Won's Rise Makes Waves [WSJ]
Korean Shipbuilding Boom Lifts Currency, Hampering Export-Oriented Economy
By EVAN RAMSTAD
June 11, 2007; Page C1
SEOUL, South Korea -- The South Korean won has risen 10% against the U.S. dollar since the start of 2005, appreciating more than any other Asian currency and causing problems for the country's export-oriented economy.
The currency's strength forces South Korean companies to raise prices of their products or cut into profit margins. Major manufacturers such as Samsung Electronics Co. and Hyundai Motor Co. in the past two years have seen their price advantage against competitors erode, operating profits tumble and stock prices decline.
While many conditions affect the value of currencies, economists and bankers point to a single industry for tilting the scale in South Korea: the country's shipbuilders, which are responsible for half the world's value of vessels on order. South Korea's dozen or so large shipbuilders are experiencing their biggest boom ever because of rising global trade and China's hunger for commodities.
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South Korea's large shipbuilders are experiencing a boom due to rising global trade and China's hunger for commodities.
But they also are a leading source of pressure on the South Korean won since shipbuilders receive the bulk of their payment only when a ship is completed -- currently at least three years after an order is placed. During that period, shipbuilders turn to banks to protect, or hedge, the value of today's orders using a forward-exchange transaction.
For example, a shipbuilder that takes a $100 million order today for a ship delivered in 2010 may receive a $10 million down payment from the buyer and then hedge the other $90 million. It does this by offering to pay a bank in 2010 the $90 million if the bank will at that time give the shipbuilder today's equivalent value in won, or about 83.4 billion won. The bank then will go to the foreign-currency market and obtain 83.4 billion won, which it will hold in an account earmarked for the shipbuilder.
The act of acquiring won today creates demand that raises the value of the currency. And the rising value of the won reinforces shipbuilders' desire to hedge and protect their future revenue. "This is a vicious circle being created, with the expectation that the won will become stronger causing it to happen," says Hong Sun-young, an economist at the Samsung Economic Research Institute in Seoul. But he doesn't blame the shipbuilders, saying they are engaging in "very rational behavior."
Some of the won's strength, of course, comes from the relative weakness of the U.S. dollar or Japanese yen. But the surging growth of the shipbuilding industry along with its large size in the South Korean economy -- it accounts for about 4% of gross domestic product and trails only computer chips and autos as a source of export income -- have combined to form a particularly influential source of pressure on the won.
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The rising value of the won is bad news for other South Korean exporters. For instance, Hyundai Motor's net profit fell 35% last year as its dollar sales in the U.S. and euro sales in Europe converted to fewer won back at South Korea headquarters. In addition, with Japan's yen down against the dollar and euro, Hyundai has been unable to raise prices against Japanese competitors, such as Toyota Motor Corp. and Honda Motor Co., that enjoy greater brand perception with overseas consumers. A Hyundai spokesman says the company is focusing on a marketing campaign to lift its brand image.
In a meeting this past December, executives from large South Korean companies asked senior government officials to "manage" the won's appreciation by intervening. Finance and Economy Minister Kwon O-kyu later that month said the government would put a top priority on "managing such downside risks" of a stronger won this year. But no one expects the shipbuilders to stop their hedging practices because to do so would put them at risk of eroding their profits in the future.
The won started rising sharply in the last three months of 2004 when the Bank of Korea stopped its longtime practice of intervening to keep the won steady. As the won fluctuated more, shipbuilders stepped up their hedging activities. In 2005, South Korean exporters, led by the shipbuilders, hedged a hefty $29.2 billion, according to the central bank. The average annual exchange rate for the won rose 10.5% against the dollar that year. Last year, the value of hedging grew almost 70% to $49.3 billion as the won's average exchange rate gained another 6.7% on the dollar.
The shipbuilders don't disclose precisely when they hedge. But last month, Hyundai Heavy Industries Co., the world's largest shipbuilder, booked a record $3.3 billion in orders, for 31 ships that will be delivered in 2010 and 2011. And early last month, the won moved to its strongest level of the year -- 922 won to the dollar. The currency is currently trading at 931 to the dollar.
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Economists note that other economic figures suggest the won shouldn't be strengthening against the dollar. "The current account is equally balanced, there's no huge trade surplus and no massive capital inflows," says Frederic Neumann, an economist at HSBC in Hong Kong. "You wouldn't expect appreciation based on the fundamentals."
But economists believe the pressure on the won will continue because the shipbuilding boom is likely to stretch on until there is a global economic slowdown. In addition, the easiest fix -- sustained dollar-buying by South Korea's central bank -- poses a political risk to the Korean government as consumers would end up paying higher interest rates since the central bank issues bonds with attractive rates to pay for the dollars it buys.
Another option, says Mr. Hong, the Samsung economist, is for the won to keep going until the market perceives that it has become overvalued against major currencies. "Then shipbuilders might change their expectations" and reduce their hedging, he says. |
