Korea’s Foreign Exchange Reserves Shrink by $5 Billion in Two Months — Where Is the Cost of Defending the Won Going?

Market intervention moves into a phase of depleted ammunition
Constraints on banks’ and companies’ foreign-currency operations likely
Debate intensifies over the “National Pension Service role”

Korea’s foreign exchange reserves have declined for a second consecutive month since the end of last year, signaling that currency defense has entered a phase of tangible resource depletion. As the impact of authorities’ intervention in the foreign exchange market and liquidity management measures becomes visible in the data, the remaining capacity of reserves itself is emerging as a subject of market scrutiny.

At the same time, growing burdens on banks’ and corporations’ foreign-currency operations, along with renewed debate over the National Pension Service’s role in currency management, suggest that exchange-rate issues are evolving beyond short-term volatility into a broader test of the country’s overall foreign exchange and funding framework.

Securities up, deposits down

According to the Bank of Korea on the 4th, Korea’s foreign exchange reserves stood at $425.91 billion at the end of January, down $2.15 billion from a month earlier. The central bank explained that after the exchange rate plunged late last year due to intervention by the foreign exchange authorities and then rebounded again at the start of the year, market-stabilization measures such as dollar-selling intervention and foreign-exchange swaps involving the National Pension Service became necessary, leading to a reduction in reserves. While foreign-exchange swaps—under which the National Pension Service sources dollars needed for overseas asset purchases from reserves and repays them later—have the immediate effect of curbing dollar demand, they still reduce reserves until maturity.

By component, securities—the largest share of reserves—rose by $6.39 billion month-on-month to $377.52 billion, while deposits fell sharply by $8.55 billion to $23.25 billion. Special Drawing Rights (SDRs) remained unchanged at $15.89 billion, and gold holdings were also unchanged at $4.79 billion as they are valued at purchase prices. The IMF position, representing claims on the International Monetary Fund, slipped by $10 million to $4.38 billion.

Reserves had already declined by roughly $2.6 billion in December, marking the largest monthly drop since December 1997, immediately after the Asian financial crisis. Typically, reserves tend to rise in December as banks’ foreign-currency deposits flow into the central bank in response to BIS regulations. At that time, however, outflows linked to market-stabilization measures were large enough to offset these seasonal inflows. The Bank of Korea noted that while the dollar value of non-dollar assets such as the euro and yen rose slightly, intervention by the foreign exchange authorities dominated the overall decline.

Some observers voiced concern over the rapid contraction of reserves. In response, the central bank stressed that a simple comparison with 1997 is inappropriate given the vastly different absolute levels of reserves, adding that the decline amounts to less than 1% of the current stock. Korea’s reserves ranked ninth globally as of November last year, and that ranking remained unchanged even after reserves fell to $428.05 billion at the end of December. Still, Hong Kong, ranked tenth, narrowed the gap with reserves of $427.9 billion, drawing renewed attention to reserve size as a comparative indicator in global financial markets.

Defensive battle amid capital outflow pressure

After briefly easing late last year, the exchange rate has resumed its upward trend this year, remaining in the mid-1,400 won range and effectively returning to levels seen before verbal and actual intervention by authorities. Despite all-out efforts, upward pressure has proven difficult to contain, largely because dollar demand remains elevated. Capital outflows last year are estimated at about $19.6 billion, and domestic investors’ net purchases of U.S. stocks have already exceeded $2.05 billion this year alone. Such outflows are not easily reversed in the short term.

Markets are increasingly focused on the possibility that declining reserves could translate into heavier burdens for banks and corporations. If authorities seek to mobilize banks’ foreign-currency liquidity or impose direct or indirect adjustments on corporate foreign-exchange operations during currency defense, pressures could mount simultaneously across the financial sector and the real economy. In practice, authorities have repeatedly urged banks to manage dollar liquidity more tightly and companies to expand currency hedging. For banks, this implies reduced flexibility in managing foreign-currency deposits and loans, while companies face higher costs for managing exchange-rate risk amid heightened volatility.

These pressures, in turn, constrain overseas business operations and investment decisions. If foreign-currency depletion of around $2 billion per month persists, banks’ foreign-currency funding costs and companies’ settlement burdens will rise in tandem. Industries with high dollar-denominated payments—such as raw materials, components, and energy—feel the impact immediately in their cost structures. The old formula under which a weaker won directly boosted export profitability has broken down, giving way to a pattern where higher production costs and logistics expenses surface first.

Small and medium-sized enterprises feel the strain more acutely than large firms, as they have fewer tools to hedge currency risk and exchange-rate swings feed directly into profits and losses. A survey by the Korea Federation of SMEs in the first half of last year put the average breakeven exchange rate for SMEs at 1,334.6 won per dollar. With the current rate far exceeding that level, many firms are already beyond what they can comfortably absorb. As a result, markets are increasingly wary that the decline in reserves is not just a numerical change but a transmission channel through which pressures spread across financial liquidity and corporate management.

“Concerns over politicization of the National Pension Service are unfounded”

As exchange-rate instability persists, debate over the role of the National Pension Service has resurfaced. At a New Year press briefing on the 29th of last month, NPS Chairman Kim Sung-joo said that while exchange-rate volatility is an unavoidable core risk for the fund, currency-related operations such as foreign-exchange swaps are part of its own risk-management strategy, not responses to requests from the central bank or the government. His remarks were widely seen as an attempt to rebut criticism from some market participants that the NPS is being mobilized to defend the currency.

Institutionally, the NPS’s foreign-exchange operations are intended to manage currency volatility arising from a portfolio increasingly weighted toward overseas assets. Kim noted that in many past cases, excessive exposure to the market actually became a burden on fund management, adding that the “new framework” being discussed with the Ministry of Economy and Finance, the Bank of Korea, and the Ministry of Health and Welfare is aimed at managing currency risk more systematically within fund operations.

Nevertheless, controversies over the NPS’s role tend to recur whenever the exchange rate spikes, reflecting uncertainty over where the costs of currency defense ultimately fall. In the short term, authorities’ intervention, foreign-exchange swaps, and institutional investors’ hedging strategies can jointly dampen sharp volatility. If the upward trend in the exchange rate becomes prolonged, however, critics warn that the burden of market stabilization could accumulate on the national treasury and public funds. Kim’s repeated insistence that fears of politicizing the NPS are misplaced appears rooted in concern over interpretations that stray from the fund’s core mandate.

The Bank of Korea has also expressed deep concern about reading recent exchange-rate movements as a warning signal for the broader economic system. Kwon Yong-oh, head of the International Finance Research Team at the central bank’s International Department, said at a recent policy symposium that the exchange-rate rise reflects excessive pessimism, heightened fears of capital outflows tied to expanded investment in the United States, and one-sided expectations feeding into short-term supply-demand imbalances. He added that considering factors such as the share of short-term external debt, the current account, and the sovereign credit rating, there are no signs of an impending crisis involving foreign-currency funding or external debt default.