[Insight & Opinion] Three Key Solutions for Exchange Rate Stabilization

The exchange rate has surged to its highest level since the global financial crisis, making exchange rate stability a critical issue. The primary reason for the rising exchange rate is the mutual tariffs imposed by the United States. However, there are also domestic factors. Political turmoil caused by the impeachment crisis has increased economic uncertainty, and the export competitiveness of key industries is weakening due to China's pursuit. Additionally, frequent labor disputes and rigid management of working hours have led to a decline in corporate investment. If domestic political instability continues and growth slows due to Donald Trump's tariff policies, there are even forecasts that the exchange rate could exceed the 1,500 won level. On the other hand, if political stability is restored and the U.S. increases pressure for currency appreciation on countries with trade surpluses after Trump's tariff policies, the exchange rate is predicted to fall to the 1,200 won range. It is urgent for policymakers to establish appropriate measures to stabilize the exchange rate.

First, foreign exchange authorities should be cautious about excessive market intervention. There is a reason why the exchange rate is rising. It is difficult to stabilize the exchange rate solely through foreign exchange market intervention without addressing the underlying causes. Excessive intervention could rather deplete foreign exchange reserves. Intervention by foreign exchange authorities is necessary when there are concerns about currency speculation or to reduce exchange rate volatility. However, excessive intervention aimed at lowering the market exchange rate to a target rate should be approached with caution. Foreign exchange reserves have already significantly decreased due to past interventions. Currently, the current account surplus is maintained, and with foreign exchange reserves around 400 billion dollars, the likelihood of a crisis is low. However, if continuous intervention depletes foreign exchange reserves, the country's external credibility could decline, exposing it to the risk of a foreign exchange crisis.

Second, measures are needed to diversify export markets and foster new industries. The reason the Korean won exchange rate is rising more sharply than the Chinese yuan or Japanese yen is due to Korea's export structure and weakening industrial competitiveness. Korea's export structure is concentrated 20% each in the U.S. and China. When China maintained high growth and relations with the U.S. were good, this was not a major issue, but now, due to U.S. sanctions on China, China's growth rate is expected to slow significantly. Furthermore, with China's technological advancement, the trade balance with China, which has already turned into a deficit, is expected to worsen. Additionally, the U.S. is using tariff policies to reduce its trade deficit and revive manufacturing. To stabilize the exchange rate, policymakers must diversify export destinations to improve the export structure overly concentrated in the U.S. and China. Moreover, to enhance industrial competitiveness weakened by China's pursuit, new industries such as biotechnology and artificial intelligence (AI) should be fostered. Improving export competitiveness will brighten the future outlook for the Korean economy and prevent a sharp rise in the exchange rate.

Third, political stability is also important. Even after the impeachment crisis ends, if political turmoil continues and national consensus remains divided, corporate investment will decline and foreign stock investment will withdraw, making it difficult to stabilize the exchange rate. Politicians must unify public opinion and reduce economic uncertainty through political stability after impeachment. Otherwise, external credibility will decline, the exchange rate will surge, and the Korean economy could be exposed to crisis.

In an open economy, the exchange rate is an indicator of the country's economic soundness. The exchange rate rising from the 1,000 won range per dollar to the 1,400 won range is partly due to the U.S.'s high interest rate policy, but it also indicates that the Korean economy's resilience has weakened. This is evident when comparing Japan’s long-term stagnation, during which the exchange rate rose from the 90 yen range per dollar to the current 150 yen range. Political turmoil, labor market rigidity, and weakening competitiveness of key industries have made the 1,400 won exchange rate the new normal. To stabilize the exchange rate and relaunch the Korean economy, now is a time when policymakers’ correct policy choices are more necessary than ever.

Kim Jeongsik, Professor Emeritus, Department of Economics, Yonsei University