[Expert Analysis] Exchange Rate Hits Monthly Average of 1,470 Won, Upper Limit Expected to Exceed 1,500 Won Next Year

This year’s average won-dollar exchange rate hits a record high of 1,420 won
Expansion of overseas investment by Korean nationals and weak Japanese yen among key factors
Next year’s exchange rate expected to exceed this year’s average... Upper l

With this year's average annual exchange rate poised to reach an all-time high, experts broadly agree that the high exchange rate, with an average exceeding 1,400 won, will likely persist into next year. Many also forecast that the upper bound could surpass 1,500 won. A key factor expected to influence next year's exchange rate is the structurally changed domestic supply and demand conditions. Analysts also note the importance of monitoring the government's ongoing efforts to stabilize the exchange rate through various measures.

Second week of December average: 1,470.49 won... Overseas investment by domestic economic agents far outpaces foreign investment in Korea

According to the Bank of Korea's Economic Statistics System (ECOS) as of December 15, the average exchange rate based on weekly closing prices for the first two weeks of this month (through December 12) was 1,470.49 won. This surpasses last month's average of 1,460.44 won, which had already been the highest since March 1998 (1,488.87 won) during the foreign exchange crisis.

This month, the major currencies-including the Australian dollar (up 1.56%), Canadian dollar (up 1.50%), European Union euro (up 1.20%), British pound (up 0.94%), and Japanese yen (up 0.17%)-all strengthened against the US dollar, while the Korean won depreciated by 0.69%. The average annual exchange rate from January to November this year was 1,418.29 won. Including December (through the 12th), the figure is around 1,420 won, surpassing the previous all-time high of 1,394.97 won set in 1998.

The weakness of the Korean won is rooted in supply and demand factors, such as the expansion of overseas investment by domestic investors. The volume of overseas investments by Korean economic agents for their various needs far exceeds the amount of foreign investment flowing into Korea. Baek Seokhyun, economist at Shinhan Bank S&T Center, explained, "Indirect investments without the aim of securing management rights are nearly three times larger, and direct investments, such as companies building factories or acquiring management rights through M&A in the United States, are also more than three times higher." He added, "Even if funds for US investments agreed upon between Korea and the US are not exchanged in the foreign exchange market, the gap in domestic investment and the expansion of overseas investment are inevitable." He continued, "Both individuals and institutions, faced with a domestic potential growth rate of less than 2%, are choosing to invest abroad because they do not expect high returns from domestic investments."

Upper bound of 1,510 won next year... Diverging views on 'low in the first half, high in the second' vs. 'high in the first half, low in the second'

Experts diagnose that the high exchange rate situation is likely to continue next year, exceeding this year's average. This is based on the assessment that the current supply and demand imbalance cannot be resolved in the short term. Some forecast the upper bound could reach 1,510 won. However, there is disagreement over whether next year will see a 'low in the first half, high in the second' trend or the reverse.

Kwon Amin, researcher at NH Investment & Securities, projected that the won-dollar exchange rate will follow a 'low in the first half, high in the second' trajectory next year, estimating a band of 1,390 to 1,500 won. Kwon said, "If external conditions stabilize and relative supply and demand improve, the won's weakness could partially reverse. However, in the long run, unlike during past export booms, the benefits are limited to certain industries, so domestic investment indicators remain weak." He added, "Even though the trade balance is solid, overseas investments have grown even more, so decoupling between exports and the exchange rate could persist." He continued, "Korea's net external assets as a share of GDP have surpassed 59%. In Japan and Germany, this figure exceeded 70% after four and three years, respectively, of hovering around 60%. Structurally considering the trend of overseas investment, the won-dollar exchange rate is likely to remain strongly resistant to downward movement, maintaining an annual average in the 1,400-won range."

Economist Baek also commented, "The current exchange rate is highly responsive to movements in asset markets, including equities. If the US Federal Reserve chair changes in May next year, the dollar could weaken due to monetary policy shifts," adding, "I expect the rate to decline until the second quarter, bottom out, and then gradually rise from the third quarter, following a 'low in the first half, high in the second' pattern. My forecast range for next year's exchange rate is 1,360 to 1,510 won."

An employee is holding up US dollars at the Counterfeit Response Center of KEB Hana Bank in Myeongdong, Jung-gu, Seoul. Photo by Yonhap News.

On the other hand, experts who expect a 'high in the first half, low in the second' trend cite differing views on the impact of World Government Bond Index (WGBI) inclusion and the easing environment for the dollar, which affect the timing of the won's relative weakness. Cho Yonggu, researcher at Shinyoung Securities, said, "It seems unlikely that the rate will fall into the 1,300-won range in the first half, but we could see a surprising low in the third quarter." He explained, "The effect of WGBI inclusion, which was postponed once, will be concentrated between April and November next year. In addition to this mechanical effect, if Kevin Hassett becomes the Federal Reserve chair, he could begin leading rate cuts as early as June, and we could see the impact around the third quarter." He set next year's forecast band at 1,350 to 1,490 won.

Min Kyungwon, economist at Woori Bank, predicted that next year the won-dollar exchange rate will move between 1,320 and 1,460 won. Min said, "The won faces structural challenges, such as increased overseas stock investments by residents and the relocation of corporate production bases, which are driving up demand for dollars in both the real economy and financial markets." He added, "Given the strong preference for US equities and the weakening expectation of a falling exchange rate, as well as preemptive currency hedging by foreign investors in the stock market, the lower bound of the exchange rate remains rigid and will be difficult to resolve quickly." However, he noted, "Since the COVID-19 pandemic, the won and yen have tended to move together, so the won is likely to join the downward trend. If exporters who delayed converting foreign currency earnings while the won was falling start selling again during a period of sharp decline, it could help stabilize the exchange rate downward."

Supply and demand trends are the key variable... Government actions warrant attention

Domestic supply and demand was cited as the main variable that will affect next year's exchange rate. Economist Baek said, "Among advanced economies, the United States remains the main driver of growth, and it is true that productivity innovation and growth are being led by artificial intelligence (AI)." He added, "I expect global capital will continue to favor US dollar assets next year." He continued, "While there will be cooperation with the government, pension funds cannot avoid overseas investment to boost profitability, and companies will continue to invest in the US. However, individuals tend to act in groups, so their impact can vary." He explained, "From mid-April to mid-September this year, individuals had little impact on the exchange rate, but from mid-September to November, they invested an average of 300 million dollars per day. If even one major player pulls back a little, there will be room for exchange rate stabilization."

Analysts also stress the importance of monitoring the government's various attempts to stabilize the exchange rate. Researcher Cho said, "Institutionally, the new framework including the National Pension Service is important. I expect there will be regulatory changes to partially curb excess demand for dollars from importers and individual investors, and this will be worth watching." Economist Baek added, "In the long term, policies to encourage foreign investment in Korea and incentives for domestic capital to invest at home should also be introduced."

However, all agreed there are no signs of crisis. The current exchange rate level is largely the result of a strong tilt in overseas investment flows, and indicators such as the credit default swap (CDS) premium show that sovereign default risk remains very low. The ratio of short-term external debt to foreign reserves, which was a problem during the foreign exchange crisis, is also at a stable level in the low 30% range. Economist Baek cautioned, however, "The reason the current high exchange rate is seen as problematic is that it reflects underlying economic weaknesses," emphasizing, "The fact that the United States is becoming Korea's largest net export destination, and that the competitiveness of Korea's main export industry-semiconductors-is declining compared to competitors, are issues that must be closely examined."