With the expectation that the exchange rate of the Korean won to the U.S. dollar will continue to soar this year, there are criticisms regarding whether it is the right decision for the National Pension Service (NPS) to engage in foreign exchange hedging. Even considering the public nature and market influence of the NPS, there are arguments about whether it is appropriate to mobilize national pension funds for foreign exchange policies that carry significant risk due to potential losses.
According to the financial investment industry on the 5th, a senior official from the Bank of Korea noted on the 2nd that "it is expected that the NPS will soon release hedging quantities based on internal decisions." The NPS's foreign exchange hedging occurs by selling a portion of its overseas assets through forward contracts. As this involves selling dollars, it effectively lowers the won-dollar exchange rate. For the Bank of Korea, which urgently needs to defend the exchange rate, the NPS's hedging is certainly welcome.
The NPS generally adheres to the principle of not hedging foreign exchange exposure from overseas investments. However, based on its own judgment, it can hedge up to 5% of its overseas assets. Furthermore, if certain conditions are met, it can implement strategic foreign exchange hedging through discussions with the fund management committee, allowing hedging up to 10%. Although the conditions for strategic foreign exchange hedging have not been disclosed, the market views the situation as a possibility when the won-dollar exchange rate drops below 1450 won and stays there for more than five trading days. This means the NPS's basic principle is an open exchange rate, allowing discretional hedging of up to 15% of its total overseas assets.
The issue is whether the NPS's foreign exchange hedging is indeed based on its own judgment. Observations suggest that high exchange rates will persist this year. According to data submitted by the Korea Institute for International Economic Policy (KIEP) to Democratic Party lawmaker Kim Hyun-jung of the National Assembly's Political Affairs Committee, the median forecast for the won-dollar exchange rate from major global investment banks (as of Dec. 24, 2024) is estimated to reach 1435 won by the end of the first quarter of 2025.
Investment banks (IB) even suggested that the won-dollar exchange rate might rise to 1440 won by the end of the second quarter and 1445 won by the end of the third quarter. Nomura Securities stated that the exchange rate could soar to 1500 won during the second quarter and maintain that level until the end of the third quarter. If the forecasts of global investment banks are accurate, the NPS's foreign exchange hedging at this point would result in a decision that forgoes the opportunity for exchange rate profits.
As a result, there is criticism in the market about whether it is justified for the government to inject national pension funds into foreign exchange policies that pose loss risks. This is not the first time the government has mobilized the NPS for exchange rate defense. Previously, when the won-dollar exchange rate exceeded 1400 won in November 2022, the government requested an increase in the hedging ratio from the NPS. At that time, the NPS expanded its tactical foreign exchange hedging by more than $7.3 billion and raised the strategic hedging ratio from 0% to 10%.
An anonymous source from the financial investment industry said, "Since it is impossible to predict the direction of the exchange rate, hasty evaluations should be avoided," adding, "We need to consider whether it is appropriate for the NPS, which should focus on maximizing revenue while delaying fund depletion, to frequently be involved in government policies."
Meanwhile, there are concerns in the market that the prolonged high exchange rate could burden the NPS as it continues to increase its overseas investment share. This is based on the rationale that the NPS's expansion in overseas investments might further drive down the value of the won, increasing exchange rate volatility.
Lee Seung-ho, a senior researcher at the Korea Capital Market Institute, stated in a report titled "Analysis of the Current Status of Overseas Securities Investment and Its Impact on the Foreign Exchange Market," published last August, that "the won-dollar exchange rate statistically has a significant positive (+) impact on both overseas stock and bond investments." The researcher also noted, "It is necessary to be cautious about the potential for increased demand for foreign exchange leading to upward pressure on the exchange rate as overseas securities investment continues to expand."
Currently, the NPS has invested 416.14 trillion won, which accounts for 35.6% of its total fund reserves of 1170.55 trillion won (as of the end of October 2024), in overseas stocks. Seventy percent of these overseas stocks are concentrated in North America. Considering overseas bonds (83.82 trillion won) and alternative investments, the share of overseas investments by the NPS exceeds 50%. The share of overseas investment by the NPS is expected to expand to 60% by 2028.
In this context, Park Sun-young, a professor of economics at Dongguk University, commented that while the expansion of the NPS's overseas investments may have some impact on exchange rate trends, it is an unavoidable choice given that the fund is increasing by 100 trillion won annually. She suggested that resolving the issue through foreign exchange swap transactions with the Bank of Korea, as is done currently, is the best approach.