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Asian currencies have come under pressure due to the dollar’s strength and a global economic slowdown. After the Japanese yen, South Korea’s won is now on a multi-year decline, falling to a 13-year-low against the US dollar in July. The Korean currency has declined more than 9% in 2022, hitting a multi-decade low of 1,318.8 on July 18, and closing at 1,308 on August 3.
The last time South Korea’s won breached the 1,300 mark was back in 2009 during the global financial crisis, and during the Asian financial crisis of 1997-98. The country is the world’s seventh largest exporter of goods, as per World Trade Organisation. In 2020, trade made up 70.1% of South Korea’s GDP, as per data from World Bank.
Why is South Korea won falling?
The South Korean economy fared relatively well during the Covid-19 pandemic, and contracted 0.9% in 2020, a figure which is muted than most other economies around the world. The country’s export-based economy has been on the path of recovery, but a global economic slowdown is expected to impact Seoul.
For the month of July, South Korea reported a 9.4% increase in exports to $60.70 bn, after rising by 5.2% in the months before. The stronger exports paint a rosy picture, but the country’s imports have risen 21.8% to $65.37 bn. The problem is the trade deficit of $4.67 bn, the biggest in six months and for the fourth straight month. For the six months until June, the trade deficit has hit a record $10 bn.
South Korea won is likely to come under pressure in the coming months if the trade deficit number fails to improve. Additionally, a slowdown in global economies and a potential recession may cause exports to remain muted, further impacting the value of the won.
On the other hand, South Korea is also battling high inflation which is hovering near a 24-year high. The consumer price index (CPI) stood 6.3% higher in July, its fastest pace since the 6.8% gain seen in November 1998.
The Bank of Korea has been diligent with raising interest rates in response to the rising prices and has scaled its policy interest rate to 2.25% from 0.5% last year. Most recently, the central bank delivered its first ever 50 basis point rate hike, and another 25 bps is expected in the next monetary policy meeting.
However, the rate hikes have failed to stem the rout in South Korea won, as investors are favouring dollar assets with the US currency strengthening.
“While it is true that KRW has stayed on the weak side, it is probably because Japan and China, the two major central banks in the region, are going against the tide of the global tightening cycle. So, the KRW may have a rather negative spillover effect as Korea’s trade volume with the two countries is relatively large,” said ING in a note.
Outlook for South Korea won
South Korea’s stock market has seen massive declines, while dividend yields have sharply reduced. The benchmark index KOSPI has fallen nearly 17% in 2022 as foreign investors have been on a selling spree, offloading $11.5 bn worth of Korean stocks in 2022.
Market experts believe the weakness in the Korean won is likely to continue in the medium term, with a Bank of America Corp strategist telling Bloomberg that he expects KRW to hit 1,350 levels against the dollar by the end of the year. Another analyst said there might be faster depreciation of the currency to hit 1,350 within the next quarter.
Another potential headwind for the won’s recovery is South Korea’s National Pension Service (NPS) plan to increase investments in overseas equities to 30.3%, which it will do by selling the won in exchange for foreign currencies. During the first five months of 2022, the NPS bought $10 bn of foreign bonds and stocks. A foreign exchange dealer told Reuters that the continued outflows by the NPS took the won down. Set up in 1988, the NPS manages 919.6 tn won ($702.03 bn) of assets, which makes up 40% of the annual GDP of the country.
However, South Korea’s economy unexpectedly picked up in the second quarter after reporting a GDP for the April-June quarter of 0.7% quarter-on-quarter. This may help the Korean won as the central bank further hikes rates.
“While more rate hikes are ahead inflation at 6% leaves Korean won with a negative rate gap of 375bp, and hence KRW support from higher interest rates should be fairly limited in our view,” said Singapore Exchange in an insights report published on SmartKarma.
