Bank of Korea Deputy Governor: "Won-Dollar Exchange Rate to Decline Into Q4 as Current Account Surplus Takes Full Effect" [Economic Policy Zoom-In]

"Won-Yen Decoupling Will Accelerate"

"Low Possibility of Yen Carry Trade Unwinding"

"Significant Concerns Over U.S., Japanese, and European Government Bonds for the Past Two Years"

Sangdae Yoo, Deputy Governor of the Bank of Korea, is being interviewed by The Asia Business Daily at the Bank of Korea on Namdaemun-ro, Jung-gu, Seoul. Photo by Jo Yongjun

Yoo Sangdae, Deputy Governor of the Bank of Korea, stated, "The direction of the won-dollar exchange rate will trend downward as we move into the fourth quarter." He explained, "Earlier this year, the exchange rate was moving lower due to expectations for a large current account surplus, but there was an unusual uptick after the outbreak of the U.S.-Iran war and as foreign investors engaged in large-scale stock rebalancing, resulting in net selling (and currency conversion into dollars)." He further noted that the current account surplus is expected to exceed USD 300 billion by a wide margin this year, and with another significant surplus projected for next year, the effects of these factors will be felt in earnest.

Regarding concerns about the unwinding of yen carry trades, he said, "For the carry trades to unwind, the Bank of Japan would have to raise its policy rate sharply, or there would need to be widespread expectations that the yen's weakness would reverse into strength, but the chances are low." He added, "The BOJ will act cautiously, and as demonstrated by the recent joint intervention by the U.S. and Japan against excessive yen depreciation, both countries intend to manage the situation effectively." As for decoupling between the won and yen, he stated, "Given the widening differences in industrial structure, fiscal soundness, and trade surpluses, the decoupling will accelerate over time."

Deputy Governor Yoo gave this interview to The Asia Business Daily ahead of his term ending on August 20.

-The European Union (EU), Japan, and other major economies have raised policy interest rates, and Korea followed suit in July. There is also a rising likelihood that the U.S. will hike rates.

▲The global supply shock caused by the U.S.-Iran war has impacted countries worldwide. While concerns about inflation and pressure to raise policy rates are present across the board, each country faces its own unique circumstances. For the U.S., Korea, Taiwan, and Japan, the spread of AI and similar factors have kept economic conditions relatively strong, enabling a more active policy rate response to inflation pressures. In contrast, Europe and China have significant concerns about economic slowdown, which could delay their rate hikes. The European Central Bank (ECB) has raised rates once, but further hikes may be gradual.

-The trajectory of the U.S.-Iran war will have a huge impact on the economy, but it seems that President Donald Trump often makes strong statements only to back down later, suggesting that the U.S. is deliberately managing the Iran situation in line with economic factors (such as oil prices, inflation, and government bond yields).

▲Right now, the phrase "The only certainty is uncertainty" is frequently mentioned in the global financial markets. With the U.S. midterm elections scheduled for November, we are likely to see continued swings between hardline and moderate stances through then, creating a hectic environment; beyond that, it's hard to predict. Ultimately, it seems likely that oil prices will continue to fluctuate in the mid-80 dollars per barrel range through November.

-There are concerns that countries such as the U.S., Japan, France, Italy, and the UK could encounter problems in their government bond markets due to ongoing fiscal deficits. Europe, in particular, must also significantly boost defense spending. Yields on major government bonds are trending higher.

▲If you listen to discussions at international finance events or G20 meetings, the greatest risk to the global financial system for the past two years has actually been developed countries’ government bond markets. Growth in key European countries has stagnated, limiting tax revenue, while aging populations, infrastructure obsolescence, lagging technology sectors, and recent surges in government defense spending (due to the Russia-Ukraine war) have all increased government outlays. With the added impact of the U.S.-Iran war, oil prices are driving inflationary pressures even higher. As a result, fears about fiscal conditions and the possibility of spiking inflation have pushed government bond yields up across the board. Previously, sharp increases in government bond yields were mainly an emerging market problem, but now, developed country bond yields have become a major global risk. Since yields in the U.S. and Europe determine international financial market liquidity, their impact on world markets and economies is enormous. Naturally, the liquidity and exchange rates for emerging market currencies, including the dollar, cannot help but be affected.

