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Brexit raises fears of global recession, financial contagion
By Kim Jae-kyoung
South Korean markets face a growing risk of capital flight to safe haven assets following Brexit, or Britain's exit from the EU, analysts said Sunday.
The odds are low that Korea will suffer any massive capital flight in the short term, but it will see a large amount of money flow out of it over time as Britain's decision is raising the risk of financial contagion and another global recession.
They suggest that the Bank of Korea (BOK) should prepare to inject ample liquidity into markets as speculators may target currencies vulnerable to external shocks, such as the Korean won, in order to benefit from uncertainty caused by Brexit turmoil.
The fallout of Brexit is expected to send a shudder through the Korean economy through two channels — volatile currency markets in the short term and declines in exports in the long term due to growing protectionism.
"Korea would be adversely affected as Korea's major trading partners including the U.K., EU and Eastern Europe are hurt. Its primary effect on Korea will come through financial markets," said Sohn Sung-won, economics professor at California State University.
"The currency markets will gyrate as uncertainties mount. No one is sure how Brexit will affect the rest of the world since this will be a new experience."
Brexit is expected to pose the biggest threat to global markets since the collapse of Lehman Brothers in 2008 because uncertainty will likely linger for a considerable time due to the long process of the U.K.'s exit and its ripple effects.
On Friday when Britons voted to leave the 28-member bloc, Korea's financial markets tumbled as foreign investors dumped local shares with the Korean won losing value sharply against the U.S. dollar. The won closed at 1,179.9, down 29.7 won from a day before.
The British pound at one point fell 11.1 percent to $1.3229, its weakest level since the mid-1980s after the UK's historic decision. Wall Street was also hit, with its stocks losing 3.6 percent on fears of another global recession.
Maruo Guillen, director of the Wharton School at the University of Pennsylvania, said, "It is possible that emerging markets might suffer capital outflows, although I do not think the potential panic would affect South Korea. The biggest exposure would be in terms of lost trade."
"Major turmoil would happen in currency markets, with pound sterling and other currencies losing ground, and safe havens like the dollar gaining. Uncertainty in Europe would hurt consumer markets, and thus exports from other countries like South Korea," he added.
Brexit's ripple effects
What is of more concern is that market turmoil is not likely to be short-lived in two aspects.
First, regardless of macroeconomic environments and policy responses, speculators will disrupt markets as they feed on uncertainty.
"Governments and central banks may talk up again, assuring speculators that they will keep liquidity plentiful. Speculators may come back again," said former Morgan Stanley economist Andy Xie.
"A world that depends on speculation is not sustainable. It is just redistribution of income from the masses to a few," he added. Xie, currently an independent economist, is well known for having forecast Asia's financial crisis in 1997 and 1998.
Second, Brexit can be the beginning of dismantlement of six decades of political and economic integration of Europe, which will intensify market uncertainties and escalate the risk of global recession.
"In the longer run, political parties will want to leave the EU. Denmark, the Netherlands, Italy and others could contemplate abandoning their EU membership," Sohn said. "EU integration would face significant headwinds with global implications."
On Friday, Dutch anti-immigration leader Geert Wilders called for a referendum on the Netherlands' membership in the EU after Britain's historic decision.
Earlier, Italian Finance Minister Pier Carlo Padoan said a British exit from the European Union could become a trigger that could lead to a wider breakup of the EU amid tensions over migration and weak economic growth.
Against this backdrop, the Korean government needs to come up with contingency plans and take preemptive measures to minimize the negative effect from Brexit and its spillover effects.
Market experts said that it is important to prepare for the worst-case scenario by securing sufficient resources.
"The Bank of Koreashould be ready todeal withcontingencies includingmassive injections ofliquidityinto thefinancial markets," said Sohn, who is also director of the Institute for Global Economic Research in the U.S.
"Thegovernmentshould beready to assist businessestemporarilysuffering fromthe aftermath."
Moody's Analytics economist Emily Dabbs said that the government should resort to a mix of policies to deal with market volatility.
"Fiscal stimulus measures are on the cards, and the central bank may even take an active role in stabilizing volatility in the exchange rate and providing liquidity support in the short term," she said.
