S. Korean lawmakers propose to adopt Tobin tax for reducing forex volatility

2012-11-19 13:10:37 GMT2012-11-19 21:10:37(Beijing Time)  Xinhua English

By Yoo Seungki

SEOUL, Nov. 19 (Xinhua) -- South Korean lawmakers proposed on Monday to adopt a so-called Tobin tax in a bid to reduce extreme volatilities in the foreign exchange market as seen during the 1997 Asian foreign exchange crisis and the 2008 global financial crisis.

A total of 26 legislators, including 24 Democratic United Party lawmakers and 2 minor progressive party members, proposed the bill to introduce the Tobin tax that will levy a low rate in ordinary times on foreign exchange (FX) transactions, while imposing a super-high rate of 10-30 percent under the crisis.

The bill defined the crisis situation as volatility of over 3 percent in the dollar/won exchange rate compared with the previous session. Over the past 22 years, the dollar/won exchange rate showed the volatility breaching the 3 percent level only 36 times, meaning that the levy will not be burdensome for FX transactions except for the extreme volatilities in times of market tensions.

Volatilities in the dollar-won exchange rate surged to 19.83 percent in January 1998 around two months after the Asian foreign exchange crisis led South Korea to seek bailout funds from the International Monetary Fund. The volatilities soared to 7.4 percent in October 2008 when the Lehman collapse drove the global financial market into unceasing instabilities.

The lawmakers said at a joint press conference that the proposed bill was mainly aimed at stabilizing the FX market, whose instabilities under the crisis led to excessive industrial restructuring, higher jobless rate and souring domestic demand. They stressed that the bill did not aim to increase tax revenues.

The Tobin tax was suggested by Nobel Laureate economist James Tobin in 1972 one year after the Bretton Woods system collapsed. The tax was devised to reduce the exchange rate fluctuations by levying a small tax on all spot conversions of one currency into another.

Tobin's suggestion failed to attract attention at that time when the economist proposed the tax, but it began to receive attention following the Asian financial crisis in late 1990s.

The Tobin tax was back in the limelight after 10 European countries, including Germany and France, showed their willingness last month to introduce another type of the Tobin tax that is called the financial transaction tax (FTT). The European Commission gave its support to the FTT adoption plan.

In Europe, such taxes were aimed at making the financial sector share the costs of the crisis that would otherwise have to be shouldered by blameless ordinary citizens. The European Commission estimated that the harmonized FTT would raise 570 billion euros in tax revenues each year.

For opponents, the transaction tax may impose burdens on households and companies as such taxes will make the financial sector, which are already in troubles, more distressed, leading to weaker access to credit. The financial institutions may pass the increased costs to businesses and households.

Despite the potential side effect, it had high probabilities for South Korea to adopt the Tobin tax because major presidential candidates will likely show favorable position on such tax adoption.

Independent presidential hopeful Ahn Cheol-soo said earlier this month that he favored the Tobin tax imposed on short-term FX transactions with a maturity of less than one year, saying that the introduction period should be decided through international cooperation.

The main opposition Democratic United Party, which led the proposal of the Tobin tax bill, said that it will talk with its presidential contender Moon Jae-in about the tax, while the ruling Saenuri Party was reported to ask its presidential candidate Park Geun-hye to include the Tobin tax launch in the campaign pledges.

The adoption in Seoul, however, was expected to be progressed in a cautious manner as it could lead to a foreign fund exodus, with foreign capital seeking to dodge the tax by trading elsewhere.

Other options remained to reduce the FX volatility. The Bank of Korea and Financial Supervisory Service reportedly conducted a joint inspection into FX forward positions held by local banks. Depending on the results, the limit on FX forward positions could be tightened further.

Currently, local branches of foreign banks are required to hold FX derivative positions equivalent to 200 percent of equity capital, with the cap being set at 40 percent for domestic banks. Expectations spread that the ceilings may be cut to 150 percent for foreign banks' branches and 30 percent for local banks.

The possibly tightened rule was expected to lessen the volatility in the dollar/won exchange market as it will reduce the foreign fund inflow into the country.

The recent foreign capital inflow boosted fears over the possible financial market instability as the possible deepening of the external uncertainties such as the U.S. fiscal cliff issue and the eurozone fiscal crisis may trigger the foreign fund exodus.

The persistent appreciation of the South Korean won against the U.S. dollar stemming from the persistent foreign fund inflow raised concerns over the country's exports, which account for around half of Asia's No. 4 economy.

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