March 17, 2020 / 11:44 PM / 22 days ago

South Korea loosens FX derivative rules to ease critical dollar shortage

SEOUL (Reuters) - South Korea on Wednesday said it will loosen one of its key foreign exchange rules to encourage banks to supply more dollars in local markets as the coronavirus pandemic drives a global rush for the U.S. currency.

The cap on the foreign currency forward positions that local banks can hold will be raised to 50% of their equity capital from 40% currently starting March 19, the finance ministry and the Bank of Korea said in a statement. For foreign banks, the same ceiling will be raised to 250% from 200%.

The targeted approach to ease the dollar funding squeeze is expected to help address mismatches in dollar liquidity in the local derivative markets, the ministry said.

Flight to safety has led to a massive decline in dollar liquidity across the world as the deepening economic impact of the pandemic forces investors to liquidate their holdings of commodities, stocks and riskier bonds. That, and a rush by brokerages to secure dollar funding out of concern about future cash flow, has led to a scramble for dollar financing.

Central banks from Japan to India have pledged to conduct dollar funding operations in the past week to ease funding constraints.

South Korea finance minister Hong Nam-ki on Wednesday said the government is preparing to roll out a more “comprehensive financial support” package soon to help companies hit by the virus outbreak.

He also vowed to deploy a fund to stabilize bond market volatility if needed, to calm investor sentiment and stop currency market panic spreading to other financial markets.

The U.S. Federal Reserve has not only cut rates to near zero and pledged to pump hundreds of billions of dollars into markets, it has also cut the pricing on its dollar swap lines with foreign central banks to make it easier for them to provide dollars to financial institutions around the world.

The premium Korean investors were paying to swap their won into dollars hit 269 points on Tuesday KRWCBS1Y=, a record high according to Refinitiv data, suggesting increased demand for the U.S. currency in local financial markets.

The won-dollar currency basis spread indicates the premium Korean financial institutions need to pay on top of dollar LIBOR.

Reporting by Cynthia Kim; Editing by Sandra Maler and Sam Holmes

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