On the 8th, the won-dollar exchange rate opened at 1,555.2 won per $1, up 16.1 won from the previous session. After topping 1,560 won during intraday night transactions on the 2nd, the sharp rise has continued in regular trading as well. If this trend persists, analysts say the decline in foreign exchange reserves, which serve as a "dollar breakwater," could widen.
So far this year, Korea's foreign exchange reserves have fallen by $1.06 billion (about 1.6 trillion won). Foreign exchange reserves decreased at the end of 2023–2024, then increased at the end of last year.
After the Middle East crisis, the won-dollar exchange rate surged rapidly amid foreign investors' net stock selling, prompting the foreign exchange authorities to sell dollars from their holdings to stem the won's sharp decline. The system of lending dollars to the National Pension Service has also contributed to reducing foreign exchange reserves.
◇ Foreign exchange reserves down 1.6 trillion won this year... ranking among major countries slips from No. 9 to No. 12
According to the Bank of Korea on the 8th, Korea's foreign exchange reserves stood at $426.99 billion at the end of May, down $1.06 billion from the end of last year. As a result, its global ranking by foreign exchange reserves fell from No. 9 at the end of December last year to No. 12 at the end of April. It was overtaken by Italy, France and Hong Kong.
The decline in reserves this year is because the Bank of Korea (BOK) has taken so-called market stabilization measures to slow the pace of the won-dollar exchange rate's rise. The closing rate climbed steadily from 1,439 won at the end of last year and has remained above 1,500 won since last month.
In night transactions that closed at 2 a.m. on the 6th, it rose to as high as 1,561.5 won during intraday trading. That was the highest in 17 years and three months since March 6, 2009 (1,597 won) during the global financial crisis. The U.S. dollar has strengthened amid the fallout from the Middle East war, and foreign investors' stock selling is strong.
When the exchange rate spikes like this, the BOK employs two main types of market stabilization measures. First, it supplies dollars from its reserves to the market. There is also a foreign exchange swap signed with the National Pension Service in 2022. Under this system, the National Pension Service borrows from the BOK the dollars needed for overseas investments instead of buying them in the market. Because the National Pension Service does not purchase dollars in the market, it neutralizes the impact on the exchange rate.
However, the reduction in reserves due to the National Pension Service's FX swap is temporary. The National Pension Service borrows dollars for a set period and then returns them to the BOK.
◇ Fell more than larger Taiwan... "Raise the share to the 20% range of GDP"
Few countries, like Korea, have a system in which a pension fund borrows dollars from the central bank. This stems from the National Pension Service's investment strategy. To capture gains from exchange rate fluctuations, the National Pension Service has used a strategy of leaving most assets currency-unhedged (exposed to exchange rate movements). As a result, the larger the fund grew, the greater its impact on the FX market became. To reduce the National Pension Service's influence on the FX market, the government devised the foreign exchange swap with the central bank.
Some analysts say this system has caused Korea's foreign exchange reserves to fall more than Taiwan's, even though Taiwan's are larger. Taiwan's reserves decreased by $100 million, from $602.6 billion at the end of last year to $602.5 billion at the end of April this year. Over the same period, Korea's reserves fell by $170 million. Taiwan, which is also highly export-dependent, saw its currency weaken after the Middle East crisis and is believed to have used reserves to defend it.
Because foreign exchange reserves serve as a breakwater during exchange rate spikes, some argue the ratio of reserves to gross domestic product (GDP) should be raised. According to a paper submitted by Sejong University researchers to an international journal, over the past two to three years Korea's reserves-to-GDP ratio has been in the 20% range, lower among non-reserve currency economies than Hong Kong (117%), Taiwan (73%) and Saudi Arabia (55%).