“Exchange Rate and Foreign Exchange Policies in Korea”, written by a thirty-year insider at the Bank of Korea, was published by Hannarae on 20 August 2013. Byungchan Ahn served as Director-General of the central bank's International Department from May 2007 to August 2010 and he is currently the chief audit executive at KB Investment & Securities, part of KB Financial Group. This book describes the inner workings of Korea’s exchange rate and foreign exchange policies related to the nation’s external finances, with a specific focus on Korea’s successful management of its foreign currency liquidity crisis in the wake of Lehman Brothers’ collapse. This English version includes recent developments and changes in Korea's foreign exchange policies since the first Korean edition was published on 10 May 2011. Korea’s National Academy of Sciences selected the Korean original as one of the “Outstanding Books of 2012.”

One of the reasons the author wrote this book is to share his experiences as head of exchange rate and foreign exchange policies at the Bank of Korea. Mr. Ahn believes that the information contained in this book should help policy-makers as well as those working in financial institutions and businesses undertaking foreign exchange transactions.

This book comprises ten chapters, differing markedly from other books in this field in two aspects. First, it covers comprehensively not only exchange rate policy but other policies related to foreign exchange transactions. Secondly, it poses key points for discussion in seven of the ten chapters, then elaborates on them in some detail so that the argument can be easily understood.

The author presents several tasks that policy makers should press ahead with in the coming years. One important task he particularly emphasizes is the rigorous and thoroughgoing management of the official foreign exchange reserves. He writes:

“The past two crises abundantly confirmed that sufficient accumulation and thorough management of foreign exchange reserves are very important. We must not forget this vital lesson. In the years ahead, it will be even more difficult to predict in advance when, where and what type of financial crisis may break out. In light of their role as a contingency fund, even if the level is deemed higher than necessary, it seems proper for a country to hold foreign exchange reserves in the form of external financial assets with a high degree of safety and liquidity rather than long-term fixed assets including the development of overseas natural resources or infrastructure projects.”

Mr. Ahn notes, though that, the benefits of foreign exchange reserves are limited:

“Even though individual countries held adequate foreign exchange reserves, the individual efforts of each country proved to be limited in coping with the global financial crisis following Lehman Brothers' failure in September 2008. Therefore, Korea should work energetically to strengthen regional financial safety nets such as the CMIM launched in March 2010. At the same time, Korea should take an active role in discussions regarding the establishment of global financial safety nets at G20 summits.

In line with this, the Bank of Korea should endeavor to maintain close ties with major central banks including the US Federal Reserve. Currency swap arrangements between the Bank of Korea and the Federal Reserve played an important role in overcoming the country’s foreign currency liquidity crisis during the global financial crisis.”

The author also maintains:

“Another important task is to make continuous efforts to improve the macroprudential soundness of banks’ foreign exchange sector. What is essential here is to reduce volatility from foreign capital flows. In the years ahead, policy efforts for systemic improvement should be sustained to alleviate structural imbalances in supply and demand in the foreign exchange market. Above all, it is more desirable to bed down the systems introduced recently such as the forward position limit rather than introduce new instruments at the present time.

The forward position limit on foreign bank branches, which is much

higher than that of domestic banks, should be gradually lowered over the medium to long term through accurate analysis of developments in inflows and outflows of foreign capital and in the demand for firms' foreign exchange hedging. But it is not desirable to make frequent adjustments to the limit in the short term.

With regard to the imposition of a financial transaction tax on foreigners’ securities investments, I believe it is difficult for Korea to introduce such a tax at the present time, considering the following: (1) Korea has already taken some measures, such as the FX forward position ceilings and macro-prudential stability levy, to respond to excessive capital inflows. Additionally, introduction of a financial transaction tax on foreign capital inflows could induce foreign capital outflows from Korea. (2) At the present time, only 11 eurozone countries in the 27-member EU have decided to introduce the tax, while the United States and the United Kingdom are reluctant to accept it. Therefore, it is desirable for Korea to defer a decision on whether to introduce it or not until a more substantial global consensus has been formed.”

