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Global Economics

Korea: Credit Crisis Sinks In; Won Plunges

South Korea's currency fell to a 10-year low Wednesday as Asian markets were battered in the wake of Wall Street's recent woes

The South Korean currency on Oct. 8 sank 4.8% to a 10-year low as the ongoing global credit crunch forced local banks to scramble for the dollar and prompted many companies to hoard the greenback. President Lee Myung Bak's dismissal the day before of speculation that the country could face a repeat of the Asian financial crisis a decade ago did little to calm the Korean currency market.

The won, which closed at 1,395 to the dollar, has lost 16.8% of its value since U.S. investment bank Lehman Brothers filed for bankruptcy in mid-September. Since the beginning of the year, the won has dropped 33% against the dollar, making it the world's worst performing major currency, and one whose direction is impossible to call. "The visibility is almost zero," said a Kookmin Bank dealer of the Korean currency's near-term movement.

Elsewhere in Asia, the Japanese yen soared even as stocks plummeted in Tokyo, where the Nikkei 225 benchmark index lost 9.4%. That marked the third biggest decline in its history, wiping $250 billion off stocks. "This isn't normal," Prime Minister Taro Aso, who became the Japanese leader two weeks ago, told Parliament. The plunge, he added, "is frankly beyond our imagination." This year Japan's stock market has lost 40% of its value despite the country's banks being relatively unaffected by the subprime crisis.

Indexes Plunge Across the Board

The carnage was evident all over the region, with benchmark stock indexes in Hong Kong, Singapore, South Korea, Taiwan, Indonesia and Thailand all falling by more than 5%. Indonesia halted share trading after the key index dropped by 10%. Concerns about unstable financial sectors in the U.S. and Europe and fears about a global recession pushed the yen below the 100 to the dollar mark for the first time in six months.

The financial turmoil has sent monetary authorities in the region scrambling to stabilize markets, so far with little apparent success. The Japanese and Australian central banks pumped $20.9 billion and $856 million respectively into their financial systems to help stop a surge in borrowing costs. Hong Kong cut the rate at which it lends to banks by one percentage point. Yet investors remained unconvinced these measures will suffice. "The panic simply isn't going away," says Park Kyung Min, chief executive officer at fund manager Hangaram Investment Management. Investors are spooked over a global credit crisis that triggered the worst capital flight from Korea since Asia's financial meltdown in the late 1990s. The International Monetary Fund warned the world's major banks may need $675 billion in fresh capital over the next several years to recover from the credit crisis.

Few economists and analysts expect Korea will face dangers this time around similar to those in 1997 when it sought a $57 billion emergency loan from the IMF to avert sovereign default. The country has one of the world's largest foreign exchange reserves, standing at $243 billion in August, although they fell for five straight months, down from $264.2 billion as the government used some of the money to try to stem the slide of the won.

Issues in Trade, Capital Investment

However, the central bank is up against a number of factors hammering the won. For starters the country's trade account swung to a deficit of $12.3 billion in the first eight months of this year from a surplus of $9.8 billion in the same period last year, mainly because of the high costs of importing oil and raw materials. Korea, which relies on imports for its oil demand, paid some 70% more for its oil bill during the period.

Korea's growing labor costs are also causing capital outflows as companies build factories overseas. While foreign direct investment (FDI) in Korea dropped to $1.6 billion last year from $3.6 billion in 2006, Koreans' direct investment overseas surged to $15.3 billion in 2007 from $8.1 billion in 2006, Bank of Korea figures show. In the first eight months of this year, Koreans invested $9.7 billion overseas, while FDI inflow in the country totaled only $30 million.

The capital outflow in the financial sector has had a great impact on dollar shortages. Hyundai Research Institute, a private think tank, figures foreign share investors pulled out $14.3 billion from Korea in the first eight months of this year after investing $30 billion in 2007. In contrast, Korean share investors brought home $900 million after selling shares overseas, although they made additional investments totaling $54.6 billion in overseas stock markets last year.

Forced to Hedge

Fund managers point out that U.S. and European financial investors regard non-Japan Asia as high-risk markets that get sold off during a liquidity crunch, and that Korea, with a large and liquid stock market, becomes the easiest place to pull money from. A survey by a government think tank shows foreign share investors yanked $14.7 billion from Korea in the past four months, larger than any other country in Asia. "Given the trade deficit, the FDI imbalance and the global financial instability, the won will stay weak for the time being, although the recent plunge is way overdone," says senior economist Baek Heung Gi at Hyundai Research.

Expediting the won's plunge has been the settlement of short-selling of the dollar by Korean companies and fund managers. The Koreans have resorted to such hedging because the won had steadily risen until last year, but as the currency began weakening this year they had to start buying the greenback to cover their positions. Hyundai Research estimates Korean fund managers need to buy up to $800 million every time the value of their share investments overseas falls by 1%.

Still, not everybody is suffering from the won's plunge. Korea's large exporters such as Samsung Electronics and Hyundai Motor are poised to benefit as a weaker local currency makes their exports more competitive (, 3/28/08). "They will do better than their rivals," says Huh Chan Guk, chief economist at Korea Economic Research Institute, a think tank for Korea's large conglomerates, "but if a global recession starts to dampen consumer sentiment, everybody will end up being a loser."

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