1

December, 2011

Shin, Je-Yoon Vice Minister

The Future of The Future of the International Monetary the International Monetary SystemSystem

Currency Internationalization,Currency Internationalization, and International Monetary Reformand International Monetary Reform- Korea’s Experience and Future Issues -- Korea’s Experience and Future Issues -

SUNGSOO EUNDirector General International Financial Policy BureauMinistry of Strategy and FinanceRepublic of Korea

2

Contents

BackgroundBackground

Internationalization of Korean Internationalization of Korean WonWon

Issues to be discussedIssues to be discussed

Ⅰ

Ⅱ

Ⅲ

3

Contents

BackgroundBackgroundⅠ

Ⅱ

Ⅲ

4

Ⅰ- (1) Current International Monetary SystemCurrent International Monetary System

Highly Volatile & Excessive Capital Flows (But, No Rules to Manage) → Sudden Stops and Rapid Reversals of capital flows

High Dependence on USD → Global liquidity fluctuations depending on US economic conditions

Dollar domination in FX transactionsDollar domination in FX transactionsDollar domination in FX transactionsDollar domination in FX transactionsDevelopment of Financial SectorDevelopment of Financial SectorDevelopment of Financial SectorDevelopment of Financial Sector

What is the problems?

Source : BIS

USD trillion USD trillion

Source : The Banker, World Bank, BIS

5

Ⅰ- (2) Emerging Markets ; Original Sin?Emerging Markets ; Original Sin?

Original sin → Financial fragility caused by either ‘currency mismatch’ or ‘maturity mismatch’

Vulnerability to ‘twin crises’ → $ 21.4 billion outflows(4% of GDP) in 5 months in 1997 → $ 69.5 billion outflows(7.5% of GDP) in 4 months in 2008

Capital inflows/outflows (USD, billion)Capital inflows/outflows (USD, billion)Capital inflows/outflows (USD, billion)Capital inflows/outflows (USD, billion) FX rate (won/dollar) movementsFX rate (won/dollar) movementsFX rate (won/dollar) movementsFX rate (won/dollar) movements

Impacts on EMs – Korea’s experience

Asian crisis Global financial crisis

‘95.1 ‘97.11

’98.4 ’08.9 ’09.1 ’12.9

78.1

221.9

116.4

-21.4 -

69.5

Financial

Crisis5 months 4 months

6

Ⅰ- (3) Policy Actions by Korean GovernmentPolicy Actions by Korean Government

Foreign exchange derivatives position ratio → ceilings on net foreign exchange derivatives position ratio of domestic banks and foreign bank branches has been set at 30% and 150%, respectively, of their capital

Macro-prudential stability levy → bank levy is charged on non-deposit foreign currency liabilities at between 2~20bp, depending on the maturities of debt instruments

Restoration of the tax on foreign holdings of KTBs and MSBs → withholding tax on interest income and capital gains of foreign holdings was restored

Measures to deal with volatile capital flows

FX derivatives position

Macro-prudentialstability levy

7

Ⅰ- (4) Needs of Currency InternationalizationNeeds of Currency Internationalization

Deal with volatile capital flowsExcessive Capital Flows

Single currency for the multi-polar economies ?High Dependence on USD

Problems of current IMSProblems of current IMSProblems of current IMSProblems of current IMS Policy ResponsePolicy ResponsePolicy ResponsePolicy Response

Currency internationalization efforts by emerging economies

is needed for more resilient and stable

international monetary system.

8

Contents

Internationalization of Korean Internationalization of Korean WonWon

Ⅱ

Ⅲ

Ⅱ

9

Ⅱ- (1) Current Landscape of Korean WonCurrent Landscape of Korean Won

No hurdle in basic transaction of won and won-denominated current transaction

Regulations concerning capital account transactions in won to some extent

Korea’s currency internationalization efforts so far

Contracts of won-denominated current transactions and capital transactions were liberalized

1988~1992

Payment and settlement of current account transactions in won were liberalized

1996

Deposits were liberalized via ‘free won account’

1999~2001

Purchase of won-denominated securities by non-residentswas liberalized

2001

Borrowing by non-residents was allowed up to KRW 30 billion

2001~2007

unitof

Account

Exchange of won

contracts of current transactions

contracts of capital transactions

paymentand

settlement

current transactions

capital transactions* off-shore settlement btn non-residents

storeof

value

deposits

Borrowings

Securities purchase and issuance

free

reported

* borrowing over KRW 30 billion

* securities issuance abroad

prohibited

10

Ⅱ- (1) Current Landscape of Korean Won Current Landscape of Korean Won

Currency use in international trade of KoreaCurrency use in international trade of KoreaCurrency use in international trade of KoreaCurrency use in international trade of Korea

