[BOK Focus] Foreign Exchange Reserves Shortage Due to Market Intervention? Hear the Bank of Korea's Rebuttal

Foreign Exchange Reserves at Lowest Level Since October Last Year
BOK: "Strong Dollar Alone Causes Decline... Increasing Reserves Is Not Always the Solution"

"Foreign exchange reserves have likely decreased over a considerable period due to market interventions. Is the amount of foreign exchange reserves held by our country appropriate relative to the size of our economy?"

As volatility in the domestic won-dollar exchange rate increases due to international oil price instability and rising U.S. Treasury yields, the adequacy of foreign exchange reserves is once again under discussion. During the National Assembly's National Audit of the Ministry of Strategy and Finance held on the 20th, Hong Seong-guk, a member of the Democratic Party of Korea, asked Deputy Prime Minister Choo Kyung-ho whether the foreign exchange reserves should be increased. In response, Deputy Prime Minister Choo said, "The IMF (International Monetary Fund) and international credit rating agencies have evaluated our country's foreign exchange reserves as being at a level sufficient to respond to external shocks."

Foreign exchange reserves are external payment reserve assets held by the government or central bank to offset international balance of payments imbalances or stabilize the foreign exchange market. They serve the policy purpose of providing a stable supply of foreign currency liquidity to the domestic foreign exchange market in emergencies. In the case of South Korea, as of the end of last year, dollar assets accounted for about 72%, and non-dollar assets about 28%. The ratio of dollar to non-dollar assets is maintained at approximately 7:3 annually.

Concerns about the adequacy of the scale arise because foreign exchange reserves have been on a declining trend recently. According to the Bank of Korea on the 25th, as of the end of last month, foreign exchange reserves stood at $414.12 billion, decreasing for two consecutive months and marking the lowest level in a year since October ($414 billion).

The Bank of Korea finds it difficult that 'market intervention' is highlighted as the cause whenever news of foreign exchange reserve declines emerges. The foreign exchange reserves announced monthly by the Bank of Korea are expressed in U.S. dollars to facilitate country comparisons. A Bank of Korea official explained, "Even without taking market stabilization measures through dollar sales, the amount can decrease simply because the calculation is done in dollars amid a strong dollar effect. When the dollar strengthens, the dollar amount remains the same, but the dollar-equivalent value of non-dollar assets decreases accordingly."

For example, in the first quarter of this year (January to March), foreign exchange reserves themselves decreased by $3.9 billion, but the net foreign exchange transactions conducted by the foreign exchange authorities in the market for stabilization purposes amounted to a net sale of only $2.1 billion. The IMF also evaluated in its External Sector Report (ESR) released in July that "(South Korea's foreign exchange authorities') market interventions were limited to preventing foreign exchange market volatility."

However, from South Korea's perspective, which has trauma from the foreign exchange crisis, the appropriate level of foreign exchange reserves remains a hot topic. Kim Jeong-sik, Professor Emeritus of Economics at Yonsei University, said, "There are many discussions about the appropriate level of foreign exchange reserves, which can be likened to emergency funds for individuals," adding, "Since South Korea has a relatively high ratio of foreign investment compared to foreign exchange reserves, it is necessary to further expand them."

The Bank of Korea explains that continuously increasing foreign exchange reserves is not a panacea. A Bank of Korea official said, "Accumulating foreign exchange reserves means buying foreign exchange, and in the process, interest burdens arise because we issue monetary stabilization bonds or foreign exchange stabilization fund bonds."

Moreover, the IMF has decided not to apply the 'Assessing Reserve Adequacy (ARA)' metric, which it started applying to emerging countries this year, to South Korea anymore. Although South Korea fell below this metric for the past three years, the IMF stated through its annual consultation this year that "South Korea's foreign exchange reserves provide an adequate buffer of foreign exchange liquidity against various potential shocks." A Bank of Korea official emphasized, "South Korea has moved beyond emerging market status to manage foreign exchange reserves at an advanced country level, so instead of a uniform adequacy standard, it has decided to switch to a qualitative evaluation method applied to advanced countries."

Professor Yoo Hye-mi of Hanyang University's College of Economics and Finance explained, "Discussions about the adequacy of foreign exchange reserves typically arise when foreign exchange market volatility increases or exchange rates rise," adding, "Compared to other countries, South Korea holds a considerable level of reserves and has signed integrated swap agreements with other countries, so it has sufficient foreign exchange reserves to defend against liquidity crises."

South Korea's foreign exchange reserves have reached an all-time high. According to the foreign exchange reserves statistics announced by the Bank of Korea on the 3rd, as of the end of May, the foreign exchange reserves stood at 456.46 billion dollars, an increase of 4.15 billion dollars compared to the end of the previous month. On this day, an employee is organizing US dollars at the Counterfeit Response Center of Hana Bank in Euljiro, Seoul. Photo by Mun Honam munonam@