Bulging coffers
The nation’s holdings of foreign currency surpassed the $300 billion mark at the end of April. Should the nation confront any financial crisis in the future, these bulging state coffers will be of great help in cushioning the blow.
To hold $300 billion in foreign reserves is nothing short of a sea change for a nation that has been exposed to the threat of sovereign bankruptcy on two occasions during the past 13 years. Korea ― the seventh largest foreign currency holder after China, Japan, Russia, Taiwan, Brazil and India ― deserves to pat itself on the back.
During the 1997-98 Asian crisis the government attempted in vain to shield the nation from the onrushing financial tsunami. Having nearly exhausted its foreign reserves in this process, the government had to ask for an IMF bailout. Though the conditions were better when it faced the global financial crisis of 2008-09, it had to secure currency swap deals with the United States and other countries.
The current high level of foreign reserves will help Korea absorb shocks during times of crisis and cope with potential limits on access to borrowing abroad. It will also help the nation meet its foreign exchange needs and external debt obligations.
If so, will it be better for the nation to maintain a higher level of foreign exchange holdings? The answer is yes. But the downside is the additional cost. The central bank is already spending a huge amount of taxpayers’ money to keep its foreign reserves at a high level and stabilize the value of the Korean currency at the same time.
To accommodate the rising foreign reserves, the Bank of Korea has to buy dollars and other foreign currencies in the market. That is what the government has been doing in response to a net foreign currency inflow, a consequence of continuous monthly trade surpluses. But the downside cannot be overlooked.
If the central bank does nothing except buying foreign currencies, the market will be awash with the Korean currency. The increase in the amount of won in circulation will push down its value and fuel inflation. That is the reason why the central bank issues monetary stabilization bonds at a high cost. Last year, the interest accrued on the outstanding bonds amounted to 6.98 trillion won.
With the foreign reserves topping $300 billion, debate is now being renewed on what the suitable level is. There is no set formula to calculate a universally appropriate level because circumstances differ from country to country.
The major factors that must be taken into consideration in determining the proper level are short-term external debt, the money supply, as measured by M2, and the amount of monthly imports. Added to the list is the amount of portfolio investments held by foreign investors.
In determining how much to put in its foreign reserves, the central bank is well advised to pay keen attention to recommendations by domestic economic think tanks. It should be worthwhile to study the rationale behind what they believe to be optimal levels.
The Samsung Economic Research Institute says $190 billion would be appropriate if only short-term debt and monthly import bills were taken into consideration, as was conventionally the case. But it says the amount will have to be raised to an amount ranging from $312.5 billion to $340 billion if foreign portfolio investments are factored in. Some others propose smaller amounts.
It goes without saying that an advanced economy with a liquid and floating currency is not as vulnerable to external shocks and, as such, not required to maintain as large precautionary reserve holdings as a less privileged one. Korea, not an advanced economy yet, will do well to be on the safe side.
To hold $300 billion in foreign reserves is nothing short of a sea change for a nation that has been exposed to the threat of sovereign bankruptcy on two occasions during the past 13 years. Korea ― the seventh largest foreign currency holder after China, Japan, Russia, Taiwan, Brazil and India ― deserves to pat itself on the back.
During the 1997-98 Asian crisis the government attempted in vain to shield the nation from the onrushing financial tsunami. Having nearly exhausted its foreign reserves in this process, the government had to ask for an IMF bailout. Though the conditions were better when it faced the global financial crisis of 2008-09, it had to secure currency swap deals with the United States and other countries.
The current high level of foreign reserves will help Korea absorb shocks during times of crisis and cope with potential limits on access to borrowing abroad. It will also help the nation meet its foreign exchange needs and external debt obligations.
If so, will it be better for the nation to maintain a higher level of foreign exchange holdings? The answer is yes. But the downside is the additional cost. The central bank is already spending a huge amount of taxpayers’ money to keep its foreign reserves at a high level and stabilize the value of the Korean currency at the same time.
To accommodate the rising foreign reserves, the Bank of Korea has to buy dollars and other foreign currencies in the market. That is what the government has been doing in response to a net foreign currency inflow, a consequence of continuous monthly trade surpluses. But the downside cannot be overlooked.
If the central bank does nothing except buying foreign currencies, the market will be awash with the Korean currency. The increase in the amount of won in circulation will push down its value and fuel inflation. That is the reason why the central bank issues monetary stabilization bonds at a high cost. Last year, the interest accrued on the outstanding bonds amounted to 6.98 trillion won.
With the foreign reserves topping $300 billion, debate is now being renewed on what the suitable level is. There is no set formula to calculate a universally appropriate level because circumstances differ from country to country.
The major factors that must be taken into consideration in determining the proper level are short-term external debt, the money supply, as measured by M2, and the amount of monthly imports. Added to the list is the amount of portfolio investments held by foreign investors.
In determining how much to put in its foreign reserves, the central bank is well advised to pay keen attention to recommendations by domestic economic think tanks. It should be worthwhile to study the rationale behind what they believe to be optimal levels.
The Samsung Economic Research Institute says $190 billion would be appropriate if only short-term debt and monthly import bills were taken into consideration, as was conventionally the case. But it says the amount will have to be raised to an amount ranging from $312.5 billion to $340 billion if foreign portfolio investments are factored in. Some others propose smaller amounts.
It goes without saying that an advanced economy with a liquid and floating currency is not as vulnerable to external shocks and, as such, not required to maintain as large precautionary reserve holdings as a less privileged one. Korea, not an advanced economy yet, will do well to be on the safe side.
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