<Import>

<Export>

medium of exchange / unit of account → won is hardly used in foreign trade of Korea

store of value → foreign investments in Korean Bond have increased recently

International use of the Won

*2010, percentage of total trade

Purchase of KTBs by foreign Central BanksPurchase of KTBs by foreign Central BanksPurchase of KTBs by foreign Central BanksPurchase of KTBs by foreign Central Banks

12243128

7477

15762

28194

35470

12.10

*2008.1-2012.10, KRW billion

Source : Korea Customs Service

11

Ⅱ- (1) Current Landscape of Korean WonCurrent Landscape of Korean Won

International bond issuance in EM currenciesInternational bond issuance in EM currenciesInternational bond issuance in EM currenciesInternational bond issuance in EM currencies

won-denominated bonds account for only 0.6% of total EM currencies bond issuance

trading volumes of won FX derivatives are bigger than those of most EM currencies → Still, however, it constitutes a small amount of world total trading volumes of FX derivatives → the lack of hedging instruments could be a major impediment to more use of EM currencies

Comparison with other emerging market currencies

*percentage of Total EM issuance

EM currencies: OTC FX derivatives turnoverEM currencies: OTC FX derivatives turnoverEM currencies: OTC FX derivatives turnoverEM currencies: OTC FX derivatives turnover

*share percentage out of 200 percent

Source : BIS Quarterly Review March 2011 Source : BIS Quarterly Review March 2011

12

Ⅱ- (2) Key Challenges for Internationalization of the WonKey Challenges for Internationalization of the Won

Demand side factors → Economic size, Network effects, Invoicing practices

Supply side factors → Domestic financial market depth, Financial openness, Policy support

Potentials for internationalizing Won

“Efforts to create international demand for the Korean won were hampered due to established practices of pricing and invoicing trade in U.S. dollar and European currencies.”

“Efforts to create international demand for the Korean won were hampered due to established practices of pricing and invoicing trade in U.S. dollar and European currencies.”

Takagi, 2009; Xu, 2009

Economic size : Economic size : Share of World GDP Share of World GDP (2011, %)(2011, %)Economic size : Economic size : Share of World GDP Share of World GDP (2011, %)(2011, %)

Source : IMF WEO on Oct 2012

13

Ⅱ- (2) Key Challenges for Internationalization of the WonKey Challenges for Internationalization of the Won

Increased offshore activities and offshore-onshore links → reducing the authorities’ control over monetary aggregates and domestic interest rates → straining the financial system’s ability to adequately absorb capital flows

Risks to monetary and financial stability

Financial openness

Exchange ratestability

Monetaryindependence

14

Ⅱ- (3) Way Toward Successful Won InternationalizationWay Toward Successful Won Internationalization

Push forward won internationalization → But balanced approach is needed to ensure stability

Trade first, capital transaction second

Balanced approach

Trade Expanding the use of won

1st step

Full Liberalization

2nd step

Capitaltransaction

Macro-prudentialmeasures

15

Ⅱ- (3) Way Toward Successful Won InternationalizationWay Toward Successful Won Internationalization

Korea’s position between two huge economies ; “double edged sword”

Cooperation with China and Japan

11

7 69

Challenge for expanding regional acceptance of Won

Chance for enhancingGlobal use of Won

68

40

12

1

162

134 86

*2011, US$ billion

184

Export and Import Values of Kor-Chi-JapExport and Import Values of Kor-Chi-JapExport and Import Values of Kor-Chi-JapExport and Import Values of Kor-Chi-JapKor-Chi-Jap’s share of global GDPKor-Chi-Jap’s share of global GDP (2011, %) (2011, %)Kor-Chi-Jap’s share of global GDPKor-Chi-Jap’s share of global GDP (2011, %) (2011, %)

10.58.4

1.6

20.5

Source : Ministry of Finance, Japan Ministry of Knowledge and Economy, KoreaSource : IMF WEO on Oct 2012

16

Ⅱ- (3) Way Toward Successful Won InternationalizationWay Toward Successful Won Internationalization

