Won expected to strengthen further due to increased investment in semiconductors and interest rate hike by the Bank of Korea

(Seoul = Yonhap News) Reporter Lim Ji-woo = The prospect of the won's further strength is growing due to strong semiconductor exports and the Bank of Korea's preemptive base interest rate hike.

With the exchange rate falling to its lowest level in 13 months, there are predictions that the value of the won may recover to the level before the COVID-19 pandemic as the yen's weakening synchrony is broken.

◇ “With the announcement of domestic investment by Samjeon and Hanik… further appreciation of the won until next year”

According to the financial sector on the 30th, the International Finance Institute (IIF) predicted in its analysis report 'Brighter Outlook for the Korean Won' released on the 25th that the current account surplus will reach 10% of the gross domestic product (GDP) by next year, increasing the possibility of further strengthening of the won.

According to the report, from last year to the first half of this year, despite the expansion of the current account surplus, the won weakened significantly due to the weakening yen, increased overseas investment by residents, and foreign net selling of stocks.

In particular, it was analyzed that when the yen weakens, the synchrony between the won and yen has been strengthened as foreign investors who believe that Korea's export price competitiveness will decline are reluctant to invest domestically. This is because the main export items such as automobiles and technology products are similar.

However, since July of this year, the won has appreciated significantly compared to the yen, breaking this trend.

The report pointed to Samsung Electronics [005930] and SK Hynix [000660]'s investment plan for domestic semiconductor production facilities worth 800 trillion won, announced at the end of June, as a key reason for the breakdown of the weakening won-yen trend.

The report said, "Market expectations regarding Korea's future balance of payments have changed significantly. Until recently, it was thought that Samsung Electronics and SK Hynix would keep a significant portion of their export proceeds overseas for overseas investment, but now there is a greater possibility that they will convert this into won to finance domestic investment projects."

He continued by predicting that even though the two companies have not yet exchanged export proceeds, the market has already established expectations for a strong won, which will support the won's strength for several quarters to come.

In addition, considering the government's policy of strengthening loan management to suppress 'debt investment' (investment through borrowing), it is predicted that Seohak Ant's overseas investment outflow will also slow down compared to last year.

Although the future exchange rate forecast was not presented in specific figures, it was expected that the value of the won would recover to around the level in early 2020.

The report pointed out, “The effects of regulatory measures to expand the exchange of export profits from semiconductor companies and suppress foreign investment outflows have not yet been fully reflected in the exchange rate,” and added, “As these capital flows become more evident, the won is expected to appreciate further, reversing much of the nominal effective exchange rate depreciation that has occurred since the start of the COVID-19 pandemic.”

The nominal effective exchange rate is an indicator of the purchasing power of the won in international trade, and moves closely with the won/dollar and won/yen exchange rates of the currencies of major trading countries.

Recently, the nominal effective exchange rate of the won has steadily fallen from 100 in 2020 to the mid-to-late 80s.

During this period, the won/dollar exchange rate rose from the annual average of 1,180.1 won in 2020 (based on weekly trading closing price) to 1,421.97 won last year. This year's average is 1,475.92 won as of the 28th.

◇ The Bank of Korea continues to raise interest rates ahead of the United States... Will the exchange rate settle in the 1,300 won range?

Domestic and external conditions, such as Korean and U.S. monetary policies, are also supporting the won's strength.

The Bank of Korea's Monetary Policy Committee continued to raise the base interest rate in August following July.

As the U.S. Federal Reserve (Fed) accelerated austerity, the policy interest rate gap between Korea (3.00% per year) and the United States (3.50-3.75% per year) decreased to 0.75 percentage points (p). This is the smallest gap in 3 years and 8 months since November 2022.

Bank of Korea Governor Shin Hyun-song said that although the current exchange rate is more stable than in the past, it is still at a high level and that this interest rate increase has created room for the won to strengthen further.

He said, “The exchange rate has fallen considerably and stabilized compared to the end of June, but it is still at a historically high level.”

He continued, “It is desirable for the won to become stronger to limit inflation,” and predicted, “There is room for further strength through preemptive monetary policy response.”

As the fundamentals for a strong won were established, the won/dollar exchange rate approached 1,370 won, hitting the lowest level in 13 months.

As of 3:30 p.m. on the 28th, the exchange rate was 1,372.5 won, the lowest since July 24 last year (1,367.2 won).

The next morning (Korean time), when U.S. Federal Reserve Chairman Kevin Warsh expressed his will to stabilize prices at the Jackson Hole Economic Symposium, the dollar strengthened and the exchange rate rebounded slightly, but stayed below 1,380 won.

The U.S. foreign exchange authorities are showing their will not to tolerate the weakening of East Asian currencies, including Japan, in order to stabilize their own government bond interest rates.

In a letter to Congress on the 27th, U.S. Treasury Secretary Scott Besant said regarding the background of the unusual intervention to buy the yen last month, "Japan is a major holder of U.S. Treasury bonds," and added, "If the yen market becomes disorderly, forced liquidation of positions may be triggered."

As the exchange rate has fallen sharply since July, it is predicted that it will take a breather for the time being and show a gradual decline.

Even if SK Hynix's ADR fund inflow is completed, the Korean won's strong fundamentals, such as Korea-US monetary policy, Samsung Electronics' policy of expanding shareholder returns, and the largest ever current account surplus, are expected to pull down the exchange rate at least until the first half of next year.

Seo Jeong-hoon, senior research fellow at Hana Bank, said, "Improvement in semiconductor supply and demand, robust exports of major companies, and the possibility of additional tightening by the Bank of Korea are increasing downward pressure on the exchange rate. Considering the fact that U.S. President Donald Trump may increase pressure to lower interest rates ahead of the midterm elections, the won's strength is expected to gain strength toward the end of the year."

He said, “The exchange rate may fall further to the 1,360 won range in the second half of this year, and the decline is expected to increase in the first half of next year, fluctuating around 1,350 won.”

There is also a prediction that the exchange rate will lower to the low 1,300 won range.

Moon Jeong-hee, chief economist at KB Kookmin Bank, said, “As the interest rate gap with the United States narrows further due to Korea’s additional interest rate hike in the first half of next year, the exchange rate is expected to fluctuate in the range of 1,310 to 1,390 won.”

However, some point out that there is a possibility of a rebound to the 1,400 won range as the demand for buying at low exchange rates is not small.

Lee Nak-won, NH Nonghyup Bank's FX derivative expert, said, "If U.S. stocks gain momentum, especially in the semiconductor sector, net purchases of U.S. stocks by individuals may expand. There is a possibility that the exchange rate will rise again to the low 1,400 won range at the end of the year."

Baek Seok-hyeon, an economist at Shinhan Bank's S&T Center, said, "If you look at the dollar's movements over the past five years, the dollar has tended to strengthen every September. In the process of digesting the results of the Jackson Hole meeting at the end of August, exchange rate volatility may increase, and with the influx of low dollar buying, I think the fourth quarter exchange rate will average 1,410 to 1,420 won."