[Why&Next] Korea Joins WGBI... Positive Signal for Foreign Currency Inflow, What About Won Appreciation?

From Next Year, KRW 74 Trillion Funds
Inflow into Domestic Government Bond Market
Alleviating Burden of Increased Treasury Issuance
Contributing to Market Interest Rate Stabilization
Divergent Evaluations on Won-Dollar Exchange Rate Effect

South Korea has achieved its long-standing goal of inclusion in the World Government Bond Index (WGBI) for its won-denominated government bond market. Following the decision to include Korea in the WGBI, which global investors use as a benchmark, approximately 74 trillion won worth of overseas investment funds are expected to flow into the domestic market starting next year. This is anticipated to contribute to reducing financing costs for the government and corporations due to interest rate stabilization and securing stable fiscal management.

FTSE Russell, part of the Financial Times Stock Exchange in the UK, announced on the 8th (local time) that Korea will be included in the WGBI starting November next year. The WGBI is considered one of the three major global bond indices alongside the Bloomberg-Barclays Global Aggregate Index and the JP Morgan Emerging Market Bond Index. It includes government bonds from 25 countries, covering major developed countries such as the United States, the United Kingdom, and Japan, as well as emerging markets like China, Mexico, and Malaysia. The assets tracking the index are estimated to range between $2.5 trillion and $3 trillion (approximately 3,372.5 trillion to 4,047 trillion won).

[Image source=Yonhap News]

FTSE Russell typically decides on WGBI inclusion twice a year, in March and September. To be included in the WGBI, a country must meet quantitative criteria such as a government bond market size of over $50 billion and a sovereign credit rating of A- or higher (based on S&P), as well as qualitative criteria known as 'market accessibility.' To enhance market accessibility, Korea has implemented institutional improvements such as opening integrated government bond accounts, extending foreign exchange trading hours, exempting foreign investors from taxation on government bond investments, and abolishing the foreign investor registration system (IRC). In this evaluation, FTSE Russell raised Korea's market accessibility to Level 2, which meets the inclusion requirements. FTSE Russell stated, "Since Korea was first listed as a watchlist country for WGBI inclusion in September 2022, it has pursued various institutional improvements to enhance government bond market accessibility, meeting the Level 2 market accessibility criteria required for WGBI inclusion."

The decision to include Korea in the WGBI has been regarded as a rapid achievement exceeding market expectations. According to FTSE regulations, at least six months must pass after an upgrade in market accessibility level before inclusion in the WGBI. Considering this, the fastest scenario for Korea’s inclusion was the upgrade to Level 2 market accessibility in September this year, followed by inclusion in March next year. Even with improved institutional accessibility, it takes time for investors to fully experience the changes in market regulations. Market accessibility is based not only on institutional improvements but also on investor feedback regarding practical implementation. The final decision on WGBI inclusion is made through approval meetings among global asset managers, and considering the time lag in reflecting meeting outcomes, the confirmation of inclusion this September is widely seen as encouraging within the financial investment industry.

Choi Sang-mok, Deputy Prime Minister and Minister of Economy and Finance, said at the WGBI inclusion announcement briefing on the 9th, "The government’s strong policy will for advancing the government bond market and effectively communicating this to global investors seems to have brought this opportunity sooner." This year, the government held a total of nine roundtable meetings with local government bond investment institutions in Tokyo, Hong Kong, London, and Singapore to actively convey its commitment to institutional activation.

The government expects that this WGBI inclusion will have a favorable impact on stabilizing market interest rates. Korea’s weighting in the WGBI is 2.22%, ranking ninth among included countries after the United States, Japan, China, France, Italy, and Germany. Even with a somewhat conservative estimate of $2.5 trillion for the assets tracking the WGBI, approximately $55 billion (about 74.195 trillion won) in funds will flow into the domestic government bond market starting next year. Considering that the net issuance of government bonds next year is 83.7 trillion won, the unprecedentedly large inflow of foreign funds of about 74 trillion won is expected to ease the burden of increased net issuance and contribute to stabilizing market interest rates.

A financial investment industry official said, "Although the official inclusion date is November next year, considering other countries’ inclusion cases and foreign capital trends, meaningful preliminary inflows are expected to begin from March next year." The official added, "The Ministry of Economy and Finance is likely to consider reducing the proportion of bond issuance in the first half of next year compared to this year and increasing issuance in the second half accordingly."

However, market opinions are divided regarding the stabilization of the won-dollar exchange rate. Some in the financial sector speculate that the inflow of foreign capital could lead to an appreciation effect of the won. There is analysis suggesting a potential won appreciation of around 4% over the next two years. Nevertheless, based on cases of developed countries previously included in the WGBI, where exchange rate depreciation effects did not persist for long periods, the prevailing view is that while this is positive for foreign currency procurement, it will not have a significant impact on the won-dollar spot market. For example, Mexico, which was included in the WGBI in April 2010 before Korea, saw its peso exchange rate decline by 1.3% over two days following the inclusion announcement, and South Africa experienced an appreciation of over 1% in the rand, but these effects did not last more than a month.