Strong Appetite for Won-denominated Bonds
Foreign ownership of South Korean bonds has topped 115 trillion won (US$96.52 billion), reaching a new high. Foreigners purchased more than 7 trillion won (US$5.87 billion) worth of South Korean government bonds over the past month, showing strong appetite for Korean bonds. This is because they can expect a higher financial gain thanks to a rapid fall in currency rate swap (CRS) amid a rise in the won-dollar exchange rates. Furthermore, the Bank of Korea (BOK) is forecast to lower the benchmark interest rate. Foreign investors are expected to continuously buy more domestic bonds for the time being, but foreign exchange rates can change the trend.
Foreign investors’ won-denominated bond holdings stood at 115.09 trillion won (US$96.59 billion) as of May 21, according to the Financial Supervisory Service on May 22. The figure is about 1 trillion won (US$839.28 million) higher than the previous high of 114 trillion won (US$95.68 billion) in August last year.
Generally, foreign investors purchase won-denominated bonds after exchanging U.S. dollars borrowed from overseas to the won in the domestic CRS market. The CRS rate is applied when exchanging the U.S. dollar to the won. The greater the difference between the CRS rate and the domestic bond rate, the higher the expected return of foreign investors. This is called financial arbitrage trading. Given the situation, the CRS rate sharply dropped due to strong U.S. dollar. Seoul Money Brokerage Services Ltd. (SMBS) said the one-year CRS rate fell from 1.29 percent on April 1 to 1.04 percent on May 21. In short, foreigners are more attracted by the increased swap spread.
It also strongly reflects the expectations that the BOK will lower the benchmark interest rate. Currently, foreign investors keep buying bonds, though the interest rate on bonds has continuously hit a new low. This is because they bet on a rise in bond prices as the benchmark interest rate will go down. Experts also say that they buy up bonds with expectations that the current weak won against the U.S. dollar will be leveled off in the near future. An official who is in charge of bonds from a securities firm said, “It seems that foreign investors in bonds predict that the BOK will lower the benchmark interest rate by the end of this year and the won’s value will not fall further.”
May experts expect that foreigners will keep up strong appetite for won-denominated bonds for a while. However, the possibility cannot be ruled out that capital will leave the market because of concerns over exchange losses if the value of the won goes down further. A securities firm official said, “It is the time that investors withdraw investment funds from emerging countries with a stronger preference for risk-free assets. If Korea’s current account balance posts a deficit or the won becomes weaker, foreign investors can withdraw capital from the domestic market.”