Bank of Korea, pension fund agree on $35 bln swap deal to support weak won

Korean won and U.S. dollar [Photo by Han Joo-hyung]

Bank of Korea and the National Pension Service agreed on a foreign exchange swap agreement for a maximum of $35 billion, a move to support the beleaguered Korean won.

The agreement, which will run through the end of this year, will allow the National Pension Service to borrow up to $35 billion from the country’s foreign reserves in exchange for local currency, the central bank said Thursday. The deal is aimed at ease any volatility in the local foreign exchange market as the won-dollar exchange rate has hovered around 1,300 won per dollar for a second straight month on global financial market instability and the country’s trade deficit.

The deal is an extension of a $10 billion swap arrangement made between the two from October to the end of last year as the won-dollar rate soared to around 1,400 won in the second half of the year.

“Last year, the central bank and the National Pension Service responded effectively to the increased volatility in the foreign exchange market through the swap deal, so based on the experience, we agreed to promote it again this time,” said an official from the BOK. Details of the deal are the same as before, with the maturity of each case being six months or 12 months, and neither side has the authority to end the deal early.

The National Pension Service is currently investing around $330 billion overseas, which some have pointed out could weaken the Korean won by buying dollars from the market when the won is weak. Once the swap deal is signed, the pension fund can borrow dollars from the central bank, reducing the impact on market.

“This swap arrangement is expected to ease the risk of exchange rate fluctuations for our overseas investment and help us manage foreign currency funds more efficiently,” said Kim Tae-hyun, chairman of the National Pension Service.

In the face of further depreciations of the local currency, the foreign exchange authorities have come forward to defend the won through this swap deal. The local currency ended at 1,310.4 won against the dollar Thursday, up 15.3 won from Wednesday’s close, on news of the swap deal. “The market has heaved a sigh of relief as the authorities came up with a measure to ease the concentration of foreign exchange supplies,” said Baek Seok-hyun, an economist at Shinhan Bank.

Chinese yuan [Photo by Kim Ho-young]

This swap extension is aimed at reducing exchange rate volatility and curbing further depreciations of the won. The won-dollar exchange rate remains high following the U.S. Federal Reserve’s steep rate hikes that started last year. A weaker Chinese yuan, caused by the conflict between the U.S. and China, also weakened the local currency. The value of the Korean and Chinese currencies is recently moving in the same direction as the won is recognized as the yuan’s “proxy currency” in the foreign exchange market.

The country’s trade deficit for the last year has also contributed to the country’s dollar scarcity. The BOK said in a recent report that the value of the won had declined amid continued uncertainties in the overseas banking sector, the U.S.-China conflict and the trade deficit. Last month, the won-dollar rate fluctuated sharply as financial market volatility grew in the aftermath of the collapse of U.S. Silicon Valley Bank and Switzerland-based bank Credit Suisse Group AG.

The daily exchange rate fluctuation in March was 8.7 won, larger than 7.8 won a month ago and higher than 6.9 won in the first quarter. The fluctuation rate was 0.66 percent, higher than major currencies, such as the euro, yen and the pound. The problem is that the won remains weak even though the dollar continues to weaken on growing expectations that the Fed’s monetary tightening could be over.

The dollar index, which measures the currency against six major peers, recorded 101.5 on Thursday, hovering around a one week low of 101.40. The won, meanwhile, closed at a year low of 1,325.7 won against the dollar on the same day.