-Should we then be worried about the possibility of a currency crisis in emerging markets?

▲At present, some participants in global financial markets consider countries such as Brazil, Turkey, India, and Indonesia to be in quite difficult situations, even if not on the brink of a currency crisis. Korea, too, saw the won-dollar exchange rate rise substantially from late last year through the first half of this year, but the reasons differ from those affecting these countries.

-The U.S. began shifting to a rate-cut policy last year, but has since kept rates on hold, and now there is some talk of raising rates again. If the U.S. hikes rates, global financial markets would inevitably feel the impact.

▲This is a sensitive issue. At present, long-term U.S. Treasury yields are quite high due to concerns about inflation and fiscal deficits. The question is whether long-term yields will rise further if the Federal Reserve raises its policy rate, or whether this has already been priced in, and yields will not move much. A Fed rate hike could reduce uncertainty and stabilize markets.

-Which outcome seems more likely to you right now?

▲Inflation concerns and the expansion of the U.S. fiscal deficit need to be resolved—especially the Middle East issue. Much depends on the U.S.-Iran conflict and its effect on oil prices.

Yusangdae, Deputy Governor of the Bank of Korea, is being interviewed by The Asia Business Daily at the Bank of Korea on Namdaemun-ro, Jung-gu, Seoul. Photo by Jo Yongjun

-The U.S. jointly intervened in the foreign exchange market with Japan against yen depreciation. This was partly aimed at discouraging Japan from selling U.S. Treasuries to buy yen, raising concerns in the market about an unwind of yen carry trades.

▲For yen carry trades to unwind, the cost of borrowing yen would have to rise quickly, or there would need to be a widespread sense that the yen would not weaken further. The question is whether Japan could surprise the market by raising policy rates sharply; the Takaichi government is said to be pursuing expansionary fiscal policy, and depending on its scale, Japanese government bond yields could also rise rapidly. Personally, I think the odds of the Bank of Japan rapidly hiking policy rates to a degree that would trigger a wholesale unwinding of yen carry trades are low. While a "panic" jump in Japanese government bond yields due to fiscal concerns can’t be ruled out, recent joint intervention between the U.S. and Japan suggests a willingness to manage such risks. In August 2024, the BOJ raised policy rates under political pressure, triggering a sizable unwinding of yen carry trades and steep falls in global stock markets, but I think such an event remains unlikely.

-It seems that recently the synchronization between the won and the yen has weakened.

▲Around 2000, when I moved from the Research Department to International Affairs, Korea had adopted a free-floating exchange rate system after the 1997 crisis, but both the authorities and market dealers had difficulty finding a reference point. Eventually, many participants agreed that an exchange rate of 1,000 won per 100 yen worked, and the won-yen synchronization persisted for quite some time. Since then, as Korea’s and Japan’s economies and industrial structures have diverged, so too has the correlation. Since last year, both our currency and the Japanese yen, along with the Taiwan dollar, have been moving together in the direction of depreciation. But there’s really no reason for this; our industrial structures are different, and fiscal soundness differs greatly. Still, psychologically, many people believe the won is correlated with the yen. Objectively, though, I think decoupling will accelerate for some time.

-But isn't the recent decoupling mostly due to SK hynix ADR proceeds of about 40 trillion won being brought into the country?

▲That plays a role, but it’s also because our exports have been doing extremely well. The current account surplus for the first half of this year exceeded the annual total achieved last year, and the full-year surplus is expected to exceed USD 300 billion by a wide margin. That’s an enormous figure—about 15% of GDP. Meanwhile, Japan has a trade deficit, though its current account is supported by income from interest and dividends. Japan's government debt-to-GDP ratio exceeds 200%, while ours is below 50%.

