[King Dollar's Bombardment] Airlines and Steel Companies on Alert Amid Currency Shock

Payment for raw material imports requires more Korean won
High proportion of foreign currency borrowings makes profitability deterioration inevitable
Price increase of steel products considered due to exchange rate rise

Editor's NoteDespite the recent global trend of a ‘King Dollar,’ the Korean won has experienced an unusually sharp decline, and South Korea’s foreign exchange reserves are also rapidly decreasing. As foreign exchange reserves, which serve as a safety net for external payment settlements and crisis response during national economic emergencies, have shifted to a downward trend, debates over the adequacy of the reserve size have intensified. Currently, there are conflicting views: some argue that South Korea’s foreign exchange reserves fall short of the appropriate level estimated by major institutions such as the Bank for International Settlements (BIS), while others contend that the current strong dollar phenomenon is a global commonality and should be viewed differently from the 1997 foreign exchange crisis. In this context, Asia Economy has gathered opinions for and against the adequacy of foreign exchange reserves.

As the area gradually moves out of the influence of Typhoon Hinnamnor, the aircraft (OZ1085) heading from Gimpo International Airport to Haneda, Japan, is taking off. Photo by Korea Airports Corporation

[Asia Economy Reporters Oh Hyung-gil and Yoo Hyun-seok] There is no sign that the exchange rate increase will stop. Predictions that the rate will soon rise to the 1,400 won per dollar range have put companies on high alert.

Steel and aviation industries, which import raw materials in dollars, are already enduring losses related to exchange rates, but concerns are growing that these losses will snowball as the exchange rate continues to soar in the second half of the year. The four major conglomerates planning large-scale investments in the United States are also facing increased burdens as investment amounts grow.

The aviation and steel industries are the most directly hit by the rising exchange rate. Although they generally subscribe to foreign exchange hedging to mitigate risks, the expected continued rise in exchange rates suggests that the scale of damage will be significant.

Airlines are particularly sensitive to exchange rate changes because a large portion of their expenses, such as jet fuel and lease fees, are paid in foreign currency. Especially since their foreign currency expenditures exceed foreign currency income and they have a high proportion of foreign currency borrowings, an exchange rate increase can deteriorate profitability.

Although jet fuel prices have recently fallen following a surge in oil prices in the first half of the year, the rising exchange rate has offset these benefits. As of the second quarter, Korean Air is estimated to incur about 35 billion won in foreign exchange losses for every 10 won increase in the exchange rate, and Asiana Airlines about 28.4 billion won.

The industry emphasizes that larger airlines bear a greater burden from exchange rate increases. Larger airlines have bigger foreign currency borrowings, which means higher amounts to be paid. An aviation industry official explained, "Although low-cost carriers (LCCs) have become more prominent due to COVID-19, the impact of exchange rates is greater on large airlines," adding, "The larger the debt or the fleet size, the more foreign currency is used."

Moreover, the ongoing impact of COVID-19 adds to the burden. Another industry insider said, "Due to the nature of the aviation industry, it is inevitably affected by various external factors," and added, "Currently, passenger numbers are not recovering properly, and combined with rising exchange rates and economic recession, concerns are bound to grow."

[Image source=Yonhap News]

Steel companies are concerned that although raw material prices have stabilized recently, the benefits may be offset by the exchange rate. While they offset increased import costs through product exports, the large domestic market share still reduces profitability.

They practice a 'Natural Hedge' by using dollars earned from exports to pay for raw material imports, but as more won is required to pay for these imports, liquidity pressure from dollar exchange inevitably increases.

Steel companies worry that if the exchange rate rise continues long-term, they will have no choice but to consider raising sales prices, which could have ripple effects across the industry. In response, in July, POSCO Group entered an emergency management system at the company-wide level due to the impact of the 'three highs'?exchange rate, interest rate, and inflation.

Refineries and chemical companies are also worried about rising purchasing costs. LG Chem estimated in its first-half report that a 10% rise in the exchange rate could cause losses of 166.9 billion won. SK Innovation also projected a 30.2 billion won decrease in profits if the exchange rate rises by 5%. SK Innovation experienced about 320 billion won in non-operating losses in the second quarter due to increased foreign exchange losses from the exchange rate rise.

Especially companies planning large-scale overseas investments in semiconductors, automobiles, and secondary batteries have been forced to bear greater burdens. The four major domestic conglomerates, including Samsung and SK, recently announced a total U.S. investment amount of $70 billion, approximately 94 trillion won. At the beginning of the year’s exchange rate, this was about 84 trillion won, but the rise in exchange rates has increased it by 10 trillion won.

On the other hand, industries with a high export ratio that earn dollars, such as semiconductors, automobiles, and shipbuilding, benefit from the rising exchange rate. Among them, automakers are particularly benefiting. Since they export finished vehicles produced domestically overseas, they can expect increased operating profits from the exchange rate rise.

Hyundai Motor recorded an operating profit of 2.9798 trillion won on a consolidated basis in the second quarter, reportedly benefiting significantly from the exchange rate effect. Seo Kang-hyun, Vice President and Head of Hyundai Motor’s Planning and Finance Division, said during the second-quarter earnings conference call, "Sales and operating profit both showed a significant increase compared to the same period last year due to improved sales mix, reduced incentives, and a favorable exchange rate environment."

Hyundai Motor estimates that a 5% rise in the won-dollar exchange rate (won depreciation) in the second quarter would impact net profit by 31.1 billion won, and Kia estimates 311.5 billion won for a 10% change. In the second quarter, Hyundai Motor actually saw about 600 billion won and Kia about 509 billion won in exchange rate benefits.

Shipbuilding companies, whose transactions are conducted in dollars, also see increased sales and operating profits when the dollar rises. Korea Shipbuilding & Offshore Engineering expects to return to profitability from the third quarter due to the exchange rate rise and other factors. During the second-quarter earnings conference call last month, Korea Shipbuilding & Offshore Engineering said, "We initially expected the shipbuilding division to turn a profit around the fourth quarter, but now we expect it from the third quarter," adding, "We anticipate a turnaround due to the exchange rate rise and other factors."

[Image source=Yonhap News]