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2022 Oct/24
Need and Directions for Reform of the Foreign Exchange Transactions Act
Issue Papers 22-20
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- Research Topic Macrofinance
- Page 22
- Summary
- The Foreign Exchange Transactions Act (the “Act”) was enacted in 1999 immediately after the Asian financial crisis, aiming for freeing up foreign exchange transactions and invigorating market functions. Contrary to its purpose, the Act has been used to adjust and manage the foreign exchange sector to implicitly curb the outflow of foreign capital and ease excessive foreign exchange rate volatility over the past two decades. This has been inevitable to some extent because the prolonged external uncertainty has made external stability a top priority in the aftermath of the 2008 global financial crisis.
As a result, policy measures implemented in the era of the lack of foreign exchange still underpin the fundamentals of the Act, including prior reporting of capital transactions, procedural restrictions on international payment and receipts, and foreign exchange agencies. These measures cause the inconvenience that outweighs the benefits of contributing to external soundness, run counter to the liberalization of foreign exchange transactions and invigoration of market functions, and undermine crisis response capabilities and balanced development of the entire financial industry. Notably, Korea has experienced macroeconomic changes, transforming from a foreign exchange-deficit nation to a capital exporter. In addition, its competence in dealing with a crisis has improved immensely and it has seen non-banking financial institutions gaining importance due to the rise in overseas financial investments. Against this backdrop, the Korean government should gear the reform of the Act towards the following directions.
First, the new Foreign Exchange Transactions Act should focus on mitigating public inconvenience and facilitating freer foreign exchange transactions. To this end, the government should overhaul the relevant legal system and free up transactions by abolishing the prior reporting of capital transactions. Second, it is necessary to address the bank-centered foreign exchange agency system and the procedural regulation that requires international payment to go through a bank. With these measures, the government needs to allow other financial institutions including financial investment firms to freely engage in foreign exchange-related business, which can contribute to balanced development in foreign exchange business competence of the entire financial industry and help maintain external soundness. Third, the new Act should be designed to stimulate the economy under the open economic system. In preparation for population aging, investment conditions should be improved further to ensure that overseas financial investments by residents lead to a stable stream of national disposable income.
The reform of the Act could structurally reinforce Korea’s external soundness under the new macroeconomic environment and hence, enhance Korea’s capability to cope with external shocks. In this respect, a prudent approach is needed for the reform, regardless of destabilizing factors in the domestic and global financial markets.