"North Korea's Significant Reduction in Foreign Currency Reserves Could Trigger Sharp Inflation and Exchange Rate Surge"

Signs of Stabilizing Prices in North Korea... "Only Changes in Foreign Currency for Value Storage"

"If Foreign Currency for Transactions Also Decreases, Economic Shock Could Worsen"

[Image source=Yonhap News]

[Asia Economy Reporter Jang Sehee] Research results have shown that if North Korea's foreign currency holdings shrink to a level insufficient to support real transactions, both North Korea's prices and exchange rates will surge simultaneously.

According to the study titled "The Impact of Decreasing Foreign Currency Holdings on Prices and Exchange Rates in a Dollarized North Korean Economy," published on the 28th in the BOK Economic Research by the Bank of Korea, when the scale of foreign currency holdings shrinks, the exchange rate begins to rise, and as this intensifies, both prices and exchange rates will increase simultaneously. Dollarization refers to a situation where a country other than the United States uses the US dollar as its official currency.

This study analyzed the issue based on the quantity theory of money, which posits that changes in the money supply affect prices, while reflecting the unique characteristics of the North Korean economy.

The report diagnosed that in the initial phase of reduction, mainly foreign currency held for value storage decreases, so prices and exchange rates were not affected. As of 2014, North Korea's foreign currency for transactions was estimated at 1 billion to 2.35 billion USD, foreign currency for value storage at 2.01 billion to 4.28 billion USD, and the total foreign currency holdings at 3.01 billion to 6.63 billion USD. In the initial phase, the decrease in foreign currency inflow can be managed by utilizing foreign currency held for value storage.

It is based on the fact that the current level of foreign currency reduction in North Korea is not insufficient to support real transactions, so North Korea's prices and exchange rates remain stable.

However, in the intermediate phase, where foreign currency for value storage is continuously depleted and foreign currency for transactions begins to decrease, the study predicted a situation where exchange rates rise and prices fall.

Senior Research Fellow Moon Seongmin of the North Korean Economy Research Office stated, "Despite North Korea's foreign currency balance showing a significant deficit since 2017, prices have remained stable because only the amount of foreign currency held for value storage has fluctuated, so actual prices did not change," adding, "If foreign currency decreases further to the point that foreign currency for transactions also declines, a phenomenon of rapid increases in prices and exchange rates will occur."

Senior Research Fellow Moon also emphasized, "Although there has been a slight rise in exchange rates and a slight drop in rice prices, it is premature to judge this as a situation where foreign currency for transactions is decreasing," stressing, "Currently, it is still a situation where foreign currency held for value storage is decreasing."

However, he observed that if sanctions against North Korea continue and foreign currency for transactions also decreases, there is a possibility of a significant economic shock in North Korea, such as a sharp rise in exchange rates and prices.

He said, "If North Korea's prices and exchange rates surge, phenomena similar to our foreign exchange crisis could occur," but added, "Since the North Korean economy is a controlled and planned economy, it remains to be seen whether this will lead to a crisis situation for the entire North Korean economy."