How Will South Korea’s National Pension Fund Act as a ‘Currency Firefighter’? < Bonds/Forex < Article

(Seoul=Yonhap Infomax) Ha Rin Song – As speculative bets on a rising dollar-won exchange rate persist despite verbal intervention by the so-called F4 group, the South Korean government has turned to the National Pension Service (NPS) as a potential stabilizing force.

On the 25th, the Ministry of Economy and Finance, Bank of Korea, Ministry of Health and Welfare, and the National Pension Service convened the inaugural meeting of a four-party consultative body.

The stated purpose of the group is “to review the impact of the NPS’s overseas investments on the foreign exchange market,” and to “discuss ways to harmonize the NPS’s investment returns with the stability of the FX market.”

Strategic and Tactical FX Hedging in Focus—Up to $77 Billion Limit

Market participants expect the consultative body to focus on both tactical and strategic FX hedging by the NPS.

The NPS is authorized to conduct tactical FX hedging on up to 5% of its foreign assets at its own discretion. Given the most recent disclosure showing overseas assets of 702.549 trillion won ($540 billion), this means the NPS’s fund management division can independently sell up to about 35 trillion won ($27 billion) worth of dollars.

Currently, the NPS is not fully utilizing its tactical hedging capacity. As of end-May, its tactical FX hedge position stood at $11.17 billion (16.5 trillion won), representing 2.17% of its total foreign assets of $51.389 billion.

Earlier this year, the NPS increased its tactical hedging to $15.094 billion (3.09%) in March, but began reducing the position from April as the dollar-won rate declined. Between April and May, the NPS cut its tactical hedge by $3.92 billion.

Rough estimates suggest the NPS still has about 18 trillion won ($13.8 billion) in remaining tactical hedging capacity.

The market’s main focus is whether the NPS will resume strategic FX hedging and at what scale. Strategic hedging can be implemented on up to 10% of foreign assets if the exchange rate deviates significantly from the long-term average, as determined by the NPS Fund Management Committee.

Earlier this year, the NPS’s strategic hedging led to sustained dollar selling in the market, helping to push down the dollar-won rate—a move closely watched by market participants.

In January, when the dollar-won rate exceeded the long-term average and broke above 1,450 won, the NPS activated strategic hedging. The NPS’s internal research assumes mean reversion in the exchange rate, so it responds with hedging when the rate is abnormally high to prevent large FX losses as the rate normalizes.

Strategic hedging reportedly ceased around June, when the dollar-won rate returned to the 1,300 won range, with the scale estimated at around 3% of foreign assets.

With the exchange rate now approaching 1,480 won, the market believes the conditions for strategic hedging have been met again and is awaiting the NPS’s next move. The consultative body is expected to discuss the timing and scale of any renewed strategic hedging.

Min Kyung-won, research fellow at Woori Bank, said, “Although the NPS’s actual hedging volume at the start of the year was not large, it clearly had a stabilizing effect on the market. The market is now highly alert to when and how much the NPS will hedge.”

He added, “At this point, the criteria for strategic hedging appear to have been met, so this will likely be discussed first. Next, there may be talks on how to handle the FX swap contract volume with the Bank of Korea.”

Bank of Korea FX Swap Likely to Be Extended—Overseas Investment Ratio Adjustment Unlikely

One likely outcome from the consultative body is the extension of the $65 billion FX swap agreement between the NPS and the Bank of Korea, a key hedging tool. Instead of sourcing dollars from the market, the NPS draws from foreign reserves, minimizing FX market pressure. The current agreement expires at year-end.

Since the swap is reportedly cheaper than market hedging costs, the NPS—concerned about hedging expenses—has little reason to oppose an extension.

Raising the NPS’s domestic asset allocation is also being discussed, but is widely seen as unrealistic. The NPS’s mid- to long-term asset allocation plan calls for reducing its domestic equity share by about 0.5 percentage points annually through 2030, though this could be reviewed in next May’s asset allocation update. Adjusting the strategic and tactical deviation bands (3% and 2%, respectively) is another option.

However, given that Korean equities account for less than 1% of global market capitalization, increasing domestic allocation is difficult from a returns perspective. Such a move would not satisfy both NPS returns and FX market stability.

Yoon Seok-myung, honorary research fellow at the Korea Institute for Health and Social Affairs, said, “The NPS is meant to secure retirement income for the public, so using it as a government ‘firefighter’ is not appropriate. If problems arise, accountability issues could surface.”

Authorities Tweak Around the Edges—“NPS Not the Core Issue”

Some argue that supply-demand factors are secondary in stabilizing the dollar-won rate. They point to fundamental drivers such as rising national debt and surging government bond yields as the main causes of the exchange rate spike, suggesting that tinkering with supply-demand has its limits.

With the market eyeing 1,500 won as the upper bound for the dollar-won rate, some believe the NPS may be reluctant to hedge at current levels.

Lee Hyo-seop, senior research fellow at the Korea Capital Market Institute, said, “Maintaining fiscal soundness and controlling the pace of government bond issuance should be the priority. NPS hedging and retail overseas investors are secondary measures. The market consensus is that we are not in an overshooting phase.”

hrsong@yna.co.kr

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Ha Rin Song hrsong@yna.co.kr