-Even so, despite forecasts for a large current account surplus, the won-dollar exchange rate was very high in the first half of this year.

▲I see the exchange rate now moving downward in a gradual way. Last year, short-term supply-demand factors pushed it up significantly, but beginning around February of this year, the rate started to fall. I had started to think we should worry about the won appreciating, not depreciating, when suddenly the U.S.-Iran war broke out. Now, mid-to-long-term factors such as the current account surplus, the economic recovery, and narrowing interest rate differentials are exerting more influence.

-Foreign investors sold 149 trillion won worth of Korean stocks in the first half of this year alone as part of their rebalancing. That must have had an effect.

▲Foreign investor rebalancing seems to largely be over now. Their recent selling of Korean stocks was primarily for profit-taking or due to adjustments in the semiconductor sector, and should be much smaller in scale going forward. Looking ahead, the large current account surplus should cause the won-dollar exchange rate to move downward. I see further declines as we move into the fourth quarter, especially since the policy rate was hiked in July and markets now expect an additional hike in the second half.

-A recent Financial Times column, "The End of Cheap," argued that the paradigm of the "low-cost economy," which has driven global growth for decades, is over—ushering in a new structural era of high inflation and high interest rates.

▲Economies move in cycles, and economic agents adapt to their changing environment. Low rates, cheap labor, and inexpensive energy fueled decades of boom and growth. Now, geopolitics, anti-immigration policies, and other factors are pushing things in the opposite direction, making everything costlier. That's a fair analysis, and there's reason to worry, but looking at the long term, I believe there's still hope. Economic players—from households and firms to countries and the international community—eventually adapt to environments where all inputs become more expensive. In labor markets, there are high hopes for artificial intelligence (AI); in energy, solar and wind as green renewables continue to expand. Geopolitical factors are forcing supply chains to be rebuilt, but even so, new supply networks and greater efficiencies are taking shape amid the fragmentation. The question is only how long it will take.

Fortunately, Korea is in a very lucky position right now. In this difficult environment, the success of the semiconductor sector driven by AI technology means we have both the time and resources needed to adapt to this new reality.

-This semiconductor supercycle is welcome, but isn't there a risk that, in two or three years, things could revert to the old situation?

▲In any case, the current semiconductor cycle seems longer and stronger than previous ones. While there is debate over when it might end, it certainly won't last forever. However, we've bought some time and resources, so even when the cycle ends, we should have enough opportunity to carry out structural reforms and build new growth drivers to withstand whatever comes next.

Sangdae Yoo, Deputy Governor of the Bank of Korea, is being interviewed by The Asia Business Daily at the Bank of Korea on Namdaemun-ro, Jung-gu, Seoul. Photo by Jo Yongjun

-The government has raised property holding taxes and increased tax liabilities for non-owner-occupied properties.

▲There are too many stakeholders and deeply divided interests in real estate. Many people have virtually all their assets tied up in property. As someone who’s always focused on the macroeconomy and financial markets, I must admit I’m not an expert on this area. Still, whatever the policy, maintaining consistency is crucial. Unfortunately, real estate policies have changed frequently, and I hope we won’t continue to see people just waiting for the next policy shift to act.

-Even if administrations change, it seems important for the parties to agree on real estate policy consistency.

▲But given that administrations often swing with changes in real estate policy sentiment, it won’t be easy. For instance, the reason the Seoul mayoralty shifted to the People Power Party in the June local elections was the real estate issue. Real estate and tax policies need to be shaped through comprehensive, cross-sectoral discussions and then maintained with consistency.

-The government has announced a roadmap for internationalizing the won. Some are concerned about exposure to currency speculation, and others are skeptical about its success.

