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Concerns are rising over a drastic rise in the won-dollar exchange rate which could be another alarming sign for the export-dependent Korean economy. The value of the Korean won compared to other major currencies has fallen to its lowest point in 19 months. This discouraging news came on the heels of a report card regarding Korea’s negative growth in the first quarter.  

Today, we’ll discuss the recent volatility in the foreign exchange market with Kim Jeong-sik, economics professor at Yonsei University. 

The depreciation of the Korean won against the U.S. dollar has both positive and negative aspects. It might bode well for Korean exporters because their products would have greater price competitiveness in overseas markets and therefore help increase Korea’s exports overall. On the flip side, though, a fall in the value of the local currency makes imports more expensive and could cause prices, including gas prices, to go up. 

A moderate depreciation of the won is acceptable, but its steep weakening may fuel speculation that it will depreciate further and prompt foreign investors to leave local bourses for fear of foreign exchange losses. A rapid exodus of a large amount of foreign capital could result in the shortage of foreign exchange reserves. 

Just early this year, the local currency lingered in the range between 1,110 won and 1,120 won against the dollar. But from mid-April, the won began to depreciate more sharply than expected. On April 8, it surpassed the 1,140 won mark for the first time this year and broke 1,180 won on May 9. The last time the won-dollar exchange rate exceeded that level was January 16, 2017. It continued to rise and hit 1,190 won on May 15. 

The rising won-dollar rate means a decline in the value of the won. A weaker won isn’t always bad news, especially for exporters. But the continuous decrease in the value of the local currency displays the deteriorating economic conditions in Korea and may trigger an outflow of foreign capital from the country. Professor Kim now explains why the won has drastically lost its value against the dollar.

Domestically, there are growing concerns about an economic downturn, which will certainly affect local businesses that have already shown poor performance. Worries about companies’ declining profits may cause foreign investors to withdraw money from the domestic market, contributing to a weak won trend. 

Externally, the ongoing trade war between the U.S. and China has worsened Korean exports. Trade protectionism pursued by the world’s two largest markets may accelerate an economic slowdown in Korea and even a stock market crash. 

The won-dollar exchange rate remained relatively stable for the past two years but began to fluctuate radically last month. Major factors include aggravating local economic conditions, struggling Korean industries that have lost their competiveness largely due to the trade dispute between the U.S. and China, and the possibility of worsening trade balance. 

This particular season could be another factor. Major Korean companies distribute dividends to their shareholders, including foreigners, in April and May. However, the foreign investors prefer to convert most of their dividends paid in won into dollars, resulting in heated demand for the greenback. 

But Korea also has some factors to make the local currency gain value. 

While the Korean won has depreciated lately, there is room for it to appreciate. For example, Korea’s foreign exchange reserves hover above 400 billion US dollars and its trade surplus has remained in the black for quite a while. 

The current account balance as a percent of gross domestic product or GDP is an indicator of a country’s economic health. The ratio of Korea’s current account surplus to GDP stood at 7 percent in 2016 and is expected to reach 4 percent this year, which is considered still high. The strong current account surplus indicates that the international credibility of Korea remains high. 

Korea had the world’s ninth largest foreign exchange reserves as of the end of April, and its trade surplus amounted to 4.12 billion dollars last month, extending the surplus streak for the 87^th consecutive month. Korea’s currency swap deals with several countries, including China and Switzerland, will strengthen its financial safety net. Also, Korea’s credit default swap premium, which reflects the national default risk, remains at a low level. 

Despite the positive aspects, however, the depreciation of the won could be a sign of weakening economic fundamentals in the nation. 

There are various reasons for a series of cuts in Korea’s growth forecasts. Outside the nation, the escalating U.S.-China trade conflict has affected Korean exports negatively and may possibly bring about further economic contraction in Korea. 

Inside the nation, the government has raised the minimum wage and reduced working hours in an effort to improve the welfare of workers. But the measures have increased the cost burden on companies, who may subsequently reduce employment and investment. Side effects like this are one of the factors that drag down economic growth. 

The Korean economy contracted 0.34 percent in the first quarter of this year from the previous quarter, the lowest among the 22 member states of the Organization for Economic Cooperation and Development or OECD. 

But future prospects are even gloomier. The OECD, the Korea Development Institute and the Korea Institute of Finance have all revised their GDP growth estimates for Korea this year to 2.4 percent from the previous 2.6 percent. 

The recent steep depreciation of the won is a result of sluggish exports, shrinking investment and worsening economic indicators in the first three months of the year. It’s an alarm bell for Korea’s major industries such as energy, petro-chemistry and steel as well as manufacturers of consumer goods. Attention now turns to how long the weak won trend will continue. 

The Korean currency has stabilized at 1,190 won for now. But the future of the foreign exchange market largely depends on what shape and form the U.S.-China trade dispute will take. Intensified trade friction between the world’s two largest economies will inevitably affect the Korean economy and could make the won further lose its value. But if they manage to reach a dramatic compromise at the G20 summit scheduled for late June in Japan, uncertainties about the global economy will be reduced significantly and the foreign exchange market in Korea will regain stability. 

If the U.S. and China somehow settle their trade dispute next month, the Korean foreign exchange market will be stabilized, but everything remains uncertain for the moment. The government needs to make efforts to minimize market turbulence and formulate a proactive policy to tackle the economic slowdown.