BOJ's Concern: "Last Year's South Korea Overseas Direct Investment 'Record High'... Foreign Exchange Outflow May Worsen"

BOK Report on Background of FDI Increase and Implications for Foreign Exchange Sector

South Korea's overseas direct investment (ODI) reached a record high of $50.2 billion last year, raising concerns that the intensified outflow of foreign exchange due to the increase in ODI could further exacerbate foreign exchange supply and demand imbalances.

On the 6th, the Bank of Korea stated in its report titled "Financial and Economic Issue Analysis: Recent Increase in Overseas Direct Investment and Implications for the Foreign Exchange Sector" that "South Korea's ODI showed a gradual increase after the global financial crisis, but the scale of increase has expanded significantly since 2021."

According to the Bank of Korea, ODI (excluding reinvested earnings) amounted to $49.4 billion in 2021, an 81.4% increase from the previous year, and reached a record high of $50.2 billion last year. This year, from January to March, it recorded $8.95 billion, continuing the upward trend. By industry, investments centered on finance, insurance, and manufacturing increased significantly, while by region, investments in North America surged.

The recent increase in ODI is attributed to a combination of factors including the rise in alternative asset investments by pension funds, the intensification of the US-China economic dispute, and corporate competition to secure new technologies. Investments in finance and insurance include alternative investments with equity stakes of 10% or more, and overseas alternative asset investments continue to grow due to increased pension fund reserves and inflows into alternative investment funds.

Manufacturing ODI aimed at entering local markets such as the US expanded due to the US-China economic dispute, the US's expansion of protectionism, and the reorganization of global supply chains centered on domestic markets. Additionally, companies' efforts to secure core technologies in future growth industries also contributed to the expansion of ODI.

The report estimates that the recent increase in corporate ODI has led to a decrease in the net foreign exchange supply from the corporate sector in the spot foreign exchange market. While the amount of foreign currency funds received through corporate trade, as reflected in the goods balance, has significantly decreased since 2019, corporate foreign currency expenditures due to ODI have greatly increased. As a result, the surplus foreign currency funds that companies can supply to the foreign exchange market have diminished.

Furthermore, the increase in overseas alternative asset investments by pension funds and financial institutions is also a factor contributing to foreign exchange supply and demand imbalances. However, as ODI increases, South Korea's direct investment income balance is gradually improving, which has a positive effect on foreign exchange supply and demand.

The report analyzed that considering the current situation in the foreign exchange sector, it is necessary to pay close attention to the impact of the increasing ODI trend on foreign exchange supply and demand. This is because the ongoing US-China economic dispute, accelerated competition in advanced industries, and other factors are expected to sustain the growth of corporate ODI, and major domestic pension funds are also expected to expand overseas alternative investments to the level of foreign pension funds.

The Bank of Korea emphasized, "While the strength of foreign exchange inflows through current account transactions is weakening, the outflow of foreign exchange due to increased ODI is rising, raising concerns about the deepening imbalance in foreign exchange supply and demand." It added, "Since fluctuations in foreign exchange supply and demand in the real sector caused by corporate investment activities are inevitable, risk management that adjusts the impact of increased ODI on foreign exchange supply and demand through incentives is important." It also stressed the need to encourage companies to increase financing through overseas securities issuance and local financing rather than the spot foreign exchange market. Additionally, efforts should continue to improve the domestic investment environment that foreign investors can perceive and to expand foreign direct securities investment inflows into South Korea.