▲Since serving as Director General of International Affairs, the internationalization of the won has been a continual focus for me. As with any policy, there are both positive expectations and negative concerns. In my view, it is the right time to push ahead in earnest. Korea’s equity market has been open to foreigners since before the 1997 currency crisis, and substantial foreign investor participation is now routine. Recently, large numbers of foreign investors have been actively trading in the bond market as well. At the same time, Korean entities—ranging from the National Pension Service to various financial companies and even individuals—are investing large sums abroad. With major capital inflows and outflows becoming routine, the foreign exchange market lacks depth, so even modest-sized outflows can move the exchange rate substantially. For this reason, we need to increase the market’s depth. The principal worry with won internationalization has always been speculative trading, but now is an ideal time to allay such fears, given the massive current account surplus. We can achieve full success with won internationalization and reap the associated benefits. Most concerns are likely to remain just that—concerns.

-Some question whether doubling transaction limits alone will make for meaningful won internationalization, perhaps motivated by risk aversion.

▲Since concerns persist, we cannot go big at the beginning; it’s enough to pursue a gradual expansion. Limits can always be increased later, depending on conditions. As skepticism fades and confidence grows, further enlargement, and even full relaxation or liberalization, become possible in time.

-Would you say Korea is a global leader in central bank digital currencies (CBDCs)? Deposit tokens are also about to be introduced, which must be a source of pride for the Bank of Korea.

▲China leads in retail CBDCs, but their system is slightly different from ours. Globally, monetary systems function with commercial bank money (deposit money) used for payments and central bank public money (base money) for settlement—what’s called a two-tier system. Korea is building this as a blockchain system—for us, CBDC represents the central bank’s base money, while deposit tokens represent commercial banks’ deposit money. We have already conducted trials with 100,000 participants, and plan to expand to over 300,000, potentially reaching 500,000. The government will also distribute fiscal subsidies in the form of deposit tokens. Using blockchain-based deposit tokens allows for the assignment of usage, expiration of unused funds, and smart contracts with specific terms. Even now, international institutions such as the Bank for International Settlements (BIS) and others have shown keen interest and are asking for presentations and explanations.

-If CBDCs are implemented successfully, wouldn’t that end debates about whether cryptocurrencies can serve as money? Surely cryptoassets cannot become currencies. Aren’t they currently used mostly for illicit purposes such as tax evasion and money laundering?

▲I believe that cryptoassets such as Bitcoin and Ethereum have played the role of speculative assets rather than actual currency. As a payment medium, only stablecoins remain; even for stablecoins, factors like anonymity and illicit use are valid concerns. Nevertheless, in countries experiencing hyperinflation, stablecoins and other cryptoassets could serve as a store of value against currency devaluation. Buying gold or dollars is cumbersome to store and transport, so they can be a useful alternative asset. If one had to leave the country, it’s enough to take just one phone.

-Given the stability of Korea’s central bank, are cryptoassets even necessary?

▲Korea has well-developed mobile payment and banking systems. Dollar stablecoins are unlikely to threaten Korea’s currency or monetary system. Trust in the won is strong, and once Korea’s CBDC and deposit tokens are launched, most blockchain-based transactions will be adequately covered. For transactions requiring trust or involving public interests, CBDCs or deposit tokens are appropriate. For small-scale uses, stablecoins can also be employed. That may well represent the future.

-Can you discuss any differences between former Governor Changyong Lee and current Governor Hyunsong Shin?

▲Having worked with both of them, I’ve never really noticed or been conscious of any significant differences. Both are used to discussing and debating policy, both have international experience, and both are highly capable, open-minded, and well-versed in central banking work. If forced to draw a distinction, perhaps it would be their external relations or communication styles, which reflect the differences between the International Monetary Fund (IMF) and the BIS. The IMF is mainly led by national finance ministries and focuses more on the real economy, while the BIS is central-bank focused and places greater emphasis on financial stability and market conditions.

This content was produced with the assistance of AI translation services.