With stocks plummeting at home and abroad, jitters are rising in South Korea – one of the world’s most globally-connected, trade-reliant economies – as to whether a fresh financial crisis is bearing down.
In fact, compared to Korea’s worst financial nightmare – the 1997-8 crash, of which memories remain ever-fresh – things look reasonably bright.
Tumbling markets are attributed to uncertainties stemming from the novel coronavirus pandemic and the collapse of the US market. Algorithm trading has steepened the fall of US share prices, which have enjoyed a long-term rise without major corrections.
But Korean experts are not panicked. While equities plunge, they say the financial system remains intact. A wider range of metrics that suggest South Korean stocks may continue to fall, but neither the financial system nor the real economy are in special danger – at least, not in the near term.
1997 vs. 2020
Whence crises?
They can appear through financial and foreign currency market channels; or through real economy channels. Currently, the possibility of a crisis arising via either the real economy or the foreign exchange market looks distant for Korea, despite the rapid fall of stock prices and a rising dollar/won rate.
“Korea is now in a different situation from the past,” an expert at the Korea Center for International Finance, or KCIF, told Asia Times. “There is no shortage of foreign currency liquidity, nor is the stability of the local financial system threatened.”
“When we look at financial market volatility, it reminds us of the time of the financial crisis,” said a senior official at the Ministry of Finance. “However, it’s hard to see problems with the Korean financial system, dollar liquidity or the US market.”
Stability in the dollar funding market and the US financial system is important for Korea, which always needs dollars for financial and trade transactions.
The Fed announced on Thursday that it would inject $1.5 trillion dollars, and though some stress is emerging in the US money market, the risk of a credit crunch is limited. This is due to the resilience of the banking system, which has improved since the global financial crisis of 2008, and also due to the possibility of a further Fed response, the KCIF report said. It added, “There is no sign of avoiding loans in the unsecured loan market between banks.”
The KCIF official said: “The Fed’s action to inject liquidity was to prepare for the moment when businesses need cash, but currently the US money market is not suffering from a squeeze, despite warnings by a few investment banks of a possible credit crunch.”
South Korea, which was near broken by the 1997 foreign exchange crisis, is highly sensitive to any signs of global financial storms hence the recent plunge in stock prices has revived fears of a crisis. The benchmark KOSPI stock index fell 13.2% this week, the largest weekly drop since October 2008. It has so far dropped 19.4% this year.
The cost of raising US dollars by Korean won swap has also surged to a record level. According to Reuters, the won-dollar one-year basis swap – the “FX swap point” widened to the worst level since January 2014. The more negative the rate, the higher the premium investors have to pay. It is an indicator that shows the condition of the short-term dollar funding market.
However, currently, there seems little chance that the Korean financial institutions or companies will suffer from a foreign currency liquidity crunch.
“Although Korea may experience a sharp economic downturn, I don’t think there will be a situation where companies or financial institutions will suffer from financial difficulties or foreign debt repayment,” a financial market expert said. In the event of a global recession “weak links would be walloped,” he said, but “Korea is not the weak link at all, given the size of foreign exchange reserves, AA-level credit ratings and currency swap contracts with major economies.”
Korea’s foreign reserves reached over $409 billion this month.
Regarding FX swap market volatility, a market expert explained: “Due to the fall of overseas share prices, Korean overseas Equity Linked Securities investors have to secure dollars in response to a margin call. The volatility happened not because it’s tough to borrow dollars, but because the rapid fall of share prices has raised short-term demand for dollars.”
The Korean government is alert to the possible spillover from the ongoing global panic.
“The possibility of a crisis through the financial sector is low, but we are paying attention to risk management,” another official at the ministry said. Under the contingency plan, the Korean government plans to take measures to stabilize foreign exchange rates.
And in a bid to address stock market volatility, Korean financial regulators decided on Friday to ban short-selling for six months starting on March 16. Expectations for a policy rate cut are also growing as the Bank of Korea said on Friday that they are considering calling a meeting to discuss that cut.
Fiscal response
The US Fed made an emergency rate cut of 50 basis points, and the European Central Bank’s decided to lower the interest rate on loans for banks and increased bond purchase by 120 billion euros. But these moves failed to calm market jitters stemming from the spread of a disease that has created panic worldwide
Experts, including the finance ministry official, said that the plunge in the US stock market, which has generated a domino-effect in Korean stocks, could be the result of a long-term boom without any significant correction. Algorithm trading, which increases volatility, and the US policy response, also contributed.
“The Fed’s rate cut is not working [as] the market expected something bigger, but the US government failed to meet expectations,” said the KCIF official. “The tax cuts Trump mentioned need Congressional approval and cannot be implemented immediately. What they can do right now is lower the lending rate for small and medium-sized enterprises.”
Experts call for more drastic fiscal policy measures around the world.
The real risk
“Although central banks of major global economies continue to cooperate, the impact of monetary policy is limited compared to the past,” said Yoon Yeo-sam, an analyst of Meritz Securities, in a research note. “The widely spreading Covid-19 is fueling fears of a recession in advanced economies. Now, we need fiscal policies that directly stimulate economies.”
The Korean government drew up extra budget worth 11.7 trillion won ($9.6 billion) to boost consumption, but that may not be enough: The ruling Democratic Party is calling for an expansion to at least 18 trillion won.
Moreover, while Korea has won plaudits for its astute response to Covid-19, it is still seeing total infection numbers climbing. That means any rise in local consumption looks far off, while the global economy slides into lockdown.
Moreover, the country, as a trade-centric player, is deeply slotted into the global economy, suggesting the bigger risk is shrinking global consumption and declining trade.