[Expert Analysis] Possibility of Exchange Rate Stability in the Second Half of the Year... The Biggest Variable Is International Oil Prices

Decline in Export Competitor Japan's Currency Value
Widening Deficit Amid US-China Economic Slowdown

Prolonged Global Dollar Strength Trend
Continued Upward Pressure Due to External Risks
Exchange Rate Ceiling Should Open Up to 1350 Won

Timing of US Inflation Peak Crucial
Slower Interest Rate Hikes Expected Upon Peak Confirmation
Potential Sharp Drop in International Oil Prices During Recession

[Asia Economy Reporters Seo So-jeong and Moon Je-won] The won-dollar exchange rate has surpassed the 1,300 won mark for the first time in about 13 years, signaling the realization of the ‘3-high (高) era’ characterized by high exchange rates, high inflation, and high interest rates simultaneously, raising alarm bells for the South Korean economy. The shadow of a global economic recession has deepened due to the U.S.'s high-intensity financial tightening, and with the prolonged Russia-Ukraine conflict intensifying volatility in international raw material prices, economic uncertainty is expected to increase further in the second half of the year.

In particular, as the won-dollar exchange rate rose to the 1,300 won level for the first time since July 13, 2009, concerns over the depreciation of the won have intensified in the South Korean economy, which heavily depends on raw material imports alongside exports. A sharp decline in the won’s value could worsen corporate management conditions, potentially leading to dollar shortages and corporate bankruptcies. Similar experiences were seen during the 1997 foreign exchange crisis and the 2008 global financial crisis. Accordingly, Asia Economy reviewed expert diagnoses on the recent exchange rate situation and examined its potential impact on the South Korean economy in the second half of the year.

◆Export Benefits Are a Thing of the Past... Competitor Currencies Also Depreciating= Experts predict that the combination of the U.S.'s high-intensity tightening and high exchange rates will have a significant negative impact on domestic inflation and the economy. Kim Tae-gi, Professor Emeritus of Economics at Dankook University, said, "In the past, there was a basic formula that a rising exchange rate helped exports, but recently, with import prices rising sharply, the burden on consumers is expected to intensify more than the export benefits." He added, "Especially since competitor countries like Japan and China, which compete with South Korea in exports, are also experiencing currency depreciation, the export effect of a rising won-dollar exchange rate is not significant."

Kim Seung-hyuk, a researcher at NH Futures, also emphasized, "Exchange rate increases significantly affect import prices. Given that raw material prices are rising and consumer inflation has already reached the 5% range, the government needs to be cautious about the won’s depreciation." He also predicted that the export increase effect due to exchange rate rises would be minimal. He pointed out, "Exports should be viewed in terms of the economic conditions of export partner countries rather than the exchange rate. With the growing possibility of economic slowdowns in the U.S. and China, South Korea’s current account deficit could actually widen."

There are voices warning about the trade deficit with China. Kim Jeong-sik, Professor Emeritus of Economics at Yonsei University, said, "China accounts for 26% of South Korea’s exports, which is very high, but recently imports from China have increased significantly while export growth has slowed." He added, "In May, the trade balance with China turned to a deficit for the first time in 27 years, and if the trade deficit with China continues, South Korea’s trade deficit will expand, potentially destabilizing the exchange rate in the foreign exchange market." Regarding Japan, he noted that the U.S. has always responded with accommodative monetary policies during periods of interest rate hikes, and policymakers need to manage the exchange rate considering the extent of yen depreciation.

◆Exchange Rate Ceiling at 1,350 Won... Stabilization Expected in the Second Half= Experts forecast that the global dollar strength trend will continue long-term, suggesting that the exchange rate ceiling should be kept open up to 1,350 won.

Professor Kim Tae-gi said, "Political risks also greatly influence South Korea’s foreign exchange market, and analyses suggesting that North Korea’s 7th nuclear test is imminent are acting as negative factors on the exchange rate. The upward pressure is likely to continue for the time being." However, he added, "Since the monsoon season has already started, it may be difficult for North Korea’s nuclear test to materialize, and Russia is suffering heavy losses in Ukraine, making it hard to prolong the war. China is also unlikely to maintain zero-COVID policies for long due to significant foreign capital outflows caused by city lockdowns, so the exchange rate is expected to find its footing soon."

Joo Won, Senior Researcher at Hyundai Research Institute, said, "Currently, there are no factors supporting won appreciation, so the exchange rate ceiling should be kept open up to 1,350 won. The timing of the U.S. inflation peak is important; once the peak is confirmed in the second half, the U.S. economic slowdown will become visible, slowing the pace of interest rate hikes and allowing the exchange rate to gradually stabilize."

Experts also emphasized the need to closely monitor international oil price trends as high exchange rates further increase inflationary pressures. Moon Hong-chul, a researcher at DB Financial Investment, said, "The biggest variable in inflation forecasts is international oil prices. Although international oil prices had been soaring, they have recently shown signs of adjustment due to rapidly spreading concerns about a global economic recession, increasing uncertainty." He added, "Energy prices can fall sharply during economic crises. If the base interest rate was raised to curb inflation but the economic downturn leads to a sharp drop in international oil prices and related ripple effects, this crisis could be bigger than the previous pandemic."