[Yoo Kwon Ko's Companis]Stock Investment Migration and the High Exchange Rate

(Seoul=Yonhap Infomax) The exchange rate remains a source of trauma for South Koreans. Nearly three decades have passed since the 1997 International Monetary Fund (IMF) foreign exchange crisis, yet anxiety resurfaces whenever the dollar flows out of the country. The psychological and material aftershocks of the national default still linger. The former Deputy Prime Minister’s remark that “1,400 won per dollar is the new normal” has become a reality, with the dollar-won rate now approaching 1,500 won. The exchange rate level of a country directly reflects its economic fundamentals. In South Korea’s export-driven, once-small open economy, a high exchange rate historically boosted exports. However, this is no longer the case. The economy has outgrown its ‘small’ status, and its openness has increased significantly. Today, a high exchange rate has a more negative impact on the Korean economy.

According to a survey by the Korea Chamber of Commerce and Industry earlier this year, 63% of the country’s top 50 companies based their 2024 business plans on a dollar-won exchange rate of 1,300 won, calculating investments, financing, and costs accordingly. However, the rate has since risen by nearly 200 won. While exporters may benefit from increased won-denominated revenues, their cost burdens have risen by as much or more, negating any positive effects. The surge in raw material and intermediate goods prices has further increased cost pressures, threatening profitability. Given South Korea’s manufacturing-centric industrial structure and high dependence on imports for raw materials and key components, sharp cost fluctuations and rising burdens are likely to erode corporate earnings.

Large conglomerates, seeking to expand R&D and overseas investment, often issue bonds or borrow directly in dollars abroad. A rapid rise in the exchange rate not only increases interest expenses but also leads to accounting losses from currency fluctuations. This forces companies to delay investments and ultimately curtails business activity, undermining the foundations for growth. Hedging against exchange rate volatility is not easy, as it entails additional costs. When volatility increases, it becomes difficult to decide whether to hedge at all, trapping firms in a cycle of uncertainty.

It is not only corporations that are struggling. According to Bank of Korea data released on the 21st, last month’s Producer Price Index (PPI) rose 0.2% from the previous month to 120.82, up 1.5% year-on-year—the largest increase since February last year. The PPI, which tracks price changes for goods and services supplied by producers, typically feeds into consumer prices within a quarter. The Supply Price Index also rose 0.9% from the previous month, the biggest jump since April last year. The recent rise in semiconductor prices, coupled with the higher exchange rate, contributed to these upward trends. As long as the exchange rate remains elevated, consumer prices are likely to rise further, fueling inflation risks. This could impact interest rates and increase the interest burden on households.

Despite the clear economic burden of the current high exchange rate, most experts agree that it is unlikely to trigger the kind of trauma seen during the foreign exchange crisis. Unlike the 1997 crisis or the 2008 global financial crisis, when banks scrambled for short-term dollar funding, the current situation is markedly different. Back then, senior government officials pledged to “bring in dollars at all costs,” even traveling to the US. Unless the exchange rate suddenly surges past 2,000 won, such emergencies are unlikely. Ironically, there is no sign of a “Korea exit” by foreign investors or speculators dumping the won. Foreign investors continue to participate in both the bond and stock markets, with steady purchases of government bonds reflecting confidence in South Korea’s economic fundamentals. The dollar continues to flow into both the export and asset markets.

It is now widely recognized that the outflow of earned dollars is largely driven by the surge in overseas investment. Individual investors, known as “Seohak Ants” (Koreans investing abroad), as well as institutions led by the National Pension Service, are increasingly investing overseas. Despite the government’s strong push to boost the domestic stock market, with the KOSPI surpassing the 4,000 mark, retail investors are aggressively buying US stocks—almost akin to “stock migration.” According to Democratic Party lawmaker Park Sang-hyuk, individuals exchanged 158 trillion won ($119 billion) at nine securities firms through November 15 this year, far exceeding last year’s total of 136 trillion won ($102 billion). As of the end of Q3, the Bank of Korea reported that South Korea’s external financial assets, representing overseas investments, reached a record $2.798 trillion. Overseas securities investments by domestic residents in Q3 alone amounted to $89 billion, also an all-time high.

While the KOSPI is in a bull market, the US stock market is even hotter, with higher expected returns. Investors can profit both from rising stock prices and a strengthening dollar. As US stock investments increase, so does the incentive for a higher exchange rate. Even if US stocks correct, investors can offset losses or profit from currency gains. This two-way opportunity contrasts with the one-way structure of domestic stock trading, where gains are only made when prices rise. However, this dynamic creates a vicious cycle, perpetuating a high exchange rate. It is not feasible to ask individual investors to refrain from buying US stocks, nor can the government intervene in their pursuit of profit. Ultimately, the system itself must be improved.

Recently, President Lee Jae-myung instructed officials to devise measures to further benefit long-term investors amid the stock market rally. The Ministry of Economy and Finance is actively exploring ways to expand tax incentives, with one leading option being to benchmark Japan’s new NISA (Nippon Individual Savings Account) system introduced last year. Japan revamped its system, which previously exempted up to 1 million yen in annual dividends and capital gains from listed stocks and funds for five years, by raising the investment limit two- to threefold and effectively extending the tax-free period for life. In South Korea, the Individual Savings Account (ISA) exempts up to 2 million won ($1,500) of taxable income (4 million won for low-income accounts), with a 9.9% separate tax on the excess—far less generous than Japan’s system. If a similar product is introduced, it could attract significant interest from individual investors.

According to Japan’s Financial Services Agency, the number of new NISA accounts reached 25.6 million at the end of last year, up 17% from 21.25 million a year earlier. The expanded investment limits and generous tax exemptions have made NISA a foundation for “national asset-building,” especially among younger generations. Funds flowing into the Japanese stock market via these accounts nearly tripled. However, a growing share of these funds is being invested in overseas stocks, with 80% of NISA-linked funds allocated to foreign equities. As a result, overseas securities investment hit its highest level since 2015, contributing to the structural weakness of the yen—a problem now coming to the fore.

The South Korean government should take note. While some may argue that such measures would disadvantage overseas investors, if demand for overseas investment can be redirected domestically, even preferential tax incentives may be justified. The key is to enhance the attractiveness of the domestic stock market and create an environment conducive to investment. Tax incentives alone are not enough; structural solutions to the foreign exchange market’s supply-demand imbalance are also needed. Rather than piecemeal policies, a comprehensive approach with sound ingredients and a proven recipe is required. (Economics Editor)

pisces738@yna.co.kr

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