(Seoul=Yonhap Infomax) The planned $350 billion US investment fund, agreed upon with the United States, must not become an obstacle to ushering in the era of the KOSPI index reaching 5,000. Even if the fund is raised over three years at $117 billion per year, the scale of annual dollar procurement far exceeds what South Korea’s foreign exchange market can absorb, potentially impacting not only the exchange rate but also the entire domestic financial market, including the bond market, in ways that could be difficult to predict.


To put this in perspective, $100 billion is equivalent to nearly 25% of the Bank of Korea’s foreign reserves and more than double the National Pension Service’s estimated annual dollar demand of $40 billion. As a result, South Korea has requested a currency swap agreement with the US as a safeguard for domestic financial market stability, but such negotiations have proven challenging.


Beyond the Korea-US currency swap, all conditions—including domestic foreign exchange supply-demand and market structure—are currently unfavorable. Despite a persistent trade surplus, strong overseas asset purchases by retail investors (“Seohak Ants”) and increased US-bound investments by Korean corporates have led to a structural dollar demand surplus. According to the International Finance Center, South Korea’s cumulative current account surplus exceeded $60 billion through July this year, but monthly outflows of around $10 billion for overseas securities investments have offset these inflows. This suggests that most foreign currency inflows from the current account surplus will continue to be channeled abroad. Furthermore, although trading hours have been extended and offshore institutions have been allowed to participate since two years ago, the domestic foreign exchange market still lacks sufficient breadth and depth.


According to the Bank of Korea, the depth of South Korea’s financial and foreign exchange markets remains shallow even compared to other emerging economies. The country’s Uncovered Interest Parity (UIP) premium response coefficient stands at 2.11 percentage points, higher than both advanced economies (0.41 percentage points) and the emerging market average (1.68 percentage points). The UIP premium represents the additional cost domestic entities must pay global investors when borrowing abroad. A high response coefficient indicates that, in the event of a global financial crisis, the won could depreciate sharply and short-term interest rate spreads could widen significantly. To address this, further structural reforms of the foreign exchange market and the planned inclusion in the World Government Bond Index (WGBI) next year are seen as potential solutions. Accordingly, the Ministry of Economy and Finance and the Bank of Korea are preparing a second round of market reforms, including a roadmap for introducing 24-hour trading in the domestic foreign exchange market, to be announced around November.


Against this backdrop, it is understandable why President Lee Jae-myung recently warned that accepting the $350 billion US investment demand could expose South Korea to a financial crisis reminiscent of 1997, and why Policy Chief Kim Yong-bum emphasized that it would be difficult for policy banks to raise more than $20–30 billion in foreign currency annually. Citibank has estimated that South Korea would need to issue 119–133 trillion won ($85–95 billion) in government bonds each year to fund the US investment, equivalent to 50% of the country’s annual government bond issuance. This could drive up interest rates and weaken the won. Citi recommends measures to stabilize market sentiment, such as extending the investment deadline beyond January 2029 and making it more flexible, to mitigate risks of instability in the bond and foreign exchange markets.


Although nearly 30 years have passed since the foreign exchange crisis referenced by the president, South Korea’s foreign exchange market has not grown in line with the size of its economy. The trauma of the 1997 crisis and the limitations of being a non-reserve currency have constrained both policymakers and market participants. The key concern is that the market’s lack of both qualitative and quantitative depth should not again lead to heightened foreign exchange instability. Market consensus holds that a more aggressive opening of the foreign exchange market is necessary to achieve meaningful depth. Only then can the president’s pledge of a KOSPI 5,000 era be realized. If dollar-won exchange rates continue to rise due to US investment fund procurement, concerns over returns could reduce long-term foreign investment in the domestic stock market. Notably, inclusion of the domestic stock market in the MSCI Developed Markets Index also hinges on the degree of foreign exchange market openness. As Paulo Coelho, author of the bestseller “The Alchemist,” noted, staying in one’s comfort zone out of fear of risk can itself become fatal. It is time for authorities to devise creative solutions for both the US investment fund and the foreign exchange market. (Digital News Director)


liberte@yna.co.kr


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