Since the beginning of the year, the Korean won has been appreciating fast. On the first trading day of this year, January 2, the local currency closed at 1,061.2 won against the dollar. The won-dollar rate has fallen to the lowest point in three years and two months since October 30, 2014, when the won ended at 1,055.5 against the greenback. The rate slightly rose afterwards, but the Korean currency remains strong to emerge as one of the risks for the Korean economy this year. Here’s Kim Young-ik, a professor of economics at Sogang University, to analyze the background for the falling won-dollar rate.

As for external factors behind the current sharp appreciation of the won, the value of the dollar is falling, while that of the Chinese yuan keeps rising, with China accounting for 25 percent of overall South Korean exports. On the domestic front, the Korean economy expanded about 3 percent last year. The higher-than-expected growth is boding well for a recovery of the local economy. Also, Korea’s annual current account surplus reaches 80 to 90 billion US dollars, more than 6 percent of its GDP. In addition, South Korea’s foreign exchange reserves hit a record high of 389.3 billion dollars as of the end of December. On a more positive note, geopolitical risks related to North Korea have been simmering down lately. All these factors are contributing to the declining won-dollar rate.

The biggest factor for the won’s rapid gain is the weakening of the dollar. Even considering this global trend, however, the won is appreciating too fast. According to the Bank of Korea, the won appreciated 12.8 percent against the dollar last year, representing the fifth-highest gain among 42 currencies. In comparison, the Japanese yen tumbled 4.9 percent. Other factors include Korea’s robust exports, the solid recovery momentum of the local economy and easing tensions on the Korean Peninsula. More foreign capital is flowing into South Korea and the won-dollar rate is falling, as the Korean economy is forecast to grow 3 percent this year based on strong fundamentals. It’s good news that the Korean economy is drawing attention from foreign investors. A stronger won against the dollar may actually generate some positive effects.

The falling won-dollar rate could contribute to price stability. It may also boost domestic demand and increase Korea’s per capita income. This year, South Korea’s per capita income is expected to surpass 30-thousand US dollars for the first time. In the corporate sector, businesses such as the oil refining and steel industries can import raw materials at cheaper prices. The same is true of the aviation industry that purchases oil from overseas. The local tourism industry will also benefit from the appreciation of the Korean currency, as more Koreans are choosing to travel overseas.

If the strong won trend continues, per capita income in South Korea can easily reach
30-thousand dollars this year. Domestic prices will stabilize as a result of falling import prices, while people can save money when using airlines or staying overseas. The oil refining and steel industries, which rely on imports for most raw materials, can reduce expenses as they pay in dollars. On the flip side, though, the trend is feared to have a negative impact on exports.

The appreciation of the won will affect the electronics and automobiles industries negatively. The Korean won’s surging value against the Japanese yen will make Korean products more expensive in the world market. For example, if Toyota cars are cheaper than Hyundai cars in the U.S. market, more Americans would buy the Japanese vehicles. A stronger won may also hurt profitability of local exporters. If the won falls to 1,000 won from 1,100 won against the dollar, Korean exporters might see about a 10-percent decline in sales and profits. The ratio of exports to GDP is 54 percent, meaning that the Korean economy is depending heavily on exports. If exports decrease amid sluggish domestic consumption, Korea’s economic growth will also lose steam. Last year, Korea’s exports rose 16 percent compared to the previous year. If the strong won trend continues, however, the exports growth rate might fall to 3 to 4 percent this year. Then, the economic growth rate might drop to the mid-2 percent range from the previous projection of 3 percent. Decreasing exports will discourage businesses from making investments, with new employment shrinking.

The strengthening of the won will place a burden on Korean exporters because the prices of Korean products will go up in the global market. The local exporters will then lose price competitiveness compared to their Japanese and Chinese rivals, resulting in a reduction in Korea’s outbound shipments. The trend will deal a more serious blow to small-and mid-sized firms that mostly rely on their price competitiveness in the global market. Deteriorating profitability will also be inevitable. According to the Korea International Trade Association, when the value of the won rises 10 percent, operating profits of local manufacturers fall 1.3 percent. Given that strong exports contributed to Korea’s economic recovery, sluggish exports could slow down the recovery momentum. Unfortunately, the won seems to be appreciating at an alarming rate.

There is a possibility that the won may temporarily fall to 1,000 won against the dollar this year. But it won’t last long, with the currency projected to be around 1,070 won on average. Over the long term, however, the Korean currency will rise in value up to the three-digit level against the greenback, as the value of the dollar keeps falling. The U.S. comprised 31 percent of global GDP in 2001 but the ratio declined to 25 percent last year. And the figure is expected to continue to fall. That means the dollar will continue to depreciate, while the value of the won will relatively rise and Korea will continue to post a current account surplus. I guess the won-dollar rate will settle at a three-digit level after 2020.

The won-dollar exchange rate has remained at a four-digit level for nearly ten years since April 28, 2008. But it plunged 7 percent in the fourth quarter of last year and passed the 1,060 won threshold this year. There are concerns that it might fall below 1,000 won. Of course, it is unlikely that the rate will fall to the 900 won range anytime soon. It will happen only when both internal and external factors work, like the depreciation of major currencies such as the dollar, the yen and the yuan, as well as the Bank of Korea’s key interest rate hike. But one thing for sure is that the won will continue to appreciate against the dollar. It is necessary to come up with appropriate countermeasures.

South Korea engages in a fierce competition with Japan in the global market, so it is necessary to maintain the won-yen rate at a certain level. Japan is implementing its vast monetary easing program, and the value of the Japanese currency has dropped, compared to the Korean won. The Bank of Korea must consider this when carrying out its monetary policy. For Korea, it is also necessary to diversify its export market. The axis of consumption in the global economy is shifting to Asia from the U.S. Therefore, Korea should make the most of the consumer market in Asia. Most of all, South Korean companies have to produce excellent goods to sharpen their productivity and competitiveness. For instance, Korea continues to export semiconductors, regardless of the fluctuation of the foreign exchange rate, as they stay highly competitive in the world market. South Korea should hopefully make many more promising products like semiconductors.

On January 4, Deputy Prime Minister and finance minister Kim Dong-yeon and Bank of Korea Governor Lee Ju-yeol said that they should act aggressively if the exchange rate slants too much in one direction. But the government’s active intervention in the foreign exchange market may provide the U.S. government with an excuse to label Korea as a currency manipulator. After all, what is important is to boost corporate competitiveness. Korean exporters should manufacture high-quality products with advanced technology to overcome the growing foreign exchange challenge wisely.