[Financial Planning for the 100-Year Life] Rising Value of the Korean Won and the Stock Market

This year, the Korean stock index has recorded a higher growth rate than the global average, mainly driven by domestic sectors. The appreciation of the Korean won has been the main reason for this trend, and a similar pattern is likely to continue in the second half of the year.

By the end of May this year, the global stock index (based on MSCI) had risen by 4.5% compared to the end of the previous year. The developed markets index increased by 4.2%. Among developed countries, the US S&P 500 index rose by only 0.5%, while Germany's DAX index surged by 20.5%. In emerging markets, the index climbed by 7.6%, outpacing developed markets, largely due to significant gains in Hong Kong and Brazil.

During the same period, Korea's KOSPI rose by 12.4%, surpassing both the global and emerging market indices. By industry, construction rose by 46.7%, electricity and gas by 43.9%, and finance by 24.7%, indicating that domestically oriented sectors performed better. The electronics sector index, which is export-oriented, increased by 3.7%.

This trend in the Korean stock market is likely due to the decline in the won-dollar exchange rate (i.e., the appreciation of the won). An analysis of statistics from January 2000 to May 2025 shows that for every 1% drop in the won-dollar exchange rate, the KOSPI rose by 0.79%. By sector, construction showed a sensitivity of 1.16%, finance 0.96%, and electronics 0.59%.

The won-dollar exchange rate, which was 1,472.3 won at the end of last year, fell to 1,366.5 won on May 23. The key question is whether the exchange rate will fall further. Considering the factors that determine the won-dollar exchange rate, it is highly likely that the rate will decline further. Variables influencing the won-dollar exchange rate include the dollar index, as well as the exchange rates of counterpart countries such as Japan's yen and China's yuan. In addition, the interest rate differential between Korea and the US, and the current account balance, have also affected exchange rate fluctuations.

By using these as explanatory variables and the won-dollar exchange rate as the dependent variable, a regression analysis can estimate the appropriate level of the exchange rate. Based on statistics from January 2001 to May 2025, the estimated appropriate won-dollar exchange rate at the end of May was 1,180 won. The actual rate was 1,383.1, indicating that the won was undervalued by 17%.

It is unlikely that the won-dollar exchange rate will rapidly fall to its appropriate level in the short term. However, considering the factors that determine the exchange rate, there is a high probability that the rate will decline further. The economic variable that most strongly influences the won-dollar exchange rate is the dollar index. The dollar index fell from 110 at the beginning of the year to around 99 at the end of May. Given the US economic situation, the dollar index is likely to fall further. The US economic growth rate is expected to slow significantly this year. As consumer spending, which accounts for 69% of US GDP, slows, this year's growth rate is projected to be around 1%, lower than last year's 2.8%.

In the mid- to long-term, the dollar is likely to depreciate further. According to the International Monetary Fund (IMF), the US share of global GDP is expected to fall from 26.4% in 2024 to 25.7% in 2030. This implies a decline in the dollar index over the next six years. In addition, the widening of internal and external imbalances in the US is also a factor in the dollar index's decline. The ratio of the US net external debt to GDP surged from 16.7% in 2020 to 89.3% in 2024. Over the same period, federal government debt as a percentage of GDP increased from 89.9% to 124.1%.

Furthermore, the share of the dollar in global central banks' foreign exchange reserves fell from 71.1% in 2000 to 57.8% in 2024. If there is even a slight decrease in foreign direct investment or securities investment inflows into the US, the dollar index will decline.

Considering these factors, the dollar index is expected to fall and the value of the won to rise further. When the won appreciates, there is typically a lag of about one year, after which exports and manufacturing production in the Korean economy slow down, while domestic demand sectors such as services increase. During this period, foreign investors have been net buyers of Korean stocks, which has driven the KOSPI higher. From August last year to April this year, foreign investors were net sellers of 36.5 trillion won, but in May, they became net buyers of 1.3 trillion won. As foreign net buying continues after June, both the value of the won and the KOSPI are expected to rise. While foreign stock purchases will likely boost the electronics sector index, domestically oriented sectors are still expected to lead the stock market gains.

Kim Youngik, Adjunct Professor, Graduate School of Economics, Sogang University