The Bank of Korea argued that the traditional formula in which a current account surplus led to a stronger won is breaking down. As overseas investment by individuals and corporations has surged, the force moving the exchange rate is shifting from goods trade to capital inflows and outflows.
On the 17th, in a report released by the Bank of Korea (BOK) titled "The impact of structural changes in Korea's external sector on the exchange rate," it analyzed the relationship between Korea's current account surplus and the real won-dollar exchange rate since 2015 and stated accordingly. The report was written by Directors Kim Ji-hyeon and Kim Min of the International Finance Research Team in the International Department.
The real exchange rate refers to the exchange ratio of goods calculated by reflecting price levels. If the real exchange rate has risen, Korean goods have become relatively cheaper than foreign goods, strengthening export competitiveness; in the opposite case, Korean goods have become relatively more expensive, weakening export competitiveness.
Typically, a current account surplus driven by strong exports indicates rising overseas demand for Korea's goods and is a factor that boosts the won's value. However, since 2015, the exchange rate has instead risen even amid current account surpluses. Even when the current account relative to gross domestic product (GDP) expanded by 1 percentage point, the real exchange rate rose by an average of 0.65%.
The research team pointed to increased private overseas investment as the cause of this change. In the past, funds accumulated through current account surpluses were mostly built up as reserve assets such as foreign exchange reserves, but since the 2010s, private securities investment in overseas stocks and bonds has risen rapidly. As of the end of last year, private securities investment accounted for 44.1% of total external assets, about three times the share of reserve assets (14.9%).
When the asset accumulation structure changes, the factors that determine the exchange rate also change. In the past, dollars flowing in and out through trade moved the exchange rate, but now capital flows have a greater impact. Director Kim Ji-hyeon said, "When we name the phenomenon in which exports of Korea's goods increase due to current account surpluses and push the exchange rate down as a 'goods shock,' and the phenomenon in which capital outflows from residents' overseas asset investment push the exchange rate up as a 'financial shock,' the frequency of financial shocks has increased since 2015."
An increase in savings due to aging is also a factor pushing the exchange rate higher. The "household net savings rate," which refers to the share of income left after subtracting consumption and other spending, rose to 6.1% recently from an average of 2.4% in the 2000s. When savings increase, consumption falls, and corporations lower prices to sell remaining goods. In this process, domestic goods prices fall relatively quickly, and the real exchange rate rises.
According to the research team, the increase in savings demand is estimated to have lifted the real exchange rate by about 12%. Director Kim noted, "The rise in the savings rate contributed to the gentle, trend-like increase in the real exchange rate since 2011," adding, "By contrast, the goods shock contributed to won appreciation in the 2000s and 2010s, but its effect has weakened significantly in recent years."