This paper aims to assess the direct and indirect ripple effects of foreign exchange and capital account liberalization on the economy’s major price fluctuations, different regions and industries in order to build an effective response measure and gain an understanding of the way foreign capital liberalization influences currency depreciation through a series of case studies.
Capital account liberalization refers to the act of abolishing restrictions that limit capital flow between countries. The OECD-stipulated rule on capital account liberalization includes a wide variety of transaction activities such as direct investments by companies in the form of contributions or through the securities market. While liberalization generally distinguishes according its method of profit-accumulation–making direct investments or stock or bond investments–liberalization of capital account usually refers to the liberalization of stock investment.
While Japan and other Western developed countries began a stable liberalization of foreign capital since the 50s, Latin American countries including Chile and Argentina were unsuccessful. In the case of Asia, measures for liberalization have actively been implemented since mid 80s. Under the principle of liberty and non-discrimination, the revised version of the Korean Foreign Exchange Control Act simplifies and liberalizes current payments and international transactions in order to fulfill the obligation of building convertibility of the Won in accordance with Article VIII of the IMF’s Agreement. Meanwhile, the Act also leaves room for legal regulation to block unexpected balance deficits. Korea’s capital liberalization began based on the 1980 long-term plan of internationalization of the capital market. The process gained momentum until late 80s as foreign investors began operating in the country and the Korea Fund was established. However, the economy’s stagnation during the 90s also brought exacerbated operation outcomes for overseas funds.
As Korea adopted the currency basket system in the 80s and implemented foreign exchange liberalization in the 90s, appropriate modifications have often been made on the Won exchange rate to suit the circumstances. Although the Won exchange rate was kept at a high level since early 80s and no proper response was made between 1986 and 1987, trade was at the black line due the reinforced price competitiveness of industrial exports as a result of a prolonged revaluation. Asides from the burden of restructuring the domestic industry, Korea is going through a trade deficit since the 90s along with the American pressure for the opening of the Korean market. There would have been no need to devalue the exchange rate or make a rapid revaluation at a time of balance deficit had the local industry been reorganized back when balances were still at the black line.
The unbalance in the Won’s exchange rate led to a distortion in the price competitiveness of local commodities and an unbalanced balance of payments, all affecting actual trade as well along with the uncertainty of international trade due to the increased volatility of the exchange rate. In this circumstance, there is an expected increase in short-term flows of capital that seek short-term profit from exchange rate fluctuation once foreign capital liberalization is implemented full-scale, causing a negative influence on the stability of the currency.
In this sense, liberalization should be implemented so as to maintain the currency’s stability by taking full consideration of the degree of activeness in the foreign exchange market, conditions of the domestic financial market and trade status. For this, a target level of exchange rate should be set to make fluctuations occur only within a certain limited scale, thereby achieving the optimal level of exchange rate. Some of the suggested solutions in solving the problems are: drawing out an agreement with relevant countries regarding the optimal level of exchange rate by keeping it within a certain scale through foreign-exchange market intervention or currency policies; setting a margin on exchange fluctuations; seeking cooperative interactions for economic policies; securing foreign currency and establishing a common currency system and relevant organization between Asian countries as similar to the European system.
In conclusion, liberalization of foreign capital should be implemented according to a gradual plan, adjusting priorities and pace according to changes in the domestic and international markets. In particular, the trade market is likely to contract with the increased uncertainty in transactions due to the lack of an optimal level of exchange rate. Should the scale of exchange fluctuation along with foreign exchange liberalization, foreign exchange policies should be implemented to achieve stability considering the negative impacts. Efforts should be exerted to narrow the scale of fluctuation as much as possible, until an active exchange market is established and trade balance is achieved. Liberalizing foreign capital can increase the openness of a market as it facilitates a smoother flow of current and capital transactions between regions and industries of different countries. This however can also lead to the contraction of trade and other economic activities as uncertainty can rise from the frequent fluctuations of macro variables of price, including interest rates and exchange rates.
In general, no major impact on the domestic economy is expected. This is because the exchange rate fluctuation due to its liberalization is expected to increase gradually while the limitations of an open stock market will not be likely to bring a sudden change in exchange or interest rates. The solutions can be divided into a short and a middle/long term plan. In the short term, the export industry and participating companies will have to forecast fluctuations in interest and exchange rates, stay informed and updated on the world economy, macro economy and international financial market to be able to draw out feasible response measures whenever situations occur. The government will have to promote the technological advancement of the industrial market while making adjustments in the industries’ structure of the general economy. From a middle/long-term perspective, there is a need for an industrial restructuring in order to build up the local industry’s international competitiveness. Much effort for the promotion of technological development will also be needed. Furthermore, focus should be put on creating an economic environment for the procurement of industrial funds. The market should be structured in line with liberal policies so as to be able to detect companies that are no longer efficient and bring them down the stage.
외환 및 자본자유화가 우리나라 무역에 미치는 영향(The impact of foreign exchange and capital account liberalization on Korean trade)
[서울] : 산업연구원
|Subject Country||South Korea(Asia and Pacific)|
|Subject||Economy < Macroeconomics
Economy < Trade
|Holding||산업연구원; KDI 국제정책대학원|