[Beginner's Guide] The Return of Foreigners... The Relationship Between USD-KRW Exchange Rate and Foreign Investor Flows

[Image source=Yonhap News]

[Asia Economy Reporter Kwon Jae-hee] Recently, as the KOSPI index approached the 2,500 mark, attention has been focused on whether it will reclaim the 2,500 level. Analysts suggest that this is largely due to renewed buying by foreign investors. In fact, foreign investors have net purchased nearly 1.5 trillion won over the past five trading days. It is also analyzed that the exchange rate played a role in attracting foreign investors to our stock market. So, what is the relationship between the exchange rate and foreign investor demand?

What is the exchange rate?

The exchange rate is the ratio at which one country's currency is exchanged for a foreign currency. The won-dollar exchange rate refers to the exchange ratio between the Korean won and the US dollar, while the yen-dollar exchange rate refers to the ratio between the Japanese yen and the US dollar.

[Image source=Yonhap News]

Why does foreign buying increase when the exchange rate falls?

A falling exchange rate means that the value of that country's currency is rising. In other words, a decline in the won-dollar exchange rate indicates a stronger won and a weaker dollar. When the won-dollar exchange rate falls, the Korean stock market tends to rise, and foreign investors tend to increase their holdings of Korean stocks.

On the most recent trading day, the 5th, the won-dollar exchange rate dropped nearly 12 won in a single day, which can be understood in the same context as the increased inflow of foreign investors. On that day, the exchange rate closed at 1,298.3 won, down 11.8 won from the previous day. This was the first time in five trading days that the exchange rate closed in the 1,200 won range since the 29th of last month (1,299.1 won).

[Image source=Reuters Yonhap News]

Why is it important to understand the correlation between the exchange rate and foreign investors?

As of June, foreign investors accounted for about 30% of the Korean stock market. Since foreign investors have large capital and mainly trade large-cap stocks, they have a significant impact on the Korean stock market. Therefore, it is very important to understand whether foreign investors will increase or decrease their holdings of Korean stocks.

How can we forecast foreign investors' investment proportions in the Korean stock market?

[Image source=Yonhap News]

This can be done by examining the value of the dollar and the exports of Korean companies.

For example, imagine you are a foreign investor managing about 1 trillion won. Given the large scale of your assets, you would consider various factors before investing. You would analyze the US economy, global economic conditions, the US Federal Reserve's monetary policy, emerging market economies, geopolitical risks, exchange rates, and other variables to decide where and how much to invest. If you expect the US economy to perform well and the dollar to strengthen, you would allocate more to the US market. Conversely, if emerging markets are doing well and the dollar weakens, you would focus your investments on emerging markets.

So, what should foreign investors consider when investing in the Korean stock market? As mentioned earlier, the primary factor is the won-dollar exchange rate. If the won is stronger relative to the dollar (i.e., the won-dollar exchange rate falls), it is advantageous to sell dollars and buy Korean stocks like Samsung Electronics.

Let's look more closely at the value of the dollar and the won. Suppose the won-dollar exchange rate is 2,000 won per dollar, and Samsung Electronics' stock price is 100,000 won. To buy one share of Samsung Electronics, you would need 50 dollars. However, if the won-dollar exchange rate suddenly drops to 1,000 won per dollar and Samsung Electronics' stock price remains at 100,000 won, selling one share of Samsung Electronics and converting it back to dollars would yield 100 dollars. Although the stock price hasn't changed, the 50% drop in the won-dollar exchange rate allows foreign investors to realize a 100% gain.

The second factor is the export ratio of Korean companies. Since Korea has a high export ratio, predicting whether exports will increase or decrease is very important. For Samsung Electronics' stock price to rise, key export products like semiconductors and smartphones must increase. The growth rate of Korean exports tends to be favorable when the won-dollar exchange rate falls. Because the won-dollar exchange rate tends to decline when the global economy improves, exports are expected to increase accordingly.

Thus, understanding the trends of the won-dollar exchange rate is crucial for grasping foreign investors' behavior. This is why exchange rate trends are always mentioned in stock market-related articles. Terms like dollar strength and won weakness may not immediately resonate, but it is recommended to reflect on their meanings and become familiar with them. Exchange rate analysis is an essential condition for successful investing.

Editor's Note[Beginner's Guide to Stocks] is a smart investment guide for 'Joorini' (stock + children). We will kindly and easily explain stock stories that are unfamiliar to beginners.