Raising interest rates to support the won risks suffocating domestic demand. Cutting rates accelerates depreciation. — Reuters
South Korea’s won has spent the past several years on a steady downward drift, losing ground not only against the US dollar, but also against the currencies of many of its major trading partners.
Each time the exchange rate approaches levels that unsettle policymakers, government officials and the Bank of Korea (BoK) repeat familiar assurances: that they are watching markets closely, that fundamentals remain strong, and that excessive volatility will be addressed.
Occasionally, authorities step in to smooth fluctuations. Yet despite these efforts, the currency continues to weaken, largely indifferent to official statements.
This is neither an ordinary swing in market sentiment nor does it resemble the temporary bouts of weakness that South Korea has weathered in past global downturns.
The persistent softness of the won today reflects a convergence of deeper factors, such as widening interest-rate differentials with the United States, sustained capital outflows from South Korean institutions and households, a slowing domestic economy, episodes of political volatility and a more cautious stance among global investors toward South Korea’s future.
Each force is influential on its own; together, they have reshaped the balance of expectations that underpin the currency. The most visible of these forces is the growing divergence in monetary policy.
The BoK, once able to roughly track the US Federal Reserve’s (Fed) moves, now finds itself constrained by domestic realities – sluggish consumption, heavy household debt and waning momentum in potential growth.
Raising rates risks choking an already fragile economy. But leaving them unchanged widens the yield gap with the United States, where interest rates remain near historic highs.
Global investors, naturally, favour higher-yielding US dollar assets. South Korean institutions do the same, expanding their overseas portfolios in search of better returns. Retail investors, now well accustomed to global platforms, follow suit.
This outward flow of capital creates a persistent demand for US dollars and, in turn, a structural depreciation bias for the won.
Even when the Fed eventually begins easing, South Korea may find limited relief; its potential growth rate has fallen below America’s, eroding the two key advantages – interest and growth premiums – that once supported South Korean assets.
Credibility discount
More consequential for the long run, however, is South Korea’s gradual evolution into a capital-exporting economy.
Large conglomerates maintain sizeable foreign-currency holdings overseas, pension funds and insurers diversify aggressively into global markets and households routinely invest abroad, treating foreign securities as a standard component of their savings strategy.
This is not a temporary response to currency volatility, but reflects a deeper perception that domestic financial markets remain narrow, heavily concentrated and less appealing than the broader opportunities available elsewhere.
When a country’s own savers seek returns abroad faster than foreign investors bring capital in, the currency will weaken. The won today is shaped not only by foreign opinion, but also by the portfolio decisions of South Korean households and institutions.
While the nation remains a global leader in semiconductors, batteries and automobiles, signs of fatigue are evident beyond these flagship sectors.
Productivity growth has stalled. Consumption remains sluggish. And population ageing – among the fastest in the world – is constraining labour supply and steadily reducing potential output.
South Korea’s shrinking working-age population is not simply a demographic challenge; it is a structural constraint that will weigh on growth for decades.
Young South Koreans face stagnant incomes, soaring housing costs and limited upward mobility.
Markets pay close attention to these signals. Beyond headline gross domestic product or the performance of a handful of export champions, long-term investors look for durability – signs that economic fundamentals are strengthening rather than eroding.
Slipping fundamentals
When those fundamentals appear to be slipping, investors demand a risk premium. Political dynamics have compounded these concerns.
In recent years, South Korean politics has been marked by sharp polarisation and periodic standoffs that unsettle markets. In an economy as open and globally interconnected as South Korea’s, political stability is not an abstract ideal it is a source of currency stability.
Markets do not react to ideology; they react to predictability, transparency and institutional reliability. When these characteristics come into question, rebuilding credibility takes time. These internal factors help explain why the won often fails to recover even during periods when the US dollar weakens.
A currency that rises less during global risk-on periods and falls more during risk-off episodes is typically burdened by domestic vulnerabilities.
In South Korea’s case, it suggests the won carries a credibility discount that cannot be erased with routine policy measures. Policymakers now face tighter constraints than in earlier periods of currency stress.
Raising interest rates to support the won risks suffocating domestic demand. Cutting rates accelerates depreciation.
Intervening in foreign-exchange markets offers only temporary relief. — The Korea Herald/ANN
Yoo Choon-sik worked for nearly 30 years at Reuters, including as chief South Korea economics correspondent. The views expressed here are the writer’s own.