Mr. Ahn comments that the greatest reward for him from having written this book will be if he can contribute to some degree to helping all economic actors prepare themselves against future financial crises. The recent global financial turmoil brought about by the sovereign debt crisis in the euro zone, for example, generates great uncertainty, as no one can say for sure how or when it will end.

[Contents]

Chapter 1 Foreign Exchange Policy Framework

1. Objectives and Scope of Foreign Exchange Policy

2. Policy Authorities and Supervisory Agencies on Foreign Exchange

3. Financial Institutions Subject to Foreign Exchange Policy

Chapter 2 Exchange Rate Policy

1. Exchange Rate Policy

2. Changes in the Exchange Rate and Their Impact

3. Key Discussion Points

Chapter 3 Foreign Currency Liquidity Management

1. Foreign Currency Liquidity Supply System at the Bank of Korea

2. FX Swap and Currency Swap

3. Foreign Currency Loan System

4. Key Discussion Points

Chapter 4 Foreign Exchange Reserve Management

1. Concept of Foreign Exchange Reserves

2. Function of Foreign Exchange Reserves

3. Components of Foreign Exchange Reserves

4. Factors behind Reserves Assets Changes

5. Adequacy of Foreign Exchange Reserves

6. Key Discussion Points

Chapter 5 External Debt Management

1. Definition and Classification of External Debt

2. External Debt Developments

3. Key Discussion Points

Chapter 6 Capital Liberalization

1. Meaning and Effect of Capital Liberalization

2. Korea’'s Capital Liberalization Developments

3. Key Discussion Points

Chapter 7 Foreign Exchange Prudential Regulation Framework

1. Definition and Purpose of Foreign Exchange Prudential Regulation

2. Framework of Korea’'s Foreign Exchange Prudential Regulation

Chapter 8 Foreign Exchange Macroprudential Regulation

1. Establishment of Minimum Reserve Requirements for Foreign Currency Deposits

2. Restrictions on the Use of Foreign Currency Loans of Financial Institutions

3. Establishment of Foreign Exchange Position Limits

4. Introduction of a Macro-Prudential Stability Levy

5. Key Discussion Points

Chapter 9 Foreign Exchange Microprudential Regulation

1. Establishment of Foreign Currency Assets and Liabilities Ratios

2. Managing Offshore Business

3. Establishment and Operation of Risk Management Standards

4. Key Discussion Points

Chapter 10 Policy Tasks Ahead

1. Basic Direction for Improvement of Foreign Exchange Policy

2. Several Tasks for Improvement of Foreign Exchange Policy

[About author]

Mr. Byungchan Ahn graduated in February 1977 from the College of Political Science and Economics of Korea University with highest honors. Upon graduation, he joined the Bank of Korea and served over 34 years, retiring on 24 March 2011. He specialized in money and banking, foreign exchange, and international finance, while posted with Research Department, Monetary Policy Department, and International Department. Mr. Ahn also received a masters degree in economics from Pennsylvania State University in May 1987 through the fellowship of the Bank of Korea. He was seconded as a visiting scholar to the Research Division of the Federal Reserve Bank of St. Louis in the United States from September 1993 to August 1994, where he conducted research on the determination of interest rate and exchange rate policies in a small open economy. When he returned to Korea, he was appointed as Chief of Monetary Management Division at the Monetary Policy Department, where he oversaw target setting and management of monetary aggregates until February 1997. He also served as Director-General of International Department from May 2007 to August 2010, a period which included the outbreak of the biggest global crisis since the Great Depression of 1930s. Most notably, he played an important role in establishing temporary swap arrangements between the Bank of Korea and the US Federal Reserve, and provisions of swap funds to domestic commercial banks. He also led the department to introduce an FX forward position limit system in cooperation with the government. Prior to becoming the head of International Department, he served two years and six months as Chief Representative of the Bank's Washington DC Representative Office, where he strengthened the institution's ties with the US Federal Reserve, the US Treasury and the International Monetary Fund. Since March 2011, he has been the chief audit officer at KB Investment & Securities in Korea.