Economic analysis: liquidity conditions of the dollar and hard currencies

The authors are economists from Shinhan Investment Corp. They can be contacted at [email protected] – Ed.

Cases of shortage of dollar liquidity in the past

The USD/KRW exchange rate has seen a sharp rise and recently broke above the 1,380 KRW mark, approaching or exceeding levels seen during past dollar liquidity crises, such as the 1997 Asian Financial Crisis, the global financial crisis of 2008, and the COVID-19 crisis of 2020. As a result, concerns are growing about a possible crisis in the foreign capital market.

During recent periods of liquidity shortages, uncertainties have increased in the global financial market. As demand for USD has increased as a safe asset, Korea’s trade balance has deteriorated with declining surplus or deficit. Domestically, there was a mismatch between strong demand and weak supply of US dollars. In the respective crisis cases, depletion of foreign exchange reserves, demands for reimbursement of short-term debts or increased demand for currencies linked to derivatives following a fall in the prices of the underlying assets have exacerbated the imbalance between USD supply and demand, which led to a more pronounced depreciation of the KRW against the USD.

A possibility of a new dollar liquidity crisis

Although the USD/KRW exchange rate is approaching the levels recorded during past crises, the foreign capital market is stable and the external solidity remains correct. Short-term external debt represents around 10% of GDP in 2022, which is a stable figure compared to past periods of crisis. We are unlikely to see a big problem in the short term.

However, if a strong dollar and a deteriorating trade balance continue to weigh on the financial market for an extended period, problems could arise on the vulnerable fronts. We need to keep a close eye on certain issues, such as the recent accelerated growth in short-term external debt of banks, the possible damage to external soundness from the growth in external debt in general, and the outflows of bond funds triggered by a widening gap between interest rates at home and abroad.