As the Bank of Korea announced, the strategic "hedge" volume of the National Pension Service (NPS) is expected to be released into the market, drawing attention to its impact on the foreign exchange market. Some estimate that the hedge volume, estimated at up to $50 billion, will cause the won-dollar exchange rate to drop by 30 to 40 won. However, there are also forecasts that the decline in exchange rates may not be significant due to external factors such as the depreciation of the yuan.
◇ Bank of Korea says "hedge to be implemented soon… will contribute to exchange rate stability"
On the 2nd, Yun Kyung-soo, director of the International Department at the Bank of Korea, noted, "It is expected that the National Pension Service will soon release hedge volumes according to internal decisions," adding, "This will contribute to exchange rate stability." In the market, evaluations indicate that the activation of the "strategic hedge" applicable to up to 10% of overseas assets is imminent following this statement.
Hedge refers to transactions that eliminate the risks of exchange rate fluctuations. The National Pension Service initiates hedging through forward contracts when the exchange rate level exceeds its predefined criteria, selling some of its overseas assets. By selling dollars and increasing the supply of dollars in the market, it has the effect of lowering the exchange rate.
The National Pension Service adheres to the principle of not hedging foreign exchange exposure arising from overseas investments. However, 5% (approximately $25 billion) of its overseas investment assets can be hedged at its discretion. Additionally, if certain conditions are met, strategic hedging can be conducted for up to 10%. If both strategies are implemented simultaneously, hedging for up to 15% of total overseas assets is possible.
Strategic hedging is reported to be applicable when the won per dollar value falls below 1,450 won for more than five trading days. Following the state of emergency, the value of the won has decreased, thus meeting this condition. According to Seoul Foreign Exchange Brokerage, the won-dollar exchange rate has remained above 1,450 won for nine trading days since the last month’s closing price of 1,451.90 won (as of 3:30 p.m. on the 19th).
As of the end of October last year, the National Pension Service held overseas investment assets worth $482.8 billion. If the strategic hedge is activated, it will have the effect of supplying $48.2 billion (about 70 trillion won) to the market. This amount equates to 11.6% of the Bank of Korea's foreign reserves of $415.6 billion (as of December last year) and is nearly half of the $98.43 billion in foreign currency deposits held by residents of South Korea (as of the end of November last year).
The strategic hedge of the National Pension Service is expected to be implemented by this year. The National Pension Fund Management Committee held a meeting on the morning of December 19 last year at the Government Seoul Office and decided to extend the strategic hedge ratio, which was adjusted to a maximum of 10% at the end of 2022, until this year due to the continued high exchange rate.
◇ Experts say "will help stabilize the exchange rate" vs "must watch external factors"
Experts foresee downward pressure on the won-dollar exchange rate due to the strategic hedge. Kim Chanhui, a researcher at Shinhan Investment Corp., stated, "If the hedge volume of $50 billion is distributed over the next 10 months, then $20 million will be supplied to the market each day," adding, "This will lower the won-dollar exchange rate by about 30 to 40 won."
Jo Yong-gu, a researcher at Shin Young Securities, noted, "So far, the actual intervention by the foreign exchange authorities has not been as significant as expected, but if the hedge volume is actually released from the National Pension Service, it will be significant for exchange rate stabilization," and added, "It appears there is still room for additional tactical hedging, given that only about 2% has been utilized so far from the available 5%."
On the other hand, there are projections that the decline in exchange rates may not be significant due to a strong dollar trend. Park Sang-hyun, a researcher at iM Investment Corp., said, "The fact that the exchange rate has not risen further recently is likely due to the already existing caution regarding the hedge volume. If this effect dissipates and the recent depreciation of the yuan expands, the won-dollar exchange rate could return to its previous level."
There is a view that it is difficult to specify the effects of exchange rate decline due to hedging. Lee Ha-yeon, an economist at Daishin Securities, stated, "While the release of hedge volume will put downward pressure on the exchange rate, the exchange rate is significantly influenced not only by domestic factors but also by external factors, thus making it challenging to predict how much the exchange rate will drop based solely on the hedge volume released."