Korean won and Chinese Yuan have been showing similar trend since 20120

 

I have written an article that Korean won (KRW) will further depreciate against US dollar (USD), resulting in surge in KRW/USD exchange rate. The original article can be found here.

 

In the article, I briefly mentioned that downward pressure on Chinese Yuan will lead to depreciation of Korean won. This is a follow up article explaining why that is the case.

 

In fact, the CNY/USD and KRW/USD exchange rates show a correlation of 65% since June 2010, when China abandoned pegged fixed exchange rate and allowed a degree of exchange fluctuations via “managed float” exchange system.

 

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Under managed float exchange system:

  1. The central parity mechanism was established, with the RMB/USD rate allowed to fluctuate in a daily band of +/-0.3 percent around the central parity, which was the previous day’s close.
  2. The yuan would be permitted to fluctuate within a wider band, of +/-1.5 percent, against the other foreign currencies traded in the interbank market: the Euro, Hong Kong dollar, and Yen.

Source: Sonali Das, IMF Working Paper – China’s Evolving Exchange Rate Regime

 

There are a number of reasons as to why Chinese Yuan and Korean won move together:

  1. South Korea exports a quarter of entire its exports to China, and therefore, Korean economy is heavily dependent on Chinese economy
  2. South Korea and China are both export driven economies with similar exports goods that compete on global stage, such as IT and home appliances
  3. Chinese Yuna and Korean won are both considered risky currencies
  4. FX Traders trade these FX products in expectation that they will move close, resulting in a self-fulfilling prophecy

 

The following chart shows that KRW and CNY have moved in very similar directions and magnitude since 2010.

 

Korean won and Chinese Yuan exchange rate since 2010

Source: Capital IQ

 

Hence, as long as South Korea and China have similar export oriented model, compete in a global stage with similar goods, and Korean won and Chinese Yuan currencies are considered risky assets, their high correlation is most likely to continue.

 

Exchange rate is driven by a myriad of macroeconomic, political and financial factors. Predicting short term movements can thus be extremely difficult. In the long run, however, exchange rate will follow the economic fundamentals between the two countries.

 

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