Economics Markets Strategy - the DBS Vickers Securities Equities ...

Currencies
Economics – Markets – Strategy
USD/KRW
forecast, eop
Latest Prev
Close 1030 971
2Q08 1035 1000
3Q08 1075 980
4Q08 1100 940
1Q09 1075 980
2Q09 1075 980
3Q09 1050 982
4Q09 1050 982
BOK o/n call rate
forecast, eop
Latest Prev
Close 5.00 5.00
2Q08 5.00 5.00
3Q08 5.00 5.00
4Q08 4.75 5.00
1Q09 4.50 5.00
2Q09 4.50 5.00
3Q09 4.50 5.00
4Q09 4.50 5.00
Latest close on Jun 11
Prev close on Mar 12
Korean won – weakened international liquidity position
We downgraded our forecast for KRW on Apr 24. Instead of expecting the KRW
to appreciate against USD to 940 by end-2008, we see the risk for the KRW to
depreciate to 1050-1100 in the second half of the year instead.
Interestingly, the last time the KRW depreciated as dramatically as today was
back in 2001-02. Like the Y2K crisis back then, it was the subprime/credit crisis
that threatened to push the US economy into recession. Both periods witnessed
the Fed delivering inter-meeting rate cuts. But there is one difference. Foreign
reserves were rising to overtake foreign debt back then. Today, external debt
has already overtaken foreign reserves.
The first hint of the KRW’s weakness surfaced during the US mortgage/credit
crisis that broke out in Jul 2007. Despite aggressive cuts in US interest rates, the
KRW depreciated instead of appreciating. Another disturbing development was
the vulnerability of the KRW to unwinding of JPY carry trades or shortages of
USD liquidity. Instinctively, we reckoned that there was a weakening in Korea’s
international liquidity position. Our investigations did not let us down.
Over the past few years, Korean banks were aggressively expanding their loans
books. But there was one problem -- loans already exceeded deposits. To continue
the practice of lending aggressively, banks borrowed heavily from foreigners to
make up the funding gap. Why not? Back then, the KRW was considered one of
the best Asian currencies to invest in, while the JPY emerged as a funding currency
for carry trades. This eventually led to gross external debt overtaking foreign
reserves in 2Q06, with the debt-reserves shortfall widening to USD118bn in 4Q07.
The last time the shortfall exceeded USD100bn was just before the 1997/98 Asian
financial crisis.
That said, we are not suggesting that Korea is about to enter into a crisis. The
trigger for the Korean crisis in 1997/98 was the lack of foreign reserves to cover
short-term external debt. Today, this is not the case, at least not yet. Even so,
there is little room for complacency either. Left unaddressed, the rapid rise in
short-term external debt is projected overtake foreign reserves by 2012. With
international ratings agencies now concerned about the banks’ heavy reliance
on short-term external borrowings, expect the government to introduce measures
to address this issue.
Under the circumstances, it did not bode well that the current account (CA)
reported a deficit of USD5.2bn in 1Q08, contrasting sharply with the full-year
USD6.0bn surplus in 2007. If the deterioration persists, this will be the first year
that Korea posts a CA deficit after the Asian crisis.
Korean banks are relying heavily on external
borrowings to lend
140 USD bn
120
100
80
60
40
20
0
-20
-40
Commercial banks'
loans less deposits
External debt,
YoY difference
01 02 03 04 05 06 07 08
Korea needs to address its rising external debt
450
400
350
300
250
200
150
100
50
0
USD bn
Gross external debt
Gross external assets
Foreign
reserves
Short-term
external debt
96 97 98 99 00 01 02 03 04 05 06 07 08
34