A stronger won lowers import prices, boosting household purchasing power and particularly expanding spending capacity among low-income families, according to an analysis by the Bank of Korea.
A 10% drop in the won-dollar exchange rate would improve overall household real purchasing power by about 0.35%, according to a BOK report on conditions for a recovery in private consumption released on the 22nd. Of that, 0.15 percentage point comes from the direct effect of lower prices for imported finished goods, and 0.2 percentage point from the indirect effect of reduced costs for imported intermediate goods.
The gain for low-income households was more than double that for high earners. A 10% decline in the exchange rate would improve purchasing power relative to disposable income by 0.46% for households in the bottom 20% of the income distribution, compared with just 0.20% for those in the top 20%.
The central bank said the reason is that consumption spending accounts for a larger share of income among lower-income households. Exposure to imported goods does not differ much across income brackets, but the same price decline delivers greater relief to low-income families, the BOK said.
Governor Shin Hyun-song also said at a press briefing following the monetary policy board meeting that day that a stronger won helps raise household purchasing power by lowering import prices and narrows gaps between income brackets.
The won began strengthening in earnest after July. The won-dollar rate, which stood above 1,480 won in the first half of this year, continued to decline and fell to the 1,350-won range in September, 8% below the first-half average. The won also strengthened against the currencies of major trading partners, including the yuan, the yen and the euro.
Shin described the recent decline in the exchange rate as a normalization of abnormal conditions in the foreign exchange market in early summer. Although the rate has fallen quickly, the won remains undervalued compared with its historical average, he said.
He cited the Bank for International Settlements' effective exchange rate index. Against a past average of about 101, the index stood at around 89 as of the end of August, he said. The effective exchange rate is a weighted average of the currency values of major trading partners, with a lower reading indicating a relatively lower currency value.
He stopped short of suggesting the exchange rate must return to its historical average. "Market predictability matters more than the level or volatility of the exchange rate," Shin said.
Beyond the stronger won, the BOK expects larger performance bonuses and dividends tied to the semiconductor boom, along with increased government transfers to households, to support a consumption recovery next year. The report estimated that special performance bonuses at major companies would lift private consumption growth next year by 0.1 to 0.15 percentage point, higher dividend income by about 0.05 percentage point, and expanded household transfers by 0.2 to 0.25 percentage point.
The benefits of bigger bonuses and dividends, however, are likely to be concentrated among high earners. Expanded transfers and the lower exchange rate, by contrast, were seen as lifting spending capacity among middle- and low-income households and broadening the base of the recovery. "How widely the effects of the semiconductor upturn spread to the household sector will determine the strength and durability of the private consumption recovery," the BOK said.
High household debt, a slump in housing construction and the reverse wealth effect from the recent stock market correction were cited as constraints on the recovery. Shin also said the recent pullback in share prices is weighing on consumption.
"As we move into next year, the warmth of the semiconductor boom will spread across households, and the private consumption recovery will gradually strengthen," the BOK said.