Even If a Currency Swap Is Reached, Interest Costs Alone Will Reach Billions... Short Maturity Remains a Limitation [Why&Next]

In response to the United States' unrealistic demand for a full cash investment of $350 billion within three years, the Korean government has counterproposed the signing of an "unlimited currency swap." Entering into an unlimited currency swap with the United States would mean securing a definite "dollar umbrella," but the United States does not offer this umbrella to just anyone. Under the principle that currency swaps are only provided to reserve currency countries, only the European Union, the United Kingdom, Switzerland, Canada, and, in Asia, Japan are included under this umbrella. South Korea, as a non-reserve currency country, has not yet reached this status. The United States maintains that the practical benefits of a currency swap with South Korea are minimal, as the share of the Korean won in global trade settlements remains below 1%.

Yonhap News Agency

Why Propose an Unlimited Currency Swap?

According to the Bank of Korea's foreign exchange reserves statistics, South Korea's foreign exchange reserves stood at $416.29 billion (about 587 trillion won) as of the end of last month. The $350 billion investment requested by the United States is nearly equivalent to the nation’s foreign reserves. If South Korea were to comply and remit the $350 billion in a lump sum, 84% of its total foreign reserves would be depleted. This would leave the reserves at less than 14% of the minimum recommended level of $470 billion set by the International Monetary Fund (IMF) and others. In effect, this would dismantle in a single day the foreign exchange defense built up over 28 years since the 1997 IMF currency crisis and the global financial crisis.

Currency authorities estimate that funds that can be raised without reducing foreign reserves amount to about $20 billion per year (including the private sector). A financial investment industry official pointed out, "If South Korea attempts to raise $350 billion in the foreign exchange market, the exchange rate, which has already risen to 1,410 won, could soar to the 2,000 won range." In a small, open economy highly dependent on trade, any shake-up in foreign exchange soundness could undermine national credibility and potentially lead to a second currency crisis.

Will an Unprecedented 'Investment-Support Currency Swap' Emerge?

A currency swap between countries is typically an agreement in which the two central banks exchange their respective currencies. If the Bank of Korea and the U.S. Federal Reserve were to sign a currency swap, the Bank of Korea would deposit won with the Federal Reserve and borrow dollars. South Korea previously signed currency swaps with the United States-$30 billion in 2008 and $60 billion in 2020-to overcome the global financial crisis and the pandemic crisis. These swaps had a basic contract period of six months and, through extensions, lasted from one year and three months to one year and nine months, but the actual borrowing period was extremely short-term. Now, the Korean government is requesting that, during the $350 billion investment process, dollars supplied in times of crisis for the short term be made available for several years or even decades.

This type of "currency swap for investment support" is unprecedented. Aside from providing dollar liquidity, an investment-support currency swap would take a fundamentally different form from traditional currency swaps. The idea is to consider a structure suitable for raising investment funds over several years, or even decades. However, if the United States were to enter into such an investment-support currency swap with South Korea, it would likely have to offer similar arrangements to other countries engaged in tariff negotiations, which would be a significant burden for the U.S. side and remains a variable.

The enormous interest costs would be borne by South Korea. Currently, the currency swap fee is 4.5% per year, calculated as the overnight index swap (OIS) rate plus a 25 basis point premium, which is quite high. If South Korea were to borrow the full $350 billion, the annual financial cost would amount to $15 billion (about 21 trillion won, OIS+25bp). Even borrowing just $100 billion would incur $4.5 billion (about 6.3 trillion won) in annual costs. These amounts are comparable to the estimated annual loss of 7 to 9 trillion won in real GDP for 2024 if a 25% reciprocal tariff is imposed, according to the Korea Institute for International Economic Policy. Given the significant interest costs associated with a currency swap, future negotiations are expected to comprehensively consider factors such as the tariff reduction rate, the structure and execution method of the U.S.-bound investment, and the impact of foreign currency liquidity on the market.

Considering U.S. interests, including cooperation in the shipbuilding industry, some observers believe that a proposal-based currency swap to secure dollar liquidity is the next logical step. The United States has historically used currency swaps as a political tool. For instance, its recent proposal of a $20 billion currency swap to the Argentine government is widely seen as a move to counter Chinese influence. Lee Boohyeong, head of trend analysis at the Hyundai Research Institute, stated, "Depending on the overall deal concluded in the future, the period and structure of the currency swap could change," adding, "During the tariff negotiations, it will be necessary to increase the proportion of guaranteed and loan-based investments and ensure commercial rationality, while extending the currency swap contract period to more than 10 years."