009 amid the global financial crisis. The dollar has gained upward momentum against most currencies upon anticipation of lengthening in tightening in monetary cycle.

Authorities claim the won’s weakness is in different context than the past crisis periods. It is true that dollar supplies are not short. Despite widening in trade deficit, the current account still maintains surplus. Korea has kept up more external assets than debt since 2014.

The foreign exchange rate can fluctuate in reflection of economic fundamentals. But sharp volatility or excess bias to one direction such as the weaker won cannot be desirable. Korea can no longer benefit from cheap currency as in the past. Japan and Europe that vie with Korean products have seen their currencies fall by a bigger margin against the greenback this year.

The weak won makes imports more expensive and further aggravates inflation instead of lifting export competitiveness. The Bank of Korea this week is expected to raise the base rate by another 25 basis points to keep up with the galloping rises in the U.S. rates.

Alarmingly, trade deficit has been stretching, too. Deficit this month has already swelled to above $10 billion as of Aug. 20. At this rate, the trade balance would be in a red streak for the fifth month, the longest in 14 years. Cumulative deficit has hit $25.5 billion, above the last record of $20.6 billion in 1996.

The capital account last year recorded $19.3 billion in surplus thanks to Korean companies’ overseas direct investment and dividend and interest gains from overseas stock investments. But if trade deficit widens, the current account may not be safe. Korea’s trade deficit cannot look well in the eyes of international capital as the economy relies on trade. Whether the government has stocked up enough energy supplies before the winter season is also questionable.

Foreign debt should be closely watched. The short-term foreign debt-to-foreign exchange reserves ratio rose by 3.7 percentage points to 41.9 percent in June. Although the level is still far lower than 78.4 percent in 2008, it is above the 33.8 percent average of the past 10 years. If global demand and export environment worsens, short-term foreign debt could shoot up.

There cannot be an easy solution to foreign exchange instability from external factors. Although overreaction should be refrained, public finance and macroeconomic policy must be managed stably. The government must give confidence to investors that it has economic affairs under control.
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