October 28, 2013

Korean Won Riding On the Crest of Surplus


FX rate analysts at Goldman Sachs evaluated the near term balance of payments outlook for Korea as the Korean won appreciated recently. Upside risks for the USD/KRW exists which are more visible than the downside risks in the near term for some three factors:

(1) Korea’s current account surplus was at its highs in the third quarter of 2013 and it FX rate analysts expect it to fall significantly within the next few quarters. It will occur upon the cyclical rebound in imports and weak seasonality.

(2) Capital inflows will be lower in coming months on a sluggish global cycle, poor earnings momentum of KOSPI and relatively lower Korea Treasury Bond yields in the region.

(3) The stance on monetary policies on the KRW show limited room for a lower USD/KRW, that involve smoothing operations, establishment of bilateral currency swaps with Emerging Markets (EM) countries and policy measures to spur outbound flows.

Korean Won

Goldman Sachs has kept its 3 and 12 month forecasts for USD/KRW at 1,080 and 1,100, respectively. However, the brokers revised down its 6-month forecast to 1,080 from 1,100 previously, given the changing in the timing of US tapering to March 2014. Hence, the brokers noted the key risks on the USD/KRW would be further delays in US tapering, oil prices and USD/JPY.

Surplus Backdrop

Korea’s current account surplus is poised to assume a downtrend within the following quarters. FX rate analysts estimate that the current account surplus will decline from 5.1% of GDP in 2013 to 3.6% of GDP in 2014. A sequential downtrend is expected from 6.7% of GDP in the second quarter of 2013 to 1.3% of GDP in the first quarter of 2014.

The factors being mentioned will be explained in full detail in relation to domestic demand backdrop. An existing recovery in domestic demand will drive import growths. Elasticity of imports to domestic demand is 1.7 in Korea. Hence, Goldman Sachs expects that volumes of imports will be lifted up by 5.2% Y/Y within the succeeding quarters, which is up from 3.2% Y/Y in the first half of this year.

Moreover, FX rate analysts anticipate a seasonal low in the current account on pickups in imports in the energy industry and payment of dividends in the succeeding months. An increase in oil import volumes could result as much as 14% Y/Y in this quarter or an estimated value of $4B with a broad based recovery in Korean economy underway along with normalisation in operations of refinery after an extended shutdown in maintenance. It resulted to annual oil imports growing by 2% Y/Y in 2013 from a decline of 2% Y/Y for the first nine months of 2013. Payment of dividends should build up about $1.5B of capital outflows in the first quarter of 2014.

USD Positioning vs. KRW

Goldman Sachs FX rate analysts noted that capital inlflows and that the positioning of local USD holders were not supporting the Korean won like in the third quarter of 2013. It just so as capital flowing into Korean stock market will diminish in the next few months. It hit a record high in September but most probably will lessen in the coming months. Meanwhile, Korean stock markets bounced by 14% from a year low in late June, followed by a dissipation of three risks that pressures the market. The three risks are negative spillover concerns bourn out of Abenomics, geopolitical risks and a rebalancing of a major index fund.

The positioning of local USD holders points to slight pressure for KRW appreciation from the side of balance sheets. Local holdings of USD (cash and forward positions of the central bank, corporates and households) rose by $25B in third quarter of 2013, the same as a year ago, suggesting that appreciation pressures from positioning would be similar to what we observed a year ago. While it is difficult to disentangle FX pressures from new flows versus existing positions, a relatively modest appreciation of the KRW back then. It registered 2.3% in third quarter of 2012 and a total of 6.2% in the second half of 2012, as compared with appreciation of 6% in third quarter of 2013 points to limited room for KRW appreciation in the coming months.

USD/KRW Policy Outlook

Monetary regulators are concerned about a fast pace appreciation of the KRW and the risk of a steep reversal of capital inflows in any event that US tapering occurs. The monetary regulators will avoid sudden swings in the FX rate markets through policy measures including smoothing operations and strenthening of existing macro prudential measures. Two new measures would go a long way to mitigate FX rate volatility.

First, an ongoing extension of bilateral currency swap arrangements with Emerging Market countries would help smooth FX flows across balance of payments cycles. Korea has recently signed bilateral swap arrangements with Indonesia, Malaysia and the United Arab Emirates and is negotiating with Australia. Total outstanding active and announced arrangements are enormous at $108B. It is equivalent to almost one third of reserves and approximately 20% of annual goods exports.

The arrangements should in principle help smooth FX flows across balance of payment cycles, while the modality would need to be worked out. It happened at a time of strong balance of payments, the acceptance of Emerging Market currencies as exports payments would help reduce KRW appreciation against the USD, and conversely at a time of weak balance of payments, the use of the KRW for imports would help limit KRW depreciation. These arrangements could benefit both parties given the asymmetric nature of capital outflows from one country would necessarily mean inflows to others. Usually this is common among developed countries and occasionally relatively advanced developing countries like Korea. Key for KRW success would be diversification across developed countries and resource-rich developing countries.


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