US President Donald Trump’s trade pact with South Korea could deal a major blow to the won when cash starts flowing out of the country to cover investment commitments in the US, although the pact would likely be a boon for the KOSPI.
In exchange for lower tariffs — duties on South Korean cars and auto parts are expected to fall to 15 percent from 25 percent — South Korean negotiators on Wednesday agreed to inject US$350 billion in new investments into the US.
In an effort to avoid disruptions in the US dollar-won market, the two countries agreed to split the fund into two components. A first part would be US$200 billion in cash, paid in installments, which would be capped at US$20 billion a year.
For a tech and export-reliant economy like South Korea, the steady outflow of funds would mean squeezed liquidity in the local market, especially if exports and consumption slowed.
The remaining US$150 billion was earmarked for cooperation in shipbuilding.
On Wednesday, South Korean chief policy adviser Kim Yong-beom said the investments would be funded with operating income from the country’s foreign assets.
Analysts said that now the deal is done and some of the murkier areas are more clear, South Korea would need to manage the capital outflows and their effects on the nation’s currency.
“It was a better-than-expected deal for [South] Korea, especially in that uncertainties surrounding the financing of the investment have cleared,” said Moon Hong-cheol, an economist at DB Securities.
“That said, we now know that there’s going to be steady, long-term outflows, so that should be taken into account, which will work to limit short-term gains in the won,” Moon added.
The won is known for being closely monitored by local authorities, reflecting a vigilant mindset that was forged after financial traumas like the 1997 Asian Financial Crisis, during which the won lost half of its value.
The won has been one of Asia’s worst-performing currencies since last year, as a growing appetite among local retail investors and the national pension fund for US stocks has driven it lower against the US dollar.
Unlike the Hong Kong dollar or the pound, most foreign banks must trade the won through the two South Korean brokerages for spot trading.
Citigroup economist Kim Jin-wook said that over the next six months to a year, the won could weaken further to 1,450 per US dollar.
“The [South] Korean private sector’s potentially lower conversion of the dollar export proceeds to the won may generate won depreciation risks in the coming years,” Kim said, explaining that returns from corporate investments abroad are unlikely to be brought back home, which would weaken the won.
Analysts said downward pressure on the won would materialize despite the investment safeguards because South Korean investors are eager to buy US assets.
The South Korean National Pension Service has a hefty and growing appetite for overseas equities and bond investments, which it can feed only by selling won for US dollars.
The service purchased about US$27 billion worth of overseas securities this year through August, about double what it bought in the year-earlier period, according to data from the Bank of Korea.
South Korea’s retail investors are snapping up US dollar-denominated assets just as quickly. They bought US$36 billion in overseas securities in the year-to-date period that ended in September, also doubling from a year earlier.
“We’re talking about US$20 billion of FX outflows a year and details on financing and implementation of that still needs to be confirmed,” said Min Kyong-won, an economist at Woori Bank. “And companies are obviously heading overseas with their investments, so all this will work to weaken the won.”
South Korea’s benchmark KOSPI, up 71 percent this year, reached a new record high as soon as local markets opened on Thursday. Shipbuilding and auto shares surged on the news.
According to chief policy adviser Kim, the two countries agreed to apply tariff levels on chips that are “not disadvantageous compared to” the levies on their competitors in Taiwan, although he did not provide details.
South Korean manufacturers of wood products and pharmaceuticals would face the lowest tariffs, while aircraft parts and generic drugs would face zero tariffs.
On Thursday, shares of Hyundai Motor Co surged more than 12 percent before closing up 2.71 percent.
Shipbuilder Hanwha Ocean Co jumped 6.9 percent, while Samsung Electronics Co and SK Hynix Inc gained 3.6 percent and 1.8 percent respectively.
“The deal removes a major overhang on the economy and the local markets,” Morgan Stanley economist Kathleen Oh said. “[The 15 percent levy] improves [South] Korea’s price competitiveness versus Japanese and European automakers.”
JPMorgan said the KOSPI would rise well above the 5,000-point level within the next 12 months, with “a bull case upside to 6,000,” led by memory chips, financials, defense firms and shipbuilders.
The KOSPI notched another record closing by rising 0.5 percent to 4,107.50 yesterday.
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