KRW-USD Exchange Rate Stabilizes After Surge... National Pension Service Hedging Background and Outlook

[Anchor] Today, we'll take a detailed look at the background of the recent surge in the KRW-USD exchange rate, future prospects, and the National Pension Service's hedging issue that many are curious about. First, could you briefly explain the recent exchange rate trends?

[Lee Kyu-sun, Reporter] The KRW-USD exchange rate closed at 1,453.50 won yesterday. It has stepped back from the concerning 1,500 won level.

Looking at the exchange rate trend, on the 27th of last month, the rate rose to 1,486.70 won during trading, marking the highest point, and has since shown signs of stabilization. Let's examine the flow so far.

On the 27th of last month, when the peak was recorded, it was the day Acting President and Prime Minister Han Duck-soo was impeached. President Yoon Suk Yeol's impeachment bill had already passed. When concerns grew that even the acting president might be impeached, the won weakened in response.

At that time, when I asked foreign bank traders for various overseas opinions, they said there were concerns abroad about who was managing Korea's economy and that it should be viewed as a risk level of an emerging country, not an advanced one. That's why the exchange rate rose to 1,486 won.

However, the upward trend has somewhat stabilized since then. This is because Acting President and Deputy Prime Minister Choo Kyung-ho appointed constitutional court judges, reducing concerns about consecutive impeachments by the opposition party.

[Anchor] Acting President Choo appointed two out of three constitutional court judges, right?

[Reporter] Yes, that's correct. It's known that there was considerable opposition from cabinet members at the time. It's reported that Deputy Prime Minister Choo made the appointments out of concern for our country's external credibility. Especially after the appointment, Bank of Korea Governor Rhee Chang-yong actively supported Deputy Prime Minister Choo's decision, which also became a topic of discussion.

It's known that there was a sense of crisis that if Deputy Prime Minister Choo was impeached for not nominating judges this time, our country's international credit rating could even be downgraded. In fact, France's credit rating was downgraded due to political turmoil. Moody's lowered France's national credit rating from Aa2 to Aa3, seeing that fiscal deficits would be difficult to reduce due to political division.

Once a credit rating goes down, it's extremely difficult to recover. Even the United States, which was downgraded from AAA to AA+ by S&P standards in 2011, has not yet recovered.

Also, as foreign media reported that President Trump might pursue selective tariffs rather than universal tariffs, the KRW-USD exchange rate faced downward pressure. And the news that hedging volume, presumed to be from the National Pension Service, appeared in the market also made the KRW-USD decline steeper.

[Anchor] What is the National Pension Service's currency hedging?

[Reporter] The National Pension Service has a very large amount of overseas investment assets. It's about 480 billion dollars, approximately 700 trillion won. The return on foreign assets is greatly influenced by exchange rate fluctuations. If 480 billion dollars is worth 1,000 won, the asset value is 480 trillion won, but now it's 700 trillion won. The asset value has increased that much because the exchange rate has risen. Foreign investments are very vulnerable to exchange rate fluctuations.

The National Pension Service has an annual target return of 5.4%. But last year, the exchange rate rose from 1,300 won to 1,470 won, over 10%. The exchange rate alone achieved the target return. If the exchange rate falls by 10%, they could incur losses even with good management. So when the exchange rate rises too much, the National Pension Service prepares for a potential fall. This is called foreign exchange risk hedging, or simply currency hedging.

[Anchor] This currency hedging by the National Pension Service appeared in today's foreign exchange market. Could you explain what this means in more detail?

[Lee Kyu-sun, Reporter] To put it simply, it means selling dollars in advance. It's called 'forward exchange sale' or 'forward'. A forward exchange sale is a contract to sell foreign currency at a predetermined exchange rate at a specific point in time. For example, if the current exchange rate is 1,480 won and it's expected to fall in a year, they make a contract to sell dollars at 1,480 won now. This way, even if the exchange rate falls after a year, they can sell foreign currency at the predetermined price, reducing losses. In simple terms, you can think of it as a kind of insurance to reduce the risk from exchange rate fluctuations. When institutions managing large-scale assets like the National Pension Service use this strategy, they can manage funds stably even with changes in the foreign exchange market. It's estimated that this volume appeared in the Seoul foreign exchange market today. The National Pension Service holds an enormous amount of assets. As it's expected that such forward exchange sales will continue steadily in the future, there were many bets on dollar depreciation in the foreign exchange market.

