09/01/08
The Times Online, London -- The deepening woes
at Fannie Mae and Freddie Mac, badly stretched central
bank reserves and a losing battle to support the won are
pushing South Korea towards a full-blown currency crisis
this month, analysts have said.
Heavy
investment by the Korean Government in Fannie, Freddie
and other US-related agency bonds has left a potentially
huge liquidity problem - perhaps $50 billion (£27.4
billion) - in the foreign reserve portfolio. Some
believe that Seoul might have no ammunition left to
prevent a significant flight from the won. Fruitless
currency intervention by South Korea - increasingly
desperate-looking verbal and financial measures to fight
the market trend - cost about $20 billion in July alone.
Attempts to prop up the won come as
South Korea’s household and corporate sectors are
wincing from the pain of high energy prices and
inflation. A summer of strikes by lorry drivers and mass
street demonstrations calling for President Lee to
resign reflect rising public concern that the economy is
in trouble.
The intervention efforts have failed
to prevent the currency sliding more than 7 per cent
against the dollar in the past month. The won is
teetering at a 44-month low against the greenback and,
with the central bank’s foreign exchange reserves still
dwindling, economists at CLSA, the brokerage, say that
it is “a game that Korea can literally no longer afford
to play”.
Moreover, the situation could worsen
dramatically: $6.7 billion of Korean bonds mature this
month, potentially creating vast downward pressure on
the won if a large part of that sum immediately flees
abroad.
Korea’s foreign exchange reserves
stand at $247 billion. The International Monetary Fund
recommends that emerging market economies should hold
nine months’ worth of import cover, which would be about
$320 billion.
More worrying, according to
economists at HSBC, is the level of Korea’s foreign
exchange reserves relative to its short-term debt ratio.
Korea’s debt maturing within a year has shot up to
$215.6 billion because of hedging against the oil price.
While that is nominally within the 100 per cent coverage
by forex reserves deemed necessary, the Fannie and
Freddie crisis in the United States raises the question
of whether any sense of security is illusory.
A large part of Korea’s foreign
reserves are not government bonds but the kind of
US-based mortgage-related bonds that once looked so
solid. Depending on how the Fannie and Freddie situation
develops, a significant portion of Korea’s forex
reserves could turn out to be extremely illiquid,
leaving the country ever more vulnerable to external
shock.
“The coverage ratio may in reality be
not as comfortable as the authorities would like,
meaning they have less with which to defend the
currency,” said one senior Asia-based economist.
Although few are predicting a
financial meltdown such as the one that hit the region
in 1997, recent weeks have exposed some unique
vulnerabilities in Asia’s third-largest economy. The
danger, Sharmila Whelan, CLSA’s senior economist, said,
is that South Korea has not recognized the perils of
intervention, given the country’s hefty current account
deficit.
“The risk is that once investors
realize how tenuous Korea’s reserve position actually
is, they will start abandoning Korea in droves and send
the currency tumbling,” Ms Whelan wrote in a recent note
to clients.
Soaring inflation and a legacy of
massive borrowings by households add an additional,
potent layer of instability. Government insiders in
Seoul have told The Times that there is a
“credible risk” that the Korean banking system could be
ravaged by a self-generated version of the credit crunch
that has hit Wall Street and the City.
Analysts predict a rising tide of
nonperforming loans, delinquency ratios and bankruptcies
and some of the country’s large mutual savings banks are
expected to go bust.
