South Korea's trade talks with the Trump administration have become increasingly dogged by political doubts this week, spooking investors who now worry Seoul may end up with a raw deal or perhaps no deal at all.
The Korean won broke through the psychologically important 1,400 to the dollar level on Thursday, seen by markets as authorities' line in the sand against bearish speculative bets and opening the way for further downside.
The selling gained momentum this week after South Korean President Lee Jae Myung said on Monday Asia's fourth-largest economy would need a currency swap agreement with the U.S. if it accepted Washington's demands to invest $350 billion in America.
Lee's pessimism has raised public concerns that U.S. demands could lead to a financial crisis like the one Korea experienced in 1997 or completely scupper a trade agreement, a major competitive blow to the export powerhouse.
"If an agreement goes ahead as the direct cash flows as demanded by the U.S., it will create new dollar demand of about $100 billion to $120 billion annually, which will be a significant upward pressure for the dollar-won rate," Lee Sang-beom of KB Securities said.
Without a swap in place, KB Securities estimates that channeling $350 billion in direct investment to the U.S. may push the won down by 100 won per dollar a year through the next three years.
That is partly why President Lee is calling for an FX swap line with the Federal Reserve akin to the one the Bank of Japan has in place with the U.S.
However, Citigroup said the U.S. "is less likely to accept the unlimited swap lines between the Bank of Korea and the Fed, as the Fed would recommend the FIMA Repo-Facility instead," economist Kim Jin-wook said in a note, referring to an alternative dollar liquidity measure in exchange for their U.S. treasury securities.
A Korean finance ministry official and the Bank of Korea's currency chief declined to comment.
Seoul and Washington are currently in a deadlock over how to structure a $350 billion investment fund the two agreed in principle as part of a broader trade deal that caps tariffs at 15% on goods from South Korea.
If the deal is not finalised, South Korean imports could face higher tariffs of 25%, not 15% as agreed, making Korean goods more expensive for American consumers as competing goods from Japan and Europe face 15% tariffs.
LONG SHADOWS OF CRISES PAST
While Seoul has made some modest progress to make the won more global, memories of foreign exchange crisis in the late 1990s make it difficult for officials to loosen tight currency restrictions.
Unlike the yen, the dollar-won has no offshore market and the Korean currency accounts for about 2% of global FX trade, against 17% for the yen.
South Korea's history of impeaching presidents is also shaping political thinking around trade talks.
While impeachment risks for Lee are low, he has publicly spoken about the pressure he faces to put the national interests first.
A financial crisis could quickly generate opposition within his own support base at a time when many are already fuming over immigration raids on Korean firms in Georgia.
The U.S., on the other hand, demands South Korea agree to similar terms outlined in Japan’s deal, in which Tokyo agreed to transfer cash within 45 days after the U.S. selects a project.
"President Lee Jae Myung is mentioning he may get impeached if he accepts such deal in his rhetoric to show the deal can't be done as is," Professor Kim Tae-hwang at Myongji University said, adding risk of Lee's impeachment is unlikely given that the ruling party has the majority in parliament.
For now, the combination of the political and financial risks clouding a prospective trade deal, which many investors see as a lose-lose situation for the Korean economy, is compounding pressure on the won.
"If the $350 billion of outflows were to be priced in, the won could easily slide to 1,450 per dollar," a local FX dealer said, asking not to be named. "It's wobbly now because of the uncertainties, the won will immediately decline for sure if the transfer of money starts."
