Bank of Korea Governor Fears Fed Tightening

May 30, 2013, 9:13 p.m. ET

Bank of Korea Governor Fears Fed Tightening

By ALEX FRANGOS

A move by the Federal Reserve to unwind its monetary easing in the near future is a major risk for emerging economies, the head of South Korea’s central bank said.

In an interview late Thursday in Shanghai, Bank of Korea Governor Kim Choong-soo warned that the withdrawal of Fed stimulus could shake global financial markets.

“That is one of the most important concerns for me,” he said. When the Fed begins to dial back its stimulus program, “volatility in the capital markets is likely to remain high for a relatively long period of time,” he said.Federal Reserve Chairman Ben Bernanke has signaled that should the U.S. economy continue to improve, the Fed would consider tapering its $85 billion a month of bond purchases in coming months.

Aggressive stimulus efforts from the Fed and other developed-market central banks have caused substantial money flows into the global financial system and especially into emerging economies such as South Korea’s. Some fear that as the Fed withdraws its stimulus, that liquidity will dry up, unsettling financial markets and banks.

Mr. Kim pointed to the “ghost of 1994,” referring to a series of Fed interest-rate increases in 1994 that caught global markets off guard and triggered a selloff in bonds, including in emerging markets. “We all experienced that, and we all know what happened, and I hope not to experience [that] again.”

Policy makers from the Fed, other “QE countries” and emerging markets should “find a compromise solution so that all things will happen in an orderly fashion,” he said. “If not, then we are likely to face another series of difficulties.”

He added: “When they are ready, it’s their decision. We should also know what they do and how they will do it.” It would cause instability if emerging markets aren’t “given time to prepare,” he said.

Until recently, the Bank of Korea has been more preoccupied with capital inflows, rather than the prospect of outflows, which a Fed tightening could trigger. South Korea has implemented several measures since 2010 to curb risks in its banking system created by foreign capital pouring into the economy.

One such measure, introduced in 2011, is a levy on banks’ financing in foreign currencies.

Mr. Kim floated the idea that the levy could eventually be strengthened, while calling the current bank levy “appropriate” given the market conditions,

“The coverage can be extended to cover domestic currency or the nonbanking sector, so there are many, many ways to expand the regulation,” he said.

A tighter regulation would begin with an increase in the levy from the current 0.2% on short-term foreign borrowings to up to 0.5%.

“If we find that increase is not sufficient to manage the financial markets, then we would consider the other options too,” he said.

South Korea’s banking system doesn’t have a sufficient deposit base to fund its lending, so banks turn to foreign sources, such as bonds and interbank loans, to fill the gap. The aim of the bank levy is to reduce exposure in South Korea’s banking system to short-term foreign financing of the type that evaporated during the 2008 financial crisis and triggered a major fall in the Korean won.

Mr. Kim noted an unexpected softness in commodity prices, especially oil. Weak commodity prices could keep inflation in check and provide the central bank scope to leave interest rates low. The bank cut its benchmark rate a quarter point to 2.5% at its last policy meeting on May 9.

“Oil prices are among the most important variables to us, and it turned out to be a little lower than we originally planned,” he said.