Prospects for Korea's exchange rate in 2006 and enterprises' countermeasures
By Chung Young-shik Senior researcher at the Samsung Economic Research Institute.
The weakening trend of the dollar has been resurfacing. In the aftermath of the weak dollar, the won-dollar exchange rate has been plunging to tripledigit figures since May 2005.
The won-dollar exchange rate fell to 968 won per dollar on Jan. 25, 2006, the lowest level since Nov. 5, 1997. It is the fourth time that the dollar has showed a weak trend since 2002. In general, the dollar has kept a weak tone. However, when specific factors such as the recovering trend of the U.S. economy and a hike in interest rates emerged, the dollar temporarily shifted to a strong trend. During the period from 2002 to the present, the weak period of the dollar reached an average 9.3 months and the strong period was 5.7 months.
The repeated weak note of the dollar and the relatively long weak period reflect the fragile value of the dollar very well. Key factors behind the weak dollar were the expansion of the United States' 'twin deficits' and the U.S. policy to allow a weak dollar, and the call of G7 for flexible exchange rate policy in East Asian countries.
Then, the question is which direction will the dollar move toward I'd like to examine the direction of the dollar and its effects.
In conclusion, I think the depreciation of the dollar will continue through 2006. In just four years from 2002 to the present, the value of the dollar fell by 25 percent.
We can think that the dollar has fallen enough and may rebound in the coming months. However, the possibility is great that the dollar will lose its strength further. Such prospect stems from the following three reasons.
First, the U.S. is expected to stop taking steps to hike interest rates.
In the past, massive amounts of international capital flowed into the U.S. mainly owing to a series of hike in interest rates and relatively high interest rates compared with those in other countries, supporting the value of the dollar.
In the future, however, the U.S. government will suspend a hike in interest rates, whereas European countries and Japan are likely to raise their interest rates, weakening the U.S. merit stemming from a high interest rate.
In such a case, the U.S. hike in interest rates cannot work as a factor to backing up the strong value of the dollar.
This is the key reason behind the recent plunge of the value of the U.S. dollar. Secondly, the twin deficits of the U.S. are expected to worsen further in 2006. In particular, the possibility is high that the global society will increasingly worry over excessive current account deficits of the U.S.
Widely different from 2005, the U.S. current account deficits are feared to increase rapidly this year, approaching the 7 percent level of gross domestic product (GDP), as many experts are concerned. If this trend is left unchecked, the U.S. net external debt will soar to a 50 percent level in 2009 with its overseas payment of interest exceeding the 3 percent level of the country's GDP.
Some international investors will worry about such possibility and reluctant to purchase the U.S. dollar, resulting in the fall in the value of the dollar.
The third problem is the solution suggested by the U.S. and the global society to settle the U.S. current account deficits. The U.S. itself knows that it is a serious problem.
There are many ways to solve this problem. However, the U.S. is likely to prefer a card seeking weak dollar, which will pose less burden on the U.S. economy.
The U.S. persistent pressure on China, the main culprit of the U.S. trade deficit, to appreciate the Chinese yuan can be cited as one of its efforts to rectify the trade imbalance.
In 2006, the U.S. will place top policy priority on the adjustment of exchange rate by East Asian countries, including China. Affected by the U.S. efforts, about 5~10 percent of additional appreciation is expected.
Along with this, there will be louder calls for the exchange rates of some countries rather than the mutual cooperation of the global society to basically improve the trade imbalance.
A representative example is the Plaza Accord in 1985. In September 1985, finance ministers of the world's top five countries gathered at the Plaza Hotel in New York and agreed on the Plaza Accord, which called for weak U.S. dollar and reduction in the U.S. fiscal balance deficits.
Just in one year since the settlement of the Plaza Accord, the yen-dollar exchange rate fell from 240 yen to the dollar to 150 yen. Although it seems to be difficult to settle an agreement like the Plaza Accord at an early date, the value of the dollar will fall sharply whenever such assertion seeking an international agreement is raised.
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