The Korean won has been surging and the Japanese yen waning since October 2012. As of late February this year, the won was in the 1,080s range against the U.S. dollar, appreciating from the 1,110 level at the end of September 2012. Meanwhile, the yen depreciated to around 92 against the dollar from 77.6. As the currencies moved in opposite directions to the dollar, the won appreciated more than 20 percent against the yen during the five-month period to reach 1,173 to 100 yen as of Feb. 28 from 1,432 at the end of last September.

The stronger won is placing a drag on the Korean economy while the yen’s weakness is helping reenergize Japan’s growth prospects. With the strong won weakening their price competitiveness, Korean exporters are watching their earnings and stock price slide. But their Japanese counterparts are enjoying the exact opposite effects from their currency.

Characteristics of strong won and weak yen

A strong won and weak yen environment ― the won/100 yen exchange rate falling by more than 10 percent ― has been seen in every decade since 1990. In 1995-1996, the won/100 yen exchange rate fell 10.3 percent. In 2004-2007, the rate plummeted 25.4 percent and in the recent decline, the rate of 1,183 in January-February this year represented a 16.3 percent drop from the 2012 average of 1,413. 

The recent won/yen movement has three broad characteristics. First, the level of exchange rates is 250-400 won higher than in the past two periods. The average won/100 yen exchange rate was 1,183 in January-February 2013, compared to 782 on average in 1995-1996 and 900 in 2004-2007.

Second, the speed of the latest won/yen exchange rate decline has been much faster than in the past two periods. A 16.3 percent drop was seen by January-February this year compared with the 2012 average. In contrast, the preceding 10.3 percent and 8.5 percent declines happened on average over two or three years, respectively, in the 1990s and 2000s.

Finally, the recent rise in the won and decline in the yen is occurring with a weaker global economy and hard-pressed economic conditions in Korea compared to the two previous periods.

Impact on Korean economy

To analyze the impact of the surging won and waning yen on Korea’s economy, this paper assumed two more scenarios: 1) further won appreciation and yen depreciation, and 2) an ultra-high won and ultra-low yen similar to 2007. The impact of the scenarios on the Korean economy was then assessed in terms of the macroeconomy, exports of industries and exporters’ profitability.

Results of the analysis of the impact of a high won and low yen by using the Global Economic Model of Oxford Economics showed that Korea’s GDP growth rate would lose 1.8 percentage points under Scenario 1. Export decline and economic slowdown would be a bigger factor in dampening consumption than a drop in consumer inflation would have on stimulating demand. A 0.3 percentage point drop in private consumption growth would be expected in Scenario 1. In addition, export growth would drop by 2 percentage points and import growth would increase by 0.3 percentage point, causing the current account to decline $12.5 billion. If Scenario 2 occurs in 2013, the negative impact would be greater, leading to a 3.8 percentage point drop in the GDP growth rate and $25.5 billion decline in the current account.

Five industries that account for more than 60 percent of Korea’s total exports were gauged to assess the currency impact on exports. Machinery exports would be hit the hardest, followed by automobiles and electronics. Under Scenario 1, the export growth rate of machinery would fall 7.5 percentage points, followed by 6.4 percentage points for automobiles and 3.8 percentage points for electronics.

The reason these three industries are the most vulnerable is their high export share and competition with Japan. The share of exports in sales was 78.2 percent in the electronics sector, 58 percent for automobiles and 46.2 percent for machinery, as of 2011. In addition, Japanese companies are highly competitive in machinery and automobiles, and Korean companies are in intense competition with Japanese counterparts in the global market. The similarity in export composition of Korea and Japan is most visible in automobiles, followed by steel and machinery in 2012. In particular, the export similarity index of machinery was 0.51, sharply up from 0.42 in 2009.

Corporate profitability: Surging number of deficit firms

To determine the two scenarios’ impact on corporate profitability, an analysis was made on 426 companies where exports take up more than 50 percent of sales. It was found that the more the won rises and the yen sinks, the greater the number of companies going into the red. Even at the current level (won/100 yen at 1,145, and won/dollar exchange rate at 1,082), 33.6 percent of exporting companies in Korea are expected to post deficits. Under Scenario 1, the share would increase to 68.8 percent and in Scenario 2 to 85.9 percent. This is because the stronger won against the dollar is hurting corporate profitability while the weak yen is undermining competitiveness thus leading to lower export volume.

Small and medium-sized companies were more vulnerable to the currency fluctuation than large companies, as their operating profit to sales dropped at a steeper rate.

Response measures

The recent won appreciation and yen depreciation is occurring at a very fast speed and in a period of low growth that is expected to persist. Japanese companies have long coped with a high yen and have secured higher competitiveness with a slightly lower yen. This requires a comprehensive response by the Korean government and companies to respond to the mounting risks to the economy.

The government should strengthen measures to reduce currency market volatility to prevent an extreme surge in won appreciation and sharp slide in yen. Diplomatic efforts are needed in allying with emerging market economies to urge the G20 and International Monetary Fund to limit quantitative easing by advanced countries’ central banks. Internally, tighter regulation on banks’ position on foreign exchange forward deals and expansion of bank levies are necessary, while introducing a conditional financial transaction tax.

If the surging won and waning yen are not subdued with these efforts, monetary easing can be promoted while making sure that the household debt problem does not worsen further.

In addition, expansion of fiscal spending, and efforts to stimulate domestic demand should be also promoted for economic recovery. Support for foreign exchange risk management of smaller companies and diversification of settlement payment currencies for exporters are also needed.

Companies need to add strengths to overcome this situation. Existing measures such as tighter currency risk management and cost reduction efforts, diversification of overseas markets of exporting companies and relocation of production base are insufficient. As Japanese companies overcome the ultra-high yen through an “only one” strategy, Korean companies need to make efforts to strengthen technology competitiveness, upgrade value added and brand.

This article was contributed by Samsung Economic Research Institute. The opinions reflected in the article are its own. ― Ed.