Dealing with the benefits and costs of internationalisation of the Korean won

Dealing with the benefits and costs of internationalisation of the Korean won

21 Pages · 2011 · 274 KB · English

As an another example, the volume of currency option trading between Korean banks and exporting companies for the purpose of hedging foreign exchange rate risk, including KIKO. (“knock-in/knock-out”) trading, has grown considerably since 2006. However, with the sharp rise in the exchange rate i

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BIS Papers No 61 151 Dealing with the benefits and costs of internationalisation of the Korean won 1 Kyungsoo Kim 2 and Young Kyung Suh 3 1 Introduction In an integrated world with large international trade and capital flows, a country with an internationalised currency can enjoy many advantages As currency internationalisation progresses, the foreign exchange risks and costs of foreign currency financing associated with foreign transactions are expected to decrease Another important advantage of currency internationalisation is that it gets a country further away from “original sin”, that is, by allowing residents to borrow externally in local currency, it prevents the likelihood of a financial crisis caused by a sudden stop of foreign capital flows As a result of capital\ account liberalisation in emerging market economies over the last 20 years or so, the integration of domestic and foreign financial markets has substantially deepened, increasing the incidence and severity of economic volatility arising from external shocks The recent severe stress in the domestic financial markets of major currencies has led to a sharp withdrawal of foreign currency financing in emerging markets and heavy pressure on exchange rates and asset prices in them Korea has been one of the emerging markets most affected, primarily due to its heavy reliance on external transactions Recent episodes suggest that pursuing currency internationalisation may, therefore, be a strong instrument to cushion t\ he adverse effects of external financial shocks and should be consider ed as one of the important policy issues in small open economies such as Korea However, currency internationalisation cannot be carried out without costs: the internationalisation of the local currency will adversely affect monetary and credit policy, as monetary policy independence can be significantly restricted Furthermore, countries in the early stages of capital liberalisation and currency internationalisation tend to be more vulnerable to external financial shocks Once the internationalisation of the currency has reached a mature stage, there is a reduction in the risk of exposure to speculative attacks by foreign capital This implies that emerging market countries that lie somewhere on the scale between developed and undeveloped face the greatest likelihood of experiencing a foreign exchange crisis Thus, it is important for develop ing countries to find a possible strategy for pursuing currency internationalisation that maximises the advantages while minimising the risks The Korean economy has become one of the world’s largest, with a huge volume of trade and capital flows Korean financial markets are developing fast: the Korean banking market is the third largest in Asia, and its equity market and bond markets are among the largest However, wondenominated transactions are relatively small given the scale of the economy and its high degree of openness, and the won is scarcely used outside Korea As a result, 1 Paper prepared for the BoK/BIS seminar on Currency internationalisation: lessons from the global financial crisis and prospects for the future in Asia and the Pacific , Seoul, Korea, 19–20 March 2009 The views expressed in this paper are those of the authors and do not necessarily represent those of the Bank of Korea (BoK) or the Bank’s policy 2 Former Deputy Governor, Institute for Monetary and Economic Research (IMER), BoK and Professor of Economics, Sungkyunkwan University, Seoul, Korea 3 Chief Economist, International Economics Team, IMER,

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