The Risk of a Foreign Exchange Crisis and How to Prepare for It

Comparison of the Korean Foreign Exchange Crisis with the Current Situation

The 1997 IMF foreign exchange crisis and the 2008 global financial crisis had a significant impact on the Korean economy. At the time, the depletion of foreign exchange reserves, a sharp rise in exchange rates, the massive bankruptcies of large and small businesses, and bank mergers were the main contributing factors.

Main Causes:

Insufficient Foreign Exchange Reserves: At the time, the foreign exchange reserves were low, at around 20% of GDP, and the country was unprepared for external shocks.
Sharp Increase in Exchange Rates: In 1997, the dollar-to-won exchange rate exceeded 2,000 won, and it soared above 1,500 won in 2008.
Lack of International Currency Swaps: Important financial safety nets like the Korea-US currency swap and the Korea-Japan currency swap are not currently in place.

Korea still cannot completely rule out the possibility of a foreign exchange crisis and must check the current state of foreign exchange reserves and the ratio to GDP, as well as the status of currency swap agreements.

Comparison with Taiwan: Foreign Exchange Reserve Defense Strategy

Taiwan has effectively defended itself against foreign exchange crises and maintained a stable economy.

Taiwan's Foreign Exchange Preparedness Strategy:

High Foreign Exchange Reserves Compared to GDP: Taiwan has a foreign exchange reserve ratio of 75% compared to its GDP, and has thoroughly established measures to prepare for national crises.
Stable Industrial Structure: It operates a stable economic structure centered on trade and semiconductors, and is flexible in responding to changes in the global trading environment.
Securing Financial Safety Nets: Taiwan has signed currency swap agreements with various countries to minimize exchange rate volatility in the international financial market.

On the other hand, Korea's foreign exchange reserves are still at around 20% of GDP, which is less than half compared to Taiwan.

Specific Korean Financial Situation: Current Problems

Composition of Foreign Exchange Reserves:
- The approximately $410 billion in foreign exchange reserves are mostly distributed among U.S. Treasury bonds, government agency bonds, and gold.
- However, the proportion of readily available cash is low, making it difficult to respond in the event of a real liquidity crisis.
Exchange Rate Volatility:
- The Korean won accounts for only 0.1% of international trade, which indicates a low level of confidence in the global financial market.
- When exchange rates rise sharply, there is a high possibility that foreigners will sell Korean stocks or withdraw funds and send them back to their home countries.
Absence of Currency Swaps:

*   The Korea-US currency swap ended during the Moon Jae-in administration and has not been concluded with major countries such as the United States and Japan.

Risk of Short-Term Foreign Debt:
- Short-term foreign debt is foreign debt that matures within one year, which is considered one of the main risks of a foreign exchange crisis.
- The BIS (Bank for International Settlements) recommends a foreign exchange reserve of approximately $930 billion for stable foreign exchange crisis defense, but Korea is currently at about half of that level.

Required Response Direction: Measures to Prevent a Foreign Exchange Crisis

Expansion of Foreign Exchange Reserves: Foreign exchange reserves must be increased to at least $930 billion according to BIS standards, and the proportion of cash assets should be increased to strengthen the ability to respond to crises.
Currency Swap Agreements: Resume currency swap agreements with major countries such as the US and Japan to ensure stability in the event of a global financial crisis.
Financial Diversification: Encourage domestic capital market participants to access global markets such as US stocks, foreign exchange, and bonds to strengthen their role as exchange rate safety nets.
Policy Preparation: Benchmarking thorough crisis preparedness such as that of Taiwan to establish long-term policy strategies.

Conclusion: Continuous Monitoring is Necessary

Although the possibility of a foreign exchange crisis in Korea in the short term is low, the impact could be severe if it were to occur. Structural problems such as low foreign exchange reserve rates, the absence of currency swaps, and the proportion of short-term debt could exacerbate the situation. The government should prioritize expanding foreign exchange reserves and strengthening financial safety nets in preparation for a crisis.

< Summary >
The possibility of a foreign exchange crisis in Korea is indicated by risk factors in various economic indicators. Increasing foreign exchange reserves, re-establishing currency swaps, and strengthening financial stability are urgent.

Foreign Exchange Reserves: Expansion of approximately 2 times more than current levels is needed.
Currency Swaps: Securing a safety net by signing a Korea-US currency swap agreement.
Financial Policy: Benchmarking Taiwan's case, and expanding global financial investment.
Exchange Rate Safety Net: Strengthening accessibility to international financial markets such as stocks and bonds.

Crafted by Billy Yang

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South Korean Market Analysis: Economic Status and Evaluation

1. Current Evaluation of the South Korean Market

Undervalued Market: The South Korean market is currently significantly undervalued.
Currency Depreciation: The Korean won has depreciated sharply, with the current exchange rate reaching around 1,470 won. This serves as a key economic indicator.
Stock Market Decline: Overall, stock prices have fallen significantly, with the current South Korean market's P/E ratio at about 8 times and the P/B ratio at 0.8 times. These data points indicate a substantial discount from an investment perspective.

2. Current Economic Status and Key Variables

Political Uncertainty: The current growth of the South Korean economy is significantly influenced by political variables.
- The stabilization of the exchange rate and the establishment of basic conditions for economic growth are contingent upon the resolution of political uncertainty.
Potential for Expansionary Fiscal Policy:
- Once political uncertainties are resolved, fiscal policies (expansionary measures) can support South Korean economic growth.
- However, the immediate implementation of such expansionary fiscal policies is not expected at present.
Limitations of Monetary Policy:
- Monetary easing (such as interest rate cuts) faces clear limitations given the current economic structure and conditions.

3. Investment Attractiveness

High Discount Rate: The current stock market is historically undervalued, making it an "attractive entry point."
Short-Term Risks:
- Due to ongoing political and economic uncertainties, it is necessary to take a medium- to long-term perspective rather than focusing on short-term investments.
- Waiting for signs of stabilization and growth recovery, as well as monitoring how the exchange rate changes during this period, are key factors.

4. Future Outlook

Need for Political Stability:
- The resolution of political uncertainty would likely stabilize the exchange rate and improve the overall market.
Long-Term Opportunities:
- If stock prices remain at current levels, considering it a long-term investment opportunity could be a prudent strategy.
Potential for Economic Growth Recovery:
- Once fiscal policy starts playing a larger role, the pace of economic growth recovery is likely to accelerate.

< Summary >
The South Korean market is currently undervalued, with low P/E and P/B ratios and currency depreciation enhancing its investment appeal.
However, short-term approaches should be cautious due to political uncertainties and policy constraints.
Following political stability, growth potential through fiscal policy is expected to increase.