[100-Year Life Finance] High Possibility of Won Value Appreciation

Now We Must Pay More Attention to Economic Factors
Reduction of the Korea-US Interest Rate Gap

Recently, the won-dollar exchange rate has soared past 1,400 won. Political events such as Donald Trump's election as U.S. president and the domestic state of emergency have been major factors driving the exchange rate up. While these factors could push the won-dollar exchange rate even higher, economic factors suggest that the value of the won is more likely to gradually increase.

The exchange rate fluctuates reflecting various economic factors. The dollar index has the greatest influence on the won-dollar exchange rate. The exchange rates of Japan's yen and China's yuan are also economic variables affecting the won-dollar exchange rate. Additionally, the interest rate differential between Korea and the U.S. and the current account balance are factors causing exchange rate fluctuations.

The economic variable with the greatest impact on the won-dollar exchange rate is the dollar index, which reflects the value of the U.S. dollar against six major currencies of advanced countries. Before the U.S. presidential election, the dollar index was 103, but after Trump's election, it rose to 107. This was due to expectations that if Trump imposed tariffs on major U.S. imports, U.S. prices would rise and the Federal Reserve would be unable to lower interest rates further.

However, considering inherent problems in the U.S. economy, the dollar index is more likely to decline. In its October World Economic Outlook, the International Monetary Fund (IMF) projected that the U.S. share of global GDP will fall from 26.5% in 2024 to 25.4% in 2029. Given that the U.S. GDP share and the dollar index have historically moved in the same direction, this implies the dollar index will decline over the next four years.

The widening internal and external imbalances in the U.S. also contribute to the dollar index's decline. In the second quarter of this year, the U.S. net external debt accounted for 77.6% of GDP, and federal government debt was 120.0% of GDP, both very high. The dollar's share of global central banks' foreign exchange reserves has also decreased from 71.1% in 2000 to 58.2% in the second quarter of 2024.

If foreign direct investment or securities investment inflows into the U.S. decrease even slightly, the dollar index will fall. In 2025, the U.S. economy is expected to grow at a slower rate centered on consumption, with rising unemployment and lower inflation. Considering this, the dollar index is expected to decline soon.

Another economic variable influencing the won-dollar exchange rate is the interest rate differential between Korea and the U.S. and the current account balance. As the Bank of Korea cut its base rate twice in October and November, domestic market interest rates fell more than those in the U.S., acting as a factor lowering the won's value.

However, in the coming months, U.S. interest rates are likely to fall below Korean rates. On December 19 (Korean time), the Federal Open Market Committee (FOMC) is expected to lower the Federal Reserve's base rate. Along with this, the anticipated slowdown in U.S. economic growth and inflation in 2025 increases the likelihood of falling market interest rates. This would narrow the Korea-U.S. interest rate gap, potentially raising the won's value.

The current account surplus is also expanding. From January to October this year, the current account surplus was $74.2 billion, a significant improvement from $24.2 billion during the same period last year. The annual current account surplus is expected to exceed $90 billion. Although the current account surplus is being channeled overseas through financial accounts such as direct investment and securities investment, reducing its impact on the exchange rate, a large current account surplus is a factor supporting the won's appreciation.

The depreciation of China's yuan will act as a factor lowering the won's value. If President-elect Trump imposes tariffs on China, China may respond by devaluing the yuan. Additionally, domestic political instability following the state of emergency could further reduce Korea's creditworthiness, causing the won's value to decline.

However, considering all factors determining the won-dollar exchange rate comprehensively, the won's value is more likely to rise over time. Foreign investors expecting this may buy Korean stocks. When the dollar depreciates and the won appreciates, Korean stock prices tend to rise relatively more than U.S. stock prices. Over time, all economic variables return to their proper positions. Only patience is required.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University