South Korea is grappling with severe economic instability tied to its recent political crisis, following President Yoon Suk Yeol's controversial attempt to impose martial law. This intervention has ignited considerable turmoil, leading to one of the sharpest depreciations of the South Korean won on the global stage.
According to the Bank of International Settlements (BIS), the real effective exchange rate (REER) of the Korean currency fell to 91.3 by the end of December 2024, marking a drop of 1.99 points from the prior month. The REER is pivotal as it measures the strength of the currency relative to others, with any reading below 100 indicating depreciation relative to the base year.
Among the 64 countries tracked by the BIS, South Korea's REER was the second lowest, only surpassing Japan, which recorded 71.3. This recent decline is notable, as it accounts for the third steepest fall globally, ranking behind Brazil's 3.94-point drop and Australia’s 2.37-point drop. This situation has not occurred since September 2022, during the Legoland debt default crisis, which had similarly destabilized the financial environment.
Following the announcement of martial law on December 3, the won was trading around 1,370 to the U.S. dollar, but it sharply depreciated to 1,442 won by the end of the day. The weakening trend continued, with the currency reaching 1,486.7 won just weeks later as uncertainty persisted around the government’s political maneuvers.
Bank of Korea Governor Rhee Chang-yong addressed the situation, stating, "Political changes sparked by the martial law imposition have greatly affected the foreign exchange market." He emphasized the disconnect between the current won-dollar exchange rates and the underlying economic fundamentals, citing it as higher than what would typically be expected based on the economic conditions and the interest rate divergence from the U.S.
This political crisis not only threatens the stability of the won but poses broader concerns for the South Korean economy. Analysts warn of potential long-term impacts on investor confidence and market stability. The martial law declaration has created fears among investors about governance and the overall business climate, prompting sell-offs and increased volatility.
Looking back, the last two years have seen South Korea navigate various crises, including the repercussions of the Legoland debt default, which sparked fears of corporate bond yield spikes and credit crunches. The latest political upheaval appears poised to introduce similar challenges, as economic uncertainties loom large over government decisions.
The currency's downward spiral reflects deepening doubts on the part of investors concerning political leadership and economic management. This precarious situation calls for immediate and effective intervention from the South Korean government to stabilize the won and restore confidence among both domestic and international investors.
If the government can present a cohesive strategy to alleviate investor concerns and recommit to stable economic policies following the crisis, there may be opportunities to regain lost ground. Conversely, continued instability risks entrenching economic dysfunction and leading to more pronounced long-term effects on South Korea's economy and global standing.