Korea May Consider Capital Controls to Halt Won Gain; Bonds, Currency Drop
By Eunkyung Seo and Frances Yoon - Oct 27, 2010 2:29 AM CT
Bloomberg;
Bank of Korea Governor Kim Choong Soo said the nation may consider imposing capital controls to slow fund inflows that have driven up the won. Bonds and the nation’s currency fell.
Capital controls can be a “useful part of the policy toolkit” though they create “distortions and costs,” Kim said in the text of a prepared speech released in Seoul today. He later said controls wouldn’t be considered until after talks among the Group of 20 economies at a summit in Seoul next month.
The won’s 7.2 percent third-quarter gain against the dollar was Asia’s highest, and data today showed the economy slowed more than estimated in the period. Bond yields headed for their highest close since Oct. 6 after Kim’s comments, which come as nations from Brazil to Thailand try to slow record fund inflows that are driving up currencies and sapping demand for exports.
“Even if a weaker dollar opens the door to more investing in Korea, these controls will make investors less prone to buy the country’s assets,” said Seo Jeong Hun, chief economist at Korea Exchange Bank in Seoul. “A lot of the money investing in stocks and bonds is speculative. We could see that money leave the country since these controls take aim at short-term funds.”
The won closed 1 percent lower at 1,128.24 per dollar at the 3 p.m. close in Seoul today, the biggest fall since June 25. The yield on the 3.75 percent bond due June 2013 rose three basis points to 3.31 percent, according to Korea Stock Exchange.
Instability Risk
Large inflows pose risks such as excessive currency moves and asset price bubbles, Kim said in the speech. While they can boost growth, they can also trigger instability, he said.
No decision on capital controls has been made yet, he later told reporters.
“All I can say now is that those instruments can be considered but that doesn’t necessarily mean that the government and Bank of Korea have made any decisions yet,” he said. “I don’t think we will introduce an instrument which is not in line with international practices.”
Nations across Asia are trying to restrain their currencies as investors seek higher yielding emerging market assets amid near-zero interest rates in the U.S. and Japan. Thailand said it will remove a 15 percent tax exemption for foreigners on income from domestic bonds, and Brazil said it would raise a tax on foreigners’ investments in fixed-income securities to 6 percent.
Bond Tax
If a tax is imposed on foreigners’ holdings of South Korean bonds, that “will deter inflows into the bond market for a long time,” said Christian Carrillo, senior rates strategist at Societe Generale SA in Tokyo.
South Korea’s gross domestic product advanced 0.7 percent in the third quarter from the previous three months, when it gained 1.4 percent, the central bank said in Seoul today. That was less than the 0.8 percent median forecast in a Bloomberg News survey of 10 economists. From a year earlier, GDP rose 4.5 percent.
The won has risen about 28 percent over the last two years, and further gains may threaten the export competitiveness of companies such as Samsung Electronics Co., Asia’s biggest maker of semiconductors flat screens and mobile phones.
Finance chiefs from the G-20 pledged to refrain from “competitive devaluation” to ease fears of a trade war and help curb volatility in capital flows after meeting in South Korea last week.
Significant Implication
“Such a statement has a significant policy implication for a country like Korea,” Kim said. Sound economic policies are the first line of defense in reducing vulnerability to external shocks, he said.
South Korea’s government is discussing several steps to control capital flows, Vice Finance Minister Yim Jong Yong said this month. The nation’s regulators have already begun an audit of banks handling foreign-currency derivatives to tackle speculation.
“We studied several possible measures such as a Tobin tax, bank tax, leverage controls and then chose the derivatives limits in June,” Yim told reporters in Gwacheon on Oct. 21. “We’re now discussing all of these measures, but nothing has been decided yet.” A Tobin tax is applied to financial transactions.
The authorities will act when “herd behavior” causes sudden moves in the currency, Finance Minister Yoon Jeung Hyun said at a parliamentary audit this month.
The won has surged because of expectations of a second round of monetary easing by the U.S., Kim said on Oct. 18. The G-20 pledge has reduced “external uncertainties” affecting interest-rate policy, he said on Oct. 23.
To contact the reporter on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net; Frances Yoon in Seoul at fyoon2@bloomberg.net.