On October 5, the provision of the eight billion-euro portion of the bailout fund for Greece was postponed. Moody's downgraded the credit rating of Italy to A2, as Standard & Poor’s did last month. On October 7, Fitch cut the ratings of Spain, the fourth-largest economy in Europe and Italy, the third by two notches and one, to AA- and A+, respectively. It can be seen that the crisis in Greece enmeshed Italy and Spain into trouble, which goes on to throw France in difficulties to spread itself across the continent.
To tackle the sprawling fiscal calamity, European authorities have begun to take action, planning recapitalization to protect their banking systems from the threat. Though part of the bailout plan was decided to be postponed at the finance ministers’ meeting in Luxemburg October 3 and 4, Eurozone governments have a consensus on their cooperation and are now working on specific measures. According to experts, the initiative is not only to forestall a crisis of larger magnitude but also reduce the risk on the part of banks in advance in case Greece is forced to default.
Under the circumstances, many are claiming that the European Central Bank (ECB) needs to be more aggressive. Nevertheless, firm is the ECB’s stance not to step over the line. Its thought is that it will not take the role of the lone troubleshooter.
Will Base Rate Be Adjusted?
Korea, in the meantime, is also finding itself exposed to concerns about simultaneous inflation and economic recession, with many keeping a close watch on whether the Monetary Policy Committee will make any change to the key rate, which currently stands at 3.25%, during its mid-October meeting. These days, worries about inflation are not going away and some are voicing the need to raise the base rate as an exit strategy. However, overseas conditions are changing so rapidly that the committee is feeling somewhat burdened about the rate adjustment.
In its October 6 report regarding its economic outlook, the Ministry of Strategy and Finance said, “Although the global fiscal crisis and the high volatility both at home and abroad are blocking our view, we will examine recent conditions and their effects thoroughly for continued economic recovery and price stabilization.”
Going after More Dollar Liquidity
The Korean government is bending over backwards to better control dollar liquidity. It is encouraging the financial sector and state-run companies to issue overseas bonds, as well as planning to check the foreign exchange liquidity status of banks more frequently.
It goes without saying that the reason for the move lies in the global financial market tightness derived from Europe and the difficulty of financing from abroad. Since last month, the Korea Export-Import Bank and Korea Finance Corporation have issued US$1 billion and US$0.75 billion worth of dollar-denominated bonds, respectively. For all the other financial institutions, the total is zero.
On the face of it, however, the local banking sector appears to have no problem taking out foreign currency loans. The loan refinancing rate calculated by the Financial Supervisory Service was estimated at over 100% for last month. Since the rate can be defined as the ratio of actually made loans to those to be redeemed at maturity, the percentage signifies that the sector is succeeding in borrowing more than it has to repay.
What the government is nervous about is the fact that those loans are taken out only in the short-term money market, from which the funds may flow out all of a sudden when a financial crisis breaks out. Therefore, it is intending to spur the issue of more long-term overseas bonds. In particular, it is going to allow public enterprises to issue overseas bonds without any constraints so long as it is for the purchase of dollar assets. Previously, the government held the opposite position in regards to managing foreign debt. Furthermore, it is planning to help obtain non-dollar loans in order to diversify borrowing channels. Woori Bank, for example, followed the policy when it issued ringgit-denominated bonds in Malaysia. It is preparing to issue more of those in Switzerland.
Adamant to Stabilize Domestic Financial Market
With uncertainties regarding the European crisis severely affecting stock prices and the foreign exchange rate, the government showed its will yet again on October 4 to stabilize the domestic financial market. In particular, it expressed deep concern over the fluctuation of the exchange rate, which touched the psychological barrier of 1,200 won per dollar temporarily that day. The administration is wary of the possibility that such movement could fuel a flow of foreign capital out of the country.
Vice Minister of Strategy and Finance Shin Jae-yoon stopped by the pressroom in the afternoon that day without prior notice. There he said, “We are intending to take aggressive measures when the market shows any tipping effect and the intensity will be more than that of fine-tuning.” The remark can be translated as his determination not to overlook the recent exchange rate hike, which it sees as being grounded in a kind of excessive herd behavior.
It has been discovered that authorities carried out fine-tuning to slow down the speed of the hike on the day’s won-dollar rate exceeding the 1,200 mark in the morning. The authorities believe the surge was caused by an unfounded fear, irrespective of Korea’s economic fundamentals. In fact, market participants reacted very sensitively to news that Franklin Templeton disposed of 200 billion won-worth of domestic bonds, implying that they were hypersensitive to anxiety over a capital outflow.
Nevertheless, foreigners’ bond investments in Korea are continuing an upward trend. On the same day, foreign investors net-bought 920 billion won of government and monetary stabilization bonds. In addition, the central banks of some emerging countries like Thailand are assumed to have begun buying domestic bonds once the won-dollar Forex rate reached the 1,200 point. It seems that the Korean government took this into account before revealing its will to defend the exchange rate.
The vice minister emphasized that Korea is not that vulnerable to the turn of events abroad, mentioning foreign exchange reserves of over US$300 billion. Still, he said no to the financial sector’s request to appropriate some of it for liquidity. “The reserves should be in conservative hands and it is the private sector itself that has to make efforts to secure liquidity,” he said, adding, “Of course, we may step in if the global economy deteriorates so badly, as is the case of 2008, but it is sure that now is not that time.”
Park Jae-wan, who is heading the ministry, chimed in the following day, commenting, “We may be well-advised to be alert to the nocebo effect and the viral chain reaction of negative thoughts.”
“Although we recorded a trade surplus last month, and that was for no shorter than the 20th consecutive month, it is fair to say that the situation in Europe and the global recession it might entail could affect exports,” he continued, “In that case, we will try harder with the Knowledge Economy Ministry to redress the situation and monitor it more closely while pursuing deregulation to improve the service account balance.”