Foreigners Already Near Last Year's Bond Investment Amount...Last Month's Net Investment 'Slows Down'

[Asia Economy Reporter Ji Yeon-jin] Foreign investors have made a net investment of 22.6 trillion KRW in domestic bonds from the beginning of this year until last month. Foreign bond investment switched to net buying from January this year and continued net buying for four consecutive months, but since the investment scale shrank from last month, there are concerns about the possibility of capital outflow.

The Financial Supervisory Service (FSS) announced on the 14th that foreign investors net purchased about 39.4 trillion KRW in the domestic bond market and redeemed 16.8 trillion KRW in matured bonds, resulting in a final net investment of 22.6 trillion KRW through April this year. This amount is close to last year's total net investment of 24.7 trillion KRW.

Foreigners' net investment in domestic bonds recorded a historic monthly high of 9 trillion KRW in February and 9.1 trillion KRW in March, but decreased to 3.3 trillion KRW last month. In this year's bond market, Asia accounted for the largest net investment of 8.8 trillion KRW, followed by Europe (6.6 trillion KRW) and the Middle East (2.5 trillion KRW). Notably, European funds, which recorded a net outflow of 2.1 trillion KRW last year due to the euro's strength, switched to net buying this year.

As of the end of last month, the balance of foreign holdings in domestic bonds was estimated at 174 trillion KRW. Among foreign investors by holding balance, central banks, which tend to have relatively medium- to long-term investment characteristics, accounted for the largest share at 45%, followed by sovereign wealth funds (14%) and pension funds and insurance companies (2%).

This year, central banks still accounted for a large portion of bond investment at 10.7 trillion KRW (47%), but net investment from the private sector, including banks, investment banks, and funds, expanded significantly from 3.4 trillion KRW last year to 9.6 trillion KRW. In particular, net investment in short-term bonds under three years increased from 4 trillion KRW last year to 13 trillion KRW this year, with the private sector concentrating 8.8 trillion KRW in short-term bonds, accounting for 92% of the total.

The reason foreign investors increased their domestic bond investment this year is attributed to the rise in global interest rates driven by the increase in U.S. long-term Treasury yields, while domestic bond yields remain the highest among countries. Additionally, Korea experienced less damage from COVID-19 and related financial shocks compared to other countries. As of the end of last month, the 10-year Korean government bond yield stood at 2.13%, higher than Hong Kong (1.16%), the United Kingdom (0.84%), and Taiwan (0.4%).

Moreover, the arbitrage incentive, which had narrowed to 28 basis points at the end of November last year, expanded to around 40 basis points on a daily average last month, leading to increased net investment in short-term bonds.

The FSS explained that since the domestic economy's fundamentals are sound and the bond market's liquidity and infrastructure are excellent, the possibility of a large-scale short-term outflow of foreign bond funds is limited. The domestic bond market size is 2 trillion USD, ranking third in Asia after China (18.3 trillion USD) and Japan (13.4 trillion USD).

However, the FSS noted that if U.S. interest rate hikes accelerate and external factors such as early tapering (reduction of quantitative easing) increase financial market volatility, there is a possibility of capital outflows by foreign investors. In fact, for short-term bond investments (under three years) that have recently expanded mainly in the private sector (banks, investment banks, funds, etc.), if arbitrage incentives shrink, there is a possibility of switching to net outflows, as seen by the decrease in foreign net investment last month.

An FSS official stated, "We will closely monitor bond maturity situations and financial market trends, continuously monitoring for rapid short-term capital outflows and related risks to the capital market."