Is it 2008 or 1998? Korean + Russian Intervention

♠ Posted by Emmanuel in , at 9/07/2008 01:21:00 PM
Declining confidence in emerging markets...fleeing foreign investors......repatriation of funds boosting the US feels oh so very 1998 even if my calendar reads 2008. Although there may be less of a "contagion" to speak of this time around, it seems that many LDCs are returning to old habits that die hard. For this post, I have a double feature of Korea and Russia. First, South Korea has already pumped in a reported $30 billion to defend its currency, the won, from faster deterioration to help shore up foreign investor confidence in the country (among other things). As won-denominated bond issues mature, there is additional fear that large-scale repatriation can occur. Although Korea is far better placed this time around with an FX war chest of some $240 billion instead of one fast approaching zero, the memories of the hardships caused by the Asian financial crisis of a decade ago are causing Korean authorities to act quite aggressively. From Reuters:
Central bank intervention lifted the South Korean won from a four-year low on Wednesday. But the intervention was not enough to reverse the trend for the currency, which has lost more than 18 percent this year. The authorities, which have already sold $30 billion in 2008 to support the struggling won, were spotted intervening in the currency market by some dealers after the won hit a four-year low of 1,158.7 to the dollar.

It was the first significant intervention since last week and deflected growing market speculation that the authorities were backing away from aggressive dollar sales in favor of verbal warnings of "stern measures" for won sellers. In contrast, shares recouped some recent losses on Wednesday and bonds were higher after two days of market turmoil caused by fears of capital flight from South Korea. Foreign investors were still net sellers of Korean stocks for a 12th consecutive trading session, although the pace of the sales had lessened.

Overseas investors have sold large amounts of Korean stocks and have become net sellers of bonds. There are concerns in South Korea that they could repatriate billions of dollars next week when $7 billion in bonds mature. Officials maintained their verbal barrage, seeking to assure investors that the economy was solid.

Shin Je Yoon, the deputy finance minister, told the local online outlet EDaily that the economy was in difficulty but dismissed suggestions of a financial crisis. The won will recover soon, he said. He told Reuters that despite nervous markets, South Korea would go ahead with a planned bond sale abroad for about $1 billion this year.

An International Monetary Fund official also played down worries that South Korea's $243 billion in foreign reserves were shrinking too fast because of interventions. Meral Karasulu, the IMF's representative in Seoul, said the reserves were adequate to cover short-term international obligations. She also said foreign debt was not unusually large.

The won ended in Seoul on Wednesday around 1,148.5 to the dollar, nearly 1 percent above the four-year low of 1,158.7 to the dollar. But the currency was down 1.3 percent on the day.

The stock market's benchmark index rose 1.4 percent after combined losses of more than 4.5 percent on Monday and Tuesday, partly helped by speculation that the government would come up with a stimulus package for financial markets. "There are also hopes of some sort of market-stimulus package from the government amid the current worries about a financial crisis, and many investors seem to view the won currency's current level as the bottom," said Kim Joon Kie, a stock analyst at SK Securities.

The won has fallen nearly 10 percent since July 7 when the Finance Ministry and the central bank pledged in a rare joint statement to sell dollars out of the foreign reserves and take other measures to defend the currency.

The won has been under additional selling pressure in recent weeks because of concern that foreign investors will repatriate the maturing debt next week and trigger a hemorrhage of capital from South Korea. However, the idea that South Korea is on the verge of a repeat of the 1997-98 Asian financial crisis is widely dismissed by analysts because exports continue to grow, foreign exchange reserves are high and the government is stable.

But there are major challenges for the economy, which might explain the current selling by foreign investors, analysts said. South Korea is heavily dependent on imported fuels and other raw materials that have pushed the current account into deficit after years of substantial surpluses. The slump in the won adds to those costs because it makes imports more expensive. Growth in exports, although resilient, has began to lose momentum in the face of a global slowdown, casting doubt on the prospects for the economy's growth.

Next, demonstrating that developing states richly endowed with minerals and whatnot are not immune to the pressures of the marketplace, Russia has been forced to defend the ruble against widespread concern over doing business in Russia. It seems that despite the lure of vast mineral resources, investors are still concerned over such niceties such as "rule of law," "honouring of contracts," "property rights" and other related Western capitalist nonsense. When Comrade Putin wakes up one day on the wrong side of the bed and decides to nationalize your share in Russian energy investments, it does not speak very well of the governance in the wild, wild East. Bloomberg even notes that some are calling for ruble call options as a gambit to profit from surefire Russian intervention. Goodness knows, Russsia with its nearly $600 billion of currency reserves has a lot of ammo to help buoy its currency. These are not the days of Yeltsin, dear friends:

Investors should buy three-month call options on the ruble against the central bank's euro-dollar basket because the currency may rebound from a record low as Bank Rossii uses its $583 billion of reserves to curb declines, Morgan Stanley said.

The ruble slid 0.6 percent to 30.40 against the basket yesterday, after weakening 1.3 percent Sept. 3, its biggest one- day decline since the mechanism was introduced in February 2005. Bank Rossii, the central bank, monitors the ruble against a basket calculated by multiplying the ruble's rate to the dollar by 0.55, the euro rate by 0.45, then adding them.

Investors took $30 billion out of Russia since the Aug. 8 start of its five-day war with Georgia, according to BNP Paribas SA, with concern heightened by U.S. and European condemnation. The ruble should rebound against the euro and dollar once the central bank deploys its foreign-exchange reserves, the world's third-biggest, Morgan Stanley said. The Financial Times yesterday said Bank Rossii started selling dollars.

``The central bank has ample reserves and should be able to corral further ruble weakness,'' said Ronald Leven, a New York- based analyst at Morgan Stanley. ``With deviations from the government target basket at extremes and ruble carry advantage at multiyear highs, we believe it is attractive to go long via options.''

Investors should purchase call options giving them the right to buy Russian rubles in three months at a similar price to the current spot market, Leven wrote in a client note dated yesterday. They should also sell call options of the same maturity at a strike price of 29.50 to reduce the cost of the bet, he said.

Call options give the buyer the right -- but not the obligation -- to buy an asset at a pre-agreed price on a set date. By selling a call option, the investor is taking a bet the contract won't be exercised, allowing them to keep as profit the premium paid for the option. The trade offers a potential return of about 3 percent, Leven said. Investors are better putting their money into options because of the volatile political situation in the region, he said.

Russia's central bank sold as much as $4 billion in reserves yesterday to support the ruble as investors responded to Russia's war with Georgia, the Financial Times reported, citing unidentified currency dealers...

The ruble headed for its biggest weekly drop against the dollar since the second week of August, slipping 3.4 percent to 25.4872 per dollar by 11:28 a.m. in Tokyo, from 24.6450 on Aug. 29. It reached 25.7209, the weakest since Sept. 11, 2007. It dropped to 36.4137 per euro, from 36.1628 late last week.

Bank Rossii keeps the ruble within a trading band against the basket to limit the impact of fluctuations on the competitiveness of Russian exports. It has been widening the band since mid-May to introduce volatility into the currency and prepare it for a free float by 2011...