On the morning of Oct. 9 last year, FTSE (Financial Times Stock Exchange) RUSSELL announced plans to include South Korean Government Bonds in the World Government Bond Index (WGBI). The WGBI is the largest advanced bond index in the world, comprised of Government Bonds from 26 countries. The size of the tracking funds alone amounts to $2.5 trillion (3,500 trillion won).
The actual index inclusion will take place in November this year. South Korea's inclusion weight is 2.22%. It is expected that 2.22% of the total tracking funds will flow into the domestic bond market.
The funds estimated to flow into the domestic market due to inclusion in the WGBI are projected to be between $50 billion and $60 billion (70 trillion won to 80 trillion won). The Korea Institute of Finance forecasts that if this capital flows in, the yields on Government Bonds would decrease by about 0.2 to 0.6 percentage points.
The decision for WGBI inclusion is an achievement realized two years after being designated as an observation country in September 2022. During this time, the government pursued institutional improvements to enhance accessibility to the Government Bonds market, from tax exemptions on Government Bonds to the abolition of the foreign investor registration system and improvements to the foreign exchange market structure. Efforts were also made to persuade global investors. Amid growing economic uncertainties such as fluctuations in exchange rates, it has been assessed that WGBI inclusion will contribute to stabilizing the foreign exchange market as well as to stable medium- to long-term financial operations.
Perhaps due to expectations of such economic effects, the achievement of WGBI inclusion was awarded the "Daesang" in the Ministry of Strategy and Finance's policy MVP survey at the end of last year.
With just about 10 months remaining until WGBI inclusion, what is the government's preparedness status? Could political instability impact WGBI inclusion? I met with Director General Hwang Soon-kwan of the Ministry of Strategy and Finance to discuss. The interview with Director General Hwang was conducted on the 17th of last month at the Ministry's Sejong Government Complex.
The following is a Q&A.
―Please explain why WGBI inclusion is beneficial for the South Korean economy.
"The inclusion in WGBI will bring in about $50 billion to $60 billion of foreign investment capital into the country. The stabilization of interest rates will lower the funding expenses for citizens, corporations, and the government. The influx of foreign funds is also expected to stabilize the foreign exchange market. With the entry of large-scale index tracking capital, it is anticipated that the demand for Government Bonds will also expand, contributing to stabilizing medium- to long-term financial operations. It will also help improve the country's economic credibility."
―What effects have countries that joined WGBI before South Korea experienced?
"In countries like Israel and New Zealand, the influx of foreign investment in Government Bonds significantly increased due to index inclusion. However, in China's case, after the announcement of inclusion in September 2020, funds initially flowed in, but after the actual inclusion in October 2021, there was a withdrawal of funds. It is assessed that macroeconomic conditions at that time, along with low liquidity and policy uncertainties, influenced this outcome."
―Is there no problem with the scheduled inclusion in November? Some people are worried about political uncertainties such as coup and impeachment, as well as rising exchange rates.
"The announcement made in October last year was a confirmation of inclusion. FTSE has communicated that there will be no problems with inclusion as long as the quantitative requirement of a country credit rating of 'A-' or above and improvements in the foreign investor's access system are maintained. Currently, South Korea's credit rating is 'AA' according to S&P, with 'AA-' and 'A+' falling into three categories up to 'A' and below."
We will check the system to ensure that the inclusion process proceeds smoothly and continue communication with global investors.
―It took two years from being designated as an observation country to joining WGBI.
"Looking at the cases of other countries, it usually takes about two years. There are also cases like Switzerland, which was designated as an observation country for two years and six months before being excluded."
Initially, there was a view in the market that the decision for inclusion would be made in 2025. It is assessed that the inclusion decision was made more quickly than expected due to the government's active explanations and improvements in market systems.
―What preparations need to be made domestically before the inclusion in November?
"Several requests have been raised by global investors. With expectations of inflow from not only passive funds but also new investors who have not previously invested in South Korean Government Bonds, we plan to check the conditions for foreign investment and improve systems accordingly."
In addition, high liquidity in the Government Bonds market is essential for the smooth inflow of index tracking capital. We will strive to enhance government bond liquidity through the reissuance of maturities.
―You mentioned political instability earlier, but according to Government Bonds statistics, there was strong selling of South Korean Government Bonds by foreign investors last December. Have you analyzed the causes?
"In December, the foreign ownership balance of government bonds decreased by 2.9 trillion won. It seems that seasonal factors such as concentrated maturities and book-closing (seasonal accounting closures), as well as projections of a reduced rate cut by the U.S. Federal Reserve in 2025, have impacted this decrease."
In January, foreign investment in government bonds is expected to increase again due to investment fund executions by institutions at the beginning of the year.
―Is this not an alarming signal?
"The investment in foreign Government Bonds futures is expected to recur for profit realization due to future rate forecasts and external factors causing interest rate volatility."
―Among the institutional improvements requested by foreign investors, there was mention of 'exemption from tax reporting for foreign investors.'
"We are currently amending the Income and Corporate Tax Act to eliminate the obligation to submit tax exemption application forms, with the aim of upgrading convenience for global investors."
―What is the current status of preparations for the nighttime government bond futures market?
"Starting this June, 3-year and 10-year Government Bonds futures will be tradable from 6 p.m. to 6 a.m. the following day. It is expected to reflect quickly when events occur in overseas markets, thereby enhancing market efficiency. We believe this will expand access to government bond derivatives for global investors and increase overall liquidity in the Government Bonds market."
―There are calls for early supplementary budgets, mainly from opposition parties, raising concerns about increasing the burden of government bond issuance.
"This year, the issuance limit for government bonds is 197.6 trillion won, which is an increase of 39.2 trillion won compared to last year. Additionally, new issuance of foreign exchange stabilization fund bonds will amount to 20 trillion won."
The market appears to believe that a supplementary budget may be organized due to downward adjustments in this year's Gross Domestic Product (GDP) growth rate. It is assessed that this has already been reflected to some extent in interest rates. However, if uncertainties across the financial markets increase, there is a possibility that interest rates may surge, leading to higher financial burdens.
―What measures are there to minimize financial burdens?
"We are reviewing expansion plans for demand to respond to the increased issuance of government bonds. Through proactive investor relations, we aim to encourage active investment in the first half of the year. We also plan to promote government bond investments among domestic institutional investors while improving systems to activate individual government bond investments (such as the 5-year issuance and automatic subscription system)."