Use of currency swap between Korea and China (KRW 64 trillion / RMB 360 billion)→ BOK supplies RMB liquidity to Korean banks and PBOC supplies Won liquidity to Chinese banks

Payments in Won and RMB for trade between Korea and China

11

7 69

ChineseBank

Chinese Importing company

Won

Won

PBOCAccount

ofBOK

RMBBOK

Account of

PBOC Won

KoreanBanksAsk payment to the exporting company

Korean Exporting company

Won

Commodities

Won

17

Ⅱ- (4) Way Toward Successful Won InternationalizationWay Toward Successful Won Internationalization

Chiang Mai Initiatives Multilateralization → firewall for Asian countries to respond to regional crisis

Regional Financial Cooperation (1)

Agreements in 2012Agreements in 2012Agreements in 2012Agreements in 2012 AMROAMROAMROAMRO

International organization

From 120 bn US$ to 240 bn US$

Doubling the total size

From 20% to 30% in 2012, and review in 2014

Increasing the IMF-delinked portion

From 90 days to 1 yr(linked), to 6 mths(de-linked)

Lengthening the maturity

One, Simplified and Flexible

Introducing crisis prevention function

18

Ⅱ- (5) Way Toward Successful Won InternationalizationWay Toward Successful Won Internationalization

Asian Bond Market Initiative → develop local currency denominated bond markets → recycle regional savings into regional investments

Regional Financial Cooperation (2)

New roadmap+ in 2012New roadmap+ in 2012New roadmap+ in 2012New roadmap+ in 2012

To produce tangible outcomes, current and critical ongoing issues need to be further developed

Direction 1

To strengthen the momentum for the ABMI discussion, important but undiscussed issues related to bond markets should be added

Direction 2

To meet and accommodate the changing global financial needs, including mitigation of volatility in the capital flow, relevant issues need to be addressed

Direction 3

19

Contents

Issues to be discussedIssues to be discussed

Ⅱ

Ⅲ

Ⅲ

20

Ⅲ-(1) Sequencing IssuesSequencing Issues

Ensuring macroeconomic stability

Are Asian emerging countries ready for currency internationalization?Are Asian emerging countries ready for currency internationalization?

What is needed to facilitate the process towards currency internationalization?What is needed to facilitate the process towards currency internationalization?

Capacity building to control liquidity

and credit growtheffectively

Developing ordeepeningdomesticfinancial markets

Capitalaccount liberalization

Pre-requisite steps to successful currency internalization

21

Ⅲ-(2) The Benefits and Costs of Currency Internalization The Benefits and Costs of Currency Internalization

Reducing the need for large foreign exchange reserves

Eliminating the exchange rate risk in external transactions

Benefits Costs

Restricting the pursuit of domestic monetary policy

Worsening the problems caused by excessive capital inflows

IsIs it good for emerging market countries to push forward their currency internationalization?it good for emerging market countries to push forward their currency internationalization?

How can we maximize the benefits and minimize the costs?How can we maximize the benefits and minimize the costs?

22

Ⅲ-(3) The Role of Capital Flow ManagementThe Role of Capital Flow Management

Is CFM helpful for Emerging Markets’ currency internationalization and stable IMS?Is CFM helpful for Emerging Markets’ currency internationalization and stable IMS?

Is it possible to develop a global rule to manage capital flows? Is it possible to develop a global rule to manage capital flows?

Advanced Countries Emerging Market Countries

Capital Flow Management(CFM) Capital volatility caused by pull factors

(differences in growth rates and interest rates etc.)

Prudent macro-economic policy first, CFM as the last resort

CFM complementing macro-economic policies (No sequence in both)

Capital volatility cased by push factors (spillovers of advanced countries’ expansionary monetary policies)

Overall and mandatory capital liberalization

Sequential capital liberalization (Reducing negative impacts of capital liberalization is first)

23

Ⅲ-(4) Currency Cooperation at the Regional LevelCurrency Cooperation at the Regional Level

Use of local currency for local trade settlement

Short-term Long-term

Asian common currency?(Lessons from the Eurozone crisis)

How can we establish effective local currency trade settlement system in Asia?How can we establish effective local currency trade settlement system in Asia?

Is it desirable or realistic for Asia to have a single currency?Is it desirable or realistic for Asia to have a single currency?

Asian

Monetary

Unit

24

Thank you !!Thank you !!