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Issue Report

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Financial Unrest and Crisis Rumors

Financial Unrest and Crisis Rumors

JEONG Young-Sik

Apr. 29, 2009

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Originally released on March 16, 2009

 

ABSTRACT

Since the latter half of 2008, the Korean economy has been the target of recurring rumors of a crisis. Citing Korea's high amount of short-term foreign liabilities and a high dependency on foreign capital as seen by a large presence of foreign investors in the domestic stock market, the rumors predicted a massive exodus of foreign capital that would drive the economy into default and bankrupt financial institutions. Other factors fueling the rumors were a concentration of foreign capital maturing within a specific range of time and the trauma of the 1997 currency crisis that makes the country more sensitive to issues like the level of foreign currency liquidity.

Given the potential of further global financial market instability, crisis rumors may resurface even as recent rumors are buried. To be sure, there is limited room to reduce the nation's high dependency on foreign capital within a short time. Yet, chances are quite low that crisis rumors will become a reality. Even if domestic financial instability escalates, Korea, with ample foreign reserves and cross-country swaps, could handle demands to repay short-term foreign debt. Plus, it is possible to convert short-term foreign debt into long-term debt through the government's payment guarantee, and the nation's current account is trending toward a surplus, which would serve as an additional bulwark.

Still, considering that the crisis rumors have huge side effects, including heightening a sense of instability, more effort should be made to block the recurrence of crisis rumors and to quell financial anxiety. To this end, the weight of short-term foreign liabilities first needs to be reduced. Although banks should take the initial step toward this goal, it won't be enough. It is necessary to repay onerous, high-interest, short-term foreign debt by using some of foreign reserves and currency swap funds. Also needed are efforts to minimize the impact of the global financial instability on the domestic market. The monitoring of the global financial market needs to be strengthened to preemptively respond to possible external shocks. In addition, the foreign media should be given better access to information about the level of foreign currency liquidity to help prevent misunderstandings and the government should be more proactive at international conferences like the G20 in illuminating the side effects of so-called financial protectionism, which worsens global liquidity. Plus, the government also needs to strengthen coordinated efforts with the international community to secure liquidity among Asian countries.

To improve the economic and financial structure, which is vulnerable to external shocks, mid- and long-term measures also need to be taken in parallel. Efforts should be made to cultivate market makers to prevent the foreign exchange market from being lopsided, as well as increase the share of direct investment in foreign investments. Moreover, it is crucial to expand the current account surplus, a fundamental solution to address foreign currency liquidity issue, by leveraging recent depreciation of the won.

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