South Korean FX controls loom

South Korea's government, alarmed by the wild swings of the won in turbulent markets, is close to slapping new controls on currency trading, though a news report that banks will get two years to comply calmed investors nerves.

As Europe's debt crisis unfolded, the won's gyrations exceeded swings of most other currencies and officials in Seoul have made it plain they would act to limit volatility that was hurting the world's ninth-biggest exporter.

Bank of Korea Governor Kim Choong-soo threw his weight behind the plan saying it would not run counter to Seoul's commitment to opening up its .

“We have never retreated in terms of liberalisation, market-opening and international regulations and have been praised for that,” he told reporters after the central bank kept interest rates unchanged.

Kim indicated it was getting ready to counter growing inflationary pressures and start lifting rates from their record low. He also said the bank was considering controls on domestic bank lending in foreign currencies to South Korean companies to limit market volatility, but did not elaborate.

Given that the won is one of Asia's most actively and freely traded currencies and short-term debt makes up a large part of its foreign liabilities, South Korea feels particularly exposed to market movements.

In the course of one week in May, the won dropped 6.5 percent from the end of the previous week before turning to rally nine percent.

Improved stability
A senior government official told reporters that the new steps would include limits on banks' dollar/won forward trades linked to their equity capital.

The official largely confirmed what has been mooted in the media. The limits would be set at 50 percent of equity capital for domestic banks and 250 percent for foreign bank branches to level the playing field, given they tend to have much lower capital.

“This is not aimed at imposing direct restrictions on foreign bank branches but at improving the medium- to long-term stability of our financial system,” EDaily quoted an unidentified ministry official as saying.

“Therefore, existing positions that they have will not be affected right away.”

The new policy was likely to include foreign currency liquidity risk controls for foreign bank branches and the authorities were considering a three-month grace period before the new rules came into force, officials told reporters.

No discrimination
The proposed rules appeared to address concerns before details of the plan emerged that any appearance that discriminated against foreign banks could hit South Korea's standing in the eyes of foreign investors.

The EDaily also reported that the authorities would also tighten restrictions on companies' forward trades that were announced last November alongside other regulations and came into force early this year.

It said the cap on such trades would be lowered to an equivalent of the volume of the company's physical foreign trade transactions, down from initially imposed 125 percent.

Bankers say limits on bank's own exposure to forward trades may help reduce somewhat South Korea's high short-term foreign debt, but were sceptical whether it would achieve its main goal and mitigate sharp won swings.

Some economists also questioned the wisdom of implementing new controls so soon after the latest batch.

“It's not a good sign to have to bring in a new set of rules just seven months after the last set. If the November 2009 regulations didn't address the causes of KRW volatility, how confident can we be about another round?” said Sean Callow, currency strategist at Westpac in Sydney.

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