Korea May Ease Currency Forward Curbs, Affirms Growth Target (1)

As Volatility in financial markets shows signs of easing, South Korea is becoming more comfortable with capital flows and may loosen restrictions on currency forward positions for banks.

The government is also confident of achieving its 3.1 percent economic growth target this year and doesn’t plan to add to existing fiscal stimulus, according to Vice Finance Minister Choi Sang Mok. His comments Thursday came just hours after the central bank governor said monetary policy was already accommodative and that any further cuts to borrowing costs might have limited benefit.

While more capital has flowed out of Korea than has come in this year, the trend has improved since mid-February. Net withdrawals from Korean bonds have narrowed to $603 million and the amount taken from stocks has fallen to $893 million. Choi cited the Reserve Bank of Australia’s recent purchase of Korean government bonds as an encouraging sign.

“A review is underway to make limits on currency forward positions more neutral," he said in his first interview since becoming vice minister in January. "While there was a sell-off of the won in the past with the risk-averse sentiment, we now see various movements from diverse investors."

The review will be completed by June, said Choi, who added that the government is also strengthening its monitoring of the currency market.

Choi’s confidence in the growth forecast contrasts with weakness in domestic demand and an extended slump in exports.

“This is because we’re expecting consumption to recover with low oil prices and the recent resumption of sales-tax discounts,” he said. “The job market isn’t too bad either."

Bank of Korea Governor Lee Ju Yeol said weakness in economic data in February was less pronounced than in January, but still trailing his expectations. The BOK, which in January projected economic growth of 3 percent for 2016, will update its forecast next month.

The vice finance minister spoke about trade risks from any further slowdown in China, Japan and Europe, adding that this was more worrisome than volatility in markets.

The economy is suffering from weaker demand as overseas shipments fell for a 14th month in February while factory output dropped more than estimated.

Capital Controls

Foreign banks in Korea must currently limit holdings of currency forwards to 150 percent of their equity capital while local banks face a 30 percent cap. These rules last changed in early 2013, when the government was concerned that any buildup in these positions raised the risk of sudden withdrawals.

Korea also imposes a 14 percent levy on interest income from Korean treasury bonds held by foreigners, and a 20 percent tax on capital gains from their sale. Choi didn’t indicate his view on whether there should be any changes to these charges.

Easing of limits on currency forwards “would be a message that the government wants banks to secure more dollars so they can come through any funding crunch unscathed," Jeon Seung Ji, a currency analyst at Samsung Futures Inc., said on March 9.

The won traded at 1,202.40 per dollar as of 11:03 a.m. local time,. It’s weakened 2.5 percent this year. The Yield on three-year government bonds rose two basis points to 1.53 percent.

(Updates with comments on currency market from fifth paragraph.)

To contact the reporters on this story: Cynthia Kim in Seoul at ckim170@bloomberg.net, Whanwoong Choi in Seoul at wchoi70@bloomberg.net. To contact the editors responsible for this story: Brett Miller at bmiller30@bloomberg.net, Dave McCombs

By: Cynthia Kim and Whanwoong Choi

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