Starting from the second half of this year, South Korean companies will have the option to settle export and import payments in Korean won when engaging in trade transactions with certain countries from the Association of Southeast Asian Nations (ASEAN). This move is expected to allow businesses to reduce currency exchange fees and mitigate the risks associated with exchange rate fluctuations.
On Jan. 8, a senior official from the Ministry of Economy and Finance (MOEF) said, “We are in the final stages of negotiations with ASEAN countries to introduce a system for settling export and import payments in Korean won. We plan to revise foreign exchange transaction regulations within the first quarter of this year, paving the way for the direct trading system with certain ASEAN countries from the second half of the year.”
Since the end of last year, the MOEF’s international finance division has been engaged in negotiations to introduce a Korean won settlement system with ASEAN countries, including Indonesia, the Philippines, Vietnam, and Thailand. Indonesia is reported to be the top priority candidate for the implementation of this system.
The core of the Korean won settlement system lies in the easing of regulations on the transfer and disposal of Korean won, particularly as outlined in Articles 7-9 of the foreign exchange transaction regulations. The intention is to selectively allow these regulations for trade transactions with specific countries.
Until now, South Korean companies have only been able to settle export and import payments in Korean won with Iran. This arrangement was initiated in response to a specific situation created for trade dealings with Iran when the United States implemented the Comprehensive Iran Sanctions, Accountability, and Divestment Act (CISADA) in 2010, blocking dollar payments for transactions with Iran. The MOEF plans to pilot the Korean won settlement system with specific ASEAN countries and intends to broaden its application to other nations after the initial trial period.
With the government’s decision to introduce the Korean won settlement system for trade transactions to reduce transaction costs, domestic companies engaging in trade with certain ASEAN countries are expected to alleviate the burden not only of currency exchange fees but also of fluctuations in the won-to-dollar exchange rate starting from the second half of this year.
According to the MOEF on Jan. 8, the current foreign exchange transaction regulations restrict non-residents, including individuals and corporations abroad, from remitting Korean won deposited in domestic financial institutions to overseas destinations. This stringent regulation has been implemented by the government to prevent indiscriminate outflows of Korean won.
To be sure, there are exceptions. Non-residents can, in principle, freely convert and remit Korean won deposited in a domestic financial institution through a Free-Won Account, which was first introduced in 1993 as the initial step towards enabling the Korean won for international transactions. Foreign entities and other non-residents can use this Free-Won Account to pay domestic companies in Korean won for goods and services.
Although the system has been in place for 31 years, trade transactions through the Free-Won Account have been virtually non-existent. While the government introduced the Free-Won Account, it has prohibited the transfer and disposal of Korean won except for some transactions permitted through foreign exchange transaction regulations. The use of the Free-Won Account was only evident in the trade process with Iran, particularly after the U.S. sanctions against Iran in 2010.
According to the Bank of Korea, the proportion of U.S. dollar payments in the total export earnings of domestic companies was as high as 81.1% as of the end of June last year, while Korean won accounted for only 2.8%. This percentage reflects the currency composition specified in the contracts rather than actual payments made in Korean won. In essence, there were practically no Korean won transactions in the trade process, as explained by the MOEF.
The government reports that macroeconomic indicators are now robust, unlike during the Asian financial crisis in 1997 and the global financial crisis in 2008. As of the end of last month, foreign exchange reserves stand at US$420.15 billion, indicating a situation with ample reserves. It is believed that it is now time to open up the domestic foreign exchange market’s barriers. The introduction of the Korean won settlement system is also part of a plan to take the initial step towards the internationalization of the Korean won, aiming to reduce transaction costs for domestic companies.
Starting this year, foreign financial institutions based overseas will be allowed to participate directly in the domestic foreign exchange market, and from July the closing time for the domestic foreign exchange market will be extended until 2 a.m. the following day, aligning with the closure of the London financial market. These measures are part of the government’s efforts to loosen barriers in the domestic foreign exchange market.
The government plans to concentrate on introducing the Korean won settlement system by targeting ASEAN countries, which are predominantly non-key currency nations. It also considered the fact that key currency countries like the United States practically have no demand for Korean won settlements.
Korean and ASEAN private banks facilitate direct transactions between Korean won and local currencies. By eliminating the need for a currency exchange process into dollars, this arrangement helps reduce transaction costs and minimizes exchange rate fluctuation risks during the trading process.