Analysis – South Korea’s quest to make its markets global is haunted by foreign exchange history

Analysis - South Korea's quest to make its markets global is haunted by foreign exchange history

Written by Cynthia Kim and Wina Park

SEOUL (Reuters) – As South Korea seeks to boost the global standing of its financial markets, the export powerhouse is struggling to ease tight currency controls that have for many years been a major pain point for investors and traders in the country.

Asia’s fourth-largest economy is one of the most advanced in the world by many measures, but it has been unable to change its emerging market classification due to a range of issues, including the way its currency is managed.

While foreign exchange regulators are now considering modest steps to make the won more universal, such as extending trading hours, memories of painful foreign exchange crises cast a long shadow over the reforms.

For many companies and market participants, South Korea’s vague restrictions on cross-border transactions, daily reporting requirements and brokerage rules make doing business slow and expensive.

“Having foreign exchange markets open almost all day around the clock will definitely help us better plan currency conversions and get a better deal,” said Bongju Kang, CFO of a small plastics export company. “Right now, we negotiate the exchange rate with a local banker the minute we see a good rate, or sometimes hours before, especially when the transaction size is large.”

Foreign exchange restrictions are among the factors often blamed for the so-called Korean discount, the term given to the poor global performance of local stocks. Other issues include poor decision-making and poor management by major conglomerates.

Regulators say comprehensive monitoring of the forex market is needed to prevent destabilizing currency fluctuations.

“We need to monitor the market in times of volatility because liquidity is not always abundant in the local market,” a Bank of Korea official said.

Shin Jong-beom, head of the Finance Ministry’s International Finance Office, said regulators will maintain the current monitoring system and “will be ready to pick up and respond quickly to any troubling market behavior.”

Until last year, the won could only be exchanged directly with the dollar or Chinese yuan between a total of 56 financial institutions based in the country for only six and a half hours a day, through authorized brokers in Seoul.

This means higher costs for companies, as they have to rely on derivative contracts known as non-deliverable futures to manage exposure to the won outside the internal trading window from 0900 to 1530.

From July, South Korea will extend trading until 0200 to cover London business hours, and the country expects wider foreign participation with about 20 foreign banks applying to join the interbank market, according to the Finance Ministry.

The changes come amid broader reforms by President Yoon Suk-yul to remove the Korean discount and increase investment by bringing the country into top-shelf indices such as the FTSE World Government Bond Index (WGBI) and MSCI’s Advanced Market Benchmarks. WGBI’s listing could attract inflows of up to $70 billion, according to some estimates.

However, the growing political desire for reform has not yet translated into change that would meaningfully boost acquired trade, analysts and market participants say.

“With international banks only allowed partial access to Korea’s interbank market and no plans to create an offshore market on the horizon, we do not expect access to the Korean financial market to change materially from broader trading hours,” said Simon Harvey, head of the division. Forex analysis in Monex Europe.

The $66 billion daily trade represents about 1% of global foreign exchange volume, less than 3% for the Canadian dollar and 6% for the British pound, according to 2022 Bank for International Settlements data.

This keeps South Korea in the emerging markets club, where trading volumes in the won relative to GDP have remained at around 8%, similar to the Polish zloty and the Chilean peso.

“There is no reason why the won cannot overtake the pound if foreign exchange rules are relaxed enough to give the market a chance to catch up with the global exporters we have today,” said Kim Hee-jin, head of Shinhan Bank’s trading department.

Unlike the Hong Kong dollar or pound sterling, foreign banks must trade the won through two Korean brokers for spot trading and pay a commission to a local bank to fulfill reporting obligations to authorities.

Foreign banks are also not allowed to directly trade won among themselves abroad.

The intense focus on market monitoring partly reflects the hypervigilance mentality that formed after financial shocks such as the 1997 Asian financial crisis and the 2008 global financial crisis.

Currently, the Bank of Korea can look into every transaction made in dollars through brokers, a system created decades ago to avoid a repeat of the capital flight seen in 1997, when the won lost half its value.

“The rules imposed on won trading are unheard of anywhere,” said one trader with decades of experience in international banks, who declined to give his name.

“Korea is opening up the market, but that doesn’t mean everyone can join and trade the won.”

(Additional reporting by Jihoon Lee in Seoul and Ray Wei in Singapore. Editing by Sam Holmes)

Copyright 2024 Thomson Reuters.

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