South Korea’s central bank said on Friday it is setting up a currency swap arrangement with the National Pension Service to divert some of the fund’s foreign currency needs – and put a floor under the weakening won.
The Bank of Korea and the NPS said the $10 billion currency swap deal will last through the end of this year to allow the fund to access the bank’s FX reserves.
Traders said if the NPS does this rather than sell won for dollars in the onshore spot market, it would remove a big source of dollar demand.
The arrangement would also complement the bank’s interventions in the currency markets to shore up the won.
“The NPS can secure funds needed for overseas investment without counterparty risks, and the deal is also expected to stabilise currency market by easing the fund’s dollar demand from the spot FX market,” the BOK said in a statement.
South Korea’s won weakened to more than 1,400 per dollar this week for the first time since 2009 – a 16% decline for the year. The won has been one of the hardest-hit emerging market currencies against a surging US dollar.
The won’s dive has spurred expectations for a faster pace of interest rate hikes by the BOK in this year’s two remaining policy rate reviews, slated for October 12 and November 24, as policymakers would want to curb any further capital outflows.
The BOK’s current policy rate is 2.5%.
An aggressive Fed tightening has seen dollar-won yield differentials widen to 0.75 percentage points this week.
The NPS manages $626.6 billion, assets equivalent to about 40% of annual gross domestic product, and has been aggressive in investing abroad, with its operations weakening the won as it purchases billions of dollars.
“This could temporarily lift sentiment for the won as it redirects the fund’s dollar buying force, but there seems to be no floor for the won’s fall at the moment,” a currency dealer said after the announcement.
The country’s widest-ever trade deficit in the first half of this year is also fanning bearish sentiment towards the won, at a time when the Fed continues to tighten policy and Europe’s energy crisis fuel fears of a global slowdown.
The slump in the won has prompted the BOK and the finance ministry to push back hard recently, but their warnings failed to prevent the won’s slide to the 1,400 level.
“There seems to be no resistance level anymore, unlike when the won hovered around 1,300 per dollar level. Even smoothing operations won’t work if other currencies including euro plummet like now,” a currency trader said.
- Reuters with additional editing by Jim Pollard