[Anchor] There are also allegations that the government is trying to lower the exchange rate by mobilizing the National Pension Service for this hedging. What's the actual situation?

[Reporter] To conclude first, the National Pension Service's currency hedging is not forced by the government but is the fund's own operational strategy. The National Pension Service's strategic currency hedging is activated under very systematic conditions. It means it's not done because someone orders it, and it can't be. Looking at the conditions for activating strategic currency hedging, if the exchange rate exceeds 2.58 times the standard deviation level compared to the long-term average for 5 business days, they reduce foreign exchange risk through dispersed selling (currency hedging). A standard deviation of 2.58 means a 99% confidence interval. It means they hedge when the exchange rate has fallen extremely to a 1% level in the long-term time series. In terms of the KOSPI, it would be around 1,400 points. At this point, it would be worth buying for the pension, if they have a lot of money to buy. It would greatly help the return rate.

No matter how much our country is in structural low growth, the exchange rate tends to return to the long-term average eventually. Even looking at the Japanese exchange rate, which experienced long-term low growth and ultra-low interest rates in advance, the USD-JPY exchange rate has gone back and forth more than twice, from 75 yen to 160 yen. In such a situation where the exchange rate is significantly high, hedging the exchange rate to secure profits on the increase helps the return rate. If you don't hedge when the exchange rate was high, you're rather missing out on the gains you could have from the exchange rate. The National Pension Service's foreign assets are about 700 trillion won, and if they earn just 5% from the exchange rate, it's 35 trillion won. I think the pension's hedging will significantly help the return rate, and I understand that the fund management committee members also have the same stance.

[Anchor] Meanwhile, there was news that the foreign exchange reserves announced last month increased slightly. In a situation of rapid exchange rate increase, it's common for reserves to decrease due to authorities' market intervention. What could be the reason?

[Lee Kyu-sun, Reporter] Looking at our country's foreign exchange reserves as of the end of December, it's 415.6 billion dollars, an increase of 210 million dollars compared to the previous month. When the exchange rate soars, there's a high possibility that foreign exchange reserves will decrease as foreign exchange authorities release dollars into the market, but this time, the amount of foreign currency deposited by financial institutions to the Bank of Korea for managing their capital adequacy ratio at the end of the year increased significantly. As a result, reserves actually increased. The authorities admitted that they actually intervened in the market in December. Governor Rhee Chang-yong also stated that they conducted smoothing operations due to the rapid increase in the exchange rate. However, it seems that the intensity was not strong. It's also reported that there were quite a lot of foreign currency deposits from financial institutions at the end of the year. When banks deposit foreign currency in the central bank, the deposit is classified as a safe asset, making it easier to meet the capital adequacy ratio. In fact, foreign exchange reserves have repeatedly increased at the end of each quarter and decreased again the following month. So there's a high possibility that reserves will turn to decrease again in January. There are positive evaluations of the authorities' cautious market intervention like this. It's evaluated that they saved money while intervening appropriately in market panic situations. Some argue that foreign exchange reserves should be used to prevent exchange rate increases, but the Korea Institute for International Economic Policy (KIEP) warns that "if large-scale, long-term dollar selling interventions continue, it could eventually lead to a rapid decrease in reserves and a decline in external credibility." There have been cases in the past where emerging countries experienced foreign exchange crises after excessively intervening in the market to suppress exchange rates.

[Anchor] Aren't the reserves insufficient?

[Reporter] The 415 billion dollars in reserves could be seen as insufficient. However, the authorities' view is a bit different. Bank of Korea Governor Rhee Chang-yong said, "The current level of 400 billion dollars is sufficient." The IMF also classifies Korea as a market-mature country, not an emerging country, excluding it from the Assessing Reserve Adequacy (ARA) evaluation for emerging countries. According to IMF standards, there have been many claims here and there that our country's foreign exchange reserves are insufficient, but the IMF changed the evaluation criteria for Korea. It excluded Korea from the ARA quantity assessment targets. While doing so, it's evaluating that our country's foreign exchange reserves are at a sufficient level. (End)

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