The Korea Herald

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Breakup of FX swap deal with Japan unlikely to affect financial market

By 송상호

Published : Aug. 17, 2012 - 20:17

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(Yonhap) -- A possible end to the currency swap line with Japan would not have a significant impact on the financial market here as Seoul has made headway in strengthening its safety net designed to absorb shocks from unexpected global turmoil, analysts said Friday.

   South Korea expanded its currency swap line with Japan from US$13 billion to $70 billion last year in a bid to secure foreign exchange liquidity. Under the deal, Seoul can exchange its own currency with safer assets such as dollars and yen.

   Angered by President Lee Myung-bak's unprecedented visit to the easternmost islets of Dokdo last week, Japanese Finance Minister Jun Azumi told reporters Friday he is considering adjusting the terms of the currency swap deal with South Korea.
That could include a decision on whether to extend the deal or not before it expires in late October, he added.

   His remarks about the currency swap line were interpreted by many here as a response to the recently ramped-up diplomatic tensions between the two countries centering on the Dokdo islets.

   Seoul has similar foreign-currency swap arrangements with China and the Association of Southeast Asian Nations through the Chiang Mai Initiative Multilateralization fund. The country also once held a $30 billion won-dollar swap deal with the U.S., but that expired in 2010.

   Those swap deals helped South Korea stabilize its financial markets as they were pummeled by the global turmoil that swept the world in the wake of the collapse of Lehman Brothers in 2008.

   The deals eased concerns over a possible liquidity crunch in Korea by opening extra channels to secure extra dollars to add to its fast-dissipating foreign currency reserves at the time.

   Korea regained independence after 1910-45 Japanese colonial rule and reclaimed sovereignty over its territory. Japan's territorial claims over Dokdo have been viewed by Koreans as a sign Tokyo has not fully repented for its imperialist past.

   South Korean financial policymakers remain cautious in responding to Azumi's remarks in an apparent bid to keep the current diplomatic tensions from getting out of control. An official at the finance ministry said, "No comment" when asked about the latest remarks by the Japanese official.

   Market observers doubt Japan will go ahead with its threat.

They speculate the threat to close the swap line might be just a "symbolic" move to gain an upper hand in the row.

   Even if Tokyo was to close the swap line with Seoul, market watchers said the overall impact on the financial market here will not be significant as things are quite different from when South Korea was hard-hit by the global financial turmoil.

   "In 2008, our management of foreign currency was problematic. We sold a great amount of dollars in order to bring inflation under control at a time when the short-term foreign debt remained high," said Jun Min-kyu, an economist at Korea Investment & Securities Co.   
"Now is different. Our foreign currency reserves have increased sharply ever since and short-term debts also dropped significantly. We now have a stronger buffer against liquidity crunch."

   South Koreans remember years ago when the economy was hard-hit by the global financial meltdown in 2008, as stock and currency markets tumbled on worries dollar funding could dry up amid ever-deepening turmoil.

   To prevent such external shocks from swaying the local financial markets and the overall economic conditions again, South Korea has focused on strengthening its safety net against possible future crisis.

   According to the central bank, South Korea held $311.4 billion worth of foreign currency reserves at the end of last month. That amount is up from about $200 billion held in the midst of the previous financial crisis.

   In addition, the country's current account surplus widened to a record high of $5.84 billion in June, which helped it bring more dollars to the domestic market.

   Analysts say that under the current circumstances, chances are slim that a crisis could be prompted by the shortage of dollars.

   "Basically, the currency swap deal with Japan was signed against the backdrop of the global financial crisis," said Huh Jae-wan, an analyst at Daewoo Securities Co.

   "Unlike years ago when the financial crisis swept the globe, our economic and financial fundamentals are much stronger. Even if the swap line with Japan comes to a close, it would not have a significant impact on the overall markets," he added.

   There are still some lingering worries a closure of the swap line with Japan, one of the world's leading economies, could serve as an additional drag on the market here, which remains susceptible to external volatility.

   One analyst said if liquidity problems resurface, sentiment could get seriously hurt with one safety net gone, but he said that is a "big if" under the current circumstances.