South Korea and Japan have increased their currency swap arrangement to $70bn from $13bn, saying they need to steel themselves against turmoil in global markets, particularly the eurozone.
Seoul, which fears the swelling crisis in Europe could undermine its export-dependent economy, traditionally views currency swaps as one its strongest psychological weapons for cooling fears about its banks’ ability to meet short-term foreign debt payments, seen as its Achilles’ heel in times of trouble.
Korean officials are increasingly concerned about market volatility because the won sank 14 per cent against the dollar from August to early October, but the currency has been staging a recovery over recent weeks.
The Bank of Korea said on Wednesday it was lifting its won-yen arrangement with the Bank of Japan to $30bn-worth from $3bn-worth. It was also establishing a $30bn dollar swap. This will sit on top of an existing $10bn facility the countries have as part of a previous multilateral deal.
“The Bank of Korea believes this action will mitigate adverse influences of heightened uncertainty in the global market on the two sound and well-managed economies,” the bank said. The deal came at a summit in Seoul between Lee Myung-bak, South Korean president, and Yoshihiko Noda, Japan’s prime minister.
Still, economists question the effectiveness of adding an extra $70bn of potential foreign currency firepower, when Korea already has reserves of $303bn, the world’s eighth biggest. It also has a $26bn swap with China.
“The practical effectiveness of this when you already have $300bn of reserves is secondary,” said Tim Condon, Asia economist at ING.
He said Korea could feel “every nickel” counts because of the won’s plunge since August but he disagreed with this assessment, arguing the won was on a long-term trend of appreciation, even without support. The won has strengthened 27 per cent from March 2009.
“Speculators see the won as a one-way bet. The won may have been one of the worst global performers in September but it will probably be one of the best in October. They see a drop in the won as a buying opportunity,” he said.
Japanese support for Korean stability is critical as officials in Tokyo accuse Seoul of weakening the won to help exporters . South Korea denies this, arguing it smoothes market volatility but does not buck the flow of the exchange rate. In fact, a weak won is a double-edged sword for Korean exporters who buy most of their key parts from Japan, racking up a trade deficit of $36bn in 2010.
“It helps both sides,” said Sean Yokota, emerging market FX strategist at UBS. “It helps the Koreans by giving them liquidity, helping them gain access to dollars, and it helps Japan by preventing Korean won weakness.”
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