Volatility Increases in Korean Won, What Is the Future Direction?

[Asia Economy Reporter Song Hwajeong] As volatility in the KRW-USD exchange rate has increased since December, attention is focused on its future movements.

According to Kiwoom Securities on the 26th, the KRW-USD exchange rate fell below 1,100 won at the beginning of December and rapidly declined to 1,082 won on the 7th based on closing prices, but then reversed to rise and rebounded to 1,107 won as of the 22nd.

The early December decline in the KRW-USD exchange rate was influenced by the U.S. presidential election. Yumi Kim, a researcher at Kiwoom Securities, analyzed, "The faster-than-expected decline in the KRW-USD exchange rate in early December was due to the expanded weakness following the election of U.S. candidate Joe Biden as president, the strengthening of the yuan amid improvements in China's fundamentals, and better-than-expected domestic exports, which widened the current account surplus." In particular, the rapid inflow of foreign capital into the domestic financial market, centered on the stock market, accelerated the decline in the KRW-USD exchange rate.

Since mid-December, the KRW-USD exchange rate has seen limited further declines and reversed to an upward trend. Researcher Kim explained, "The number of new COVID-19 cases surged not only in advanced countries but also in Korea, raising related concerns. The euro weakened due to worries about the coronavirus variant in the UK, which slowed the dollar's weakness." She added, "Especially, the weakening of risk asset preference in the global financial market has constrained further yuan appreciation and additional dollar declines, while the decrease in foreign capital inflows into the domestic stock market is reflected in the rebound of the KRW-USD exchange rate." Additionally, increased demand for the dollar toward the year-end has also acted as a factor weakening the won.

Although the KRW-USD exchange rate has recently rebounded, the downward trend is still considered valid. First, considering the U.S. Federal Reserve's (Fed) low interest rate policy, expanding fiscal deficit, and euro strength, the dollar index could fall to the high 80s in the first half of 2021. Researcher Kim stated, "The Fed has announced it will maintain a low interest rate policy until 2023 and is expected to stimulate the economy through low real interest rates. Since U.S. President Biden is strongly committed to stimulus, the expanding fiscal deficit could also lead to dollar weakness."

The yuan is also expected to strengthen further. Researcher Kim said, "Although the Biden administration will maintain a tough stance on China, it is negative on imposing tariffs, so the possibility of continuing trade disputes using tariffs like the Trump administration is low." She added, "This could ease uncertainties caused by the U.S.-China trade disputes since 2018, potentially leading to a reversal of the yuan's weakness." Furthermore, China’s early control of COVID-19 has led to faster fundamental improvements compared to major