Question 21N.2.SL.TZ0.2c
| Date | November 2021 | Marks available | [Maximum mark: 4] | Reference code | 21N.2.SL.TZ0.2c |
| Level | SL | Paper | 2 | Time zone | TZ0 |
| Command term | Explain | Question number | c | Adapted from | N/A |
South Korea’s exchange rate and central bank intervention
- From mid-2017 until mid-2019, there was a downward trend in the exchange rate of the South Korean won (South Korea’s currency), and some commentators suggested that it was being deliberately undervalued. Despite the lower exchange rate, however, the value of South Korean exports declined by 10.3 % during 2019.
- The main reason for the decline in the value of exports was the weak market for semiconductors. Lower global prices of semiconductors, the largest single export item for South Korea, led to a drop of 25.9 % in the value of exports, despite an increase in their volume. Evidently, price competitiveness of exports from South Korea is not as significant as before, because its exports are now mainly luxury or high-technology items.
- In November 2019, South Korea’s current account surplus reached US$5.97 billion, more than 4 % of gross domestic product (GDP). The financial account in the balance of payments had a net outflow of US$5.34 billion, which was mainly due to a net outflow of US$4.01 billion in foreign direct investment (FDI). There was also a net outflow of US$1.07 billion in portfolio investment, because domestic residents increased their financial assets overseas while inward flows declined.
- The Bank of Korea (South Korea’s central bank, BoK) had reduced interest rates to record lows in October 2019, which partly accounted for the large portfolio investment outflows. Monetary policy is likely to continue to be expansionary through 2020, with the possibility of another interest rate reduction, because economic growth is forecast to be low, at less than 2.5 %. The forecast for inflation is that it will be below 1.5 %, while the unemployment rate is expected to continue to rise to over 4 %.
- While the BoK is not targeting a specific level for the exchange rate, it seems determined to intervene when the market is unstable. Its actions, however, have contributed to South Korea being accused by the United States (US) of changing the value of its currency to gain an export advantage. If the US concludes that South Korea has been manipulating its exchange rate unfairly, it could impose trade barriers on imports from South Korea.
- However, through the last six months of 2019, the South Korean won started to rise against the US dollar (US$). The appreciation was partly due to speculation and expectations of a rise in demand for semiconductors. Moreover, in August 2019, the BoK sold US dollars in order to prevent the South Korean won from depreciating again. Overall, the central bank’s foreign exchange intervention has been aimed at restraining the South Korean won’s depreciation or stabilizing the market rather than at trying to promote exports.
Figure 1: South Korea’s exchange rate with the US$
Table 1: South Korea’s balance of trade in goods and services, seasonally adjusted
Using an exchange rate diagram, explain the effect on the South Korean won’s exchange rate of South Korea’s central bank selling US dollars (paragraph [6]).
[4]
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
For an exchange rate diagram, the vertical axis may be exchange rate, price of won in another currency, other currency/won or other currency per won. The horizontal axis should be quantity, or quantity of won. A title is not necessary.
NB: an answer may alternatively draw an exchange rate diagram for the US dollar and show the supply curve shifting right with the US dollar depreciating, which is equivalent to the won appreciating. If the explanation is correct, this can be fully rewarded.
NB: the diagram may show the won initially depreciating due to declining demand and/or rising supply, with the demand curve then shifting right to reverse the depreciation. If the explanation is correct, this can be fully rewarded.
Many candidates recognised that the demand for the won increased in the foreign exchange market. In some cases, diagrams for the US$ were included and properly explained in terms of a decreasing value of the US$ which in turn represents an increasing value of the won. Often, those who were not awarded a mark on this question were those who shifted the supply of won.
