In a narrow sense, the exchange rate of a country’s currency is determined by the flow of funds across the border for transactions involving goods, services and investment assets. However, longer-term exchange rate trends are widely considered to reflect overall perceptions of the country's economic fundamentals.
Economic fundamentals not only refer to quantitative measures such as gross domestic product, current account balance, stock prices, foreign investment and consumer prices, but also encompass broader, non-economic factors such as the economy’s structural issues and sociopolitical stability.
From this perspective, the recent trend in the South Korean won's exchange rate is more concerning than before and requires a more deliberate response from the policy authorities than in the past. Both the magnitude and speed of the won’s decline in value are excessive when considering the overall economic and financial conditions of South Korea.
The won ended the final trading day of 2024 at around 1,472 per US dollar, marking a decline of 13 percent in value during the year -- the worst performance since suffering a 26 percent loss in 2008 due to a global financial crisis. While it was only half the drop seen in 2008, it is worrying because this happened even when there was no financial crisis affecting the country or global markets.
The won’s recent weakness is far more severe than the currencies of South Korea’s rival economies such as China, Japan and Taiwan. In terms of the monthly average, the won’s value in December 2024 has fallen by 9 percent in a year, compared with declines of between 2 and 6 percent for the other three currencies, according to data from the Bank for International Settlements.
This situation is worrying because the won is also much weaker than the country’s economic fundamentals measured in traditional indicators, such as the current account balance, trade balance and external debt. Most recently, the won has been hit hard by increased uncertainty stemming from the domestic political crisis over the failed attempt by President Yoon Suk Yeol to impose martial law, which led to his impeachment by the parliament.
Unfortunately, the political crisis may take some time to resolve, at least until the Constitutional Court makes a final ruling on the parliament’s impeachment of Yoon, a process that can take up to 180 days. However, this doesn’t mean that the policy authorities and the parliament have no choice but to wait until the situation settles down on its own.
Should the won’s weakness deepen or persist for a long time over the coming months, the costs will only grow, impacting not only the national economy but also the livelihoods of the general public and corporations. There was a time when a weaker won helped South Korea’s export manufacturers expand their share of the global market and enjoy extra gains from converting dollar revenue into the local currency.
However, that time has passed, as South Korean companies have increased their exposure to overseas operations, and the country’s reliance on foreign currency-denominated transactions has grown. Moreover, the country is now more dependent on imports for food, local companies have significant foreign currency-denominated debt, and stock prices are heavily influenced by the behavior of foreign investors.
The consumer price index rose 1.9 percent in December 2024 compared to a year earlier, staying below the central bank’s target of 2 percent for the fourth consecutive month. But the growth rate accelerated for the second month in a row since touching 1.3 percent in October, and this could gather momentum in the future with the won’s recent weakness taking effect.
Moreover, the consumer price index for food and energy products -- more influenced by the exchange rate than other products -- is already showing an alarming trend, increasing by 2.3 percent in December compared to a year earlier. This marks the third month of acceleration in the index’s annual growth rate since posting a decline of 0.7 percent in October. It also reached its fastest growth since a 4.0 percent gain in July 2024.
On one hand, the rebound in consumer price inflation will hurt the spending power of consumers as well as the profits of companies by increasing their raw material costs. This could not come at a worse time, as South Korea’s private consumption and corporate earnings have been in a slump for a long time.
The Bank of Korea may deliver more interest rate cuts to help shore up the sentiment of consumers and companies, following reductions at two successive meetings in late 2024. It has already promised to do so in its recent policy statement while revising its economic growth projections downward.
However, a further decline or sustained weakness in the won’s value could limit the scope of monetary policy easing by the central bank, as members of the monetary policy board may fear that aggressive rate cuts could spur capital outflows at a time when the US Federal Reserve is poised to slow down its rate-cutting campaign.
The message from this situation is clear: stabilizing the foreign exchange market is a precondition as well as a goal of current economic policies. It is welcome that the Ministry of Economy and Finance has announced a series of policy measures aimed at preventing speculative trade from exaggerating exchange rate movements while ensuring local financial markets are flush with foreign-currency funds.
Nevertheless, the measures and resolve announced by the government and the central bank still appear focused on symptoms and near-term issues rather than root causes and noneconomic factors. By nature, this mission cannot be achieved by policymakers and bureaucrats at the Ministry of Economy and Finance and the Bank of Korea alone.
There’s no denying that major political parties must focus on upcoming political events, such as a possible early presidential election if the Constitutional Court approves the impeachment. However, the parliament should play a more active role in supporting economic policy authorities throughout the process of planning and implementing bold initiatives that can save the won -- and ultimately the country.
Yoo Choon-sik
Yoo Choon-sik worked for nearly 30 years at Reuters, including as the chief Korea economics correspondent, and briefly worked as a business strategy consultant. The views expressed here are the writer’s own. -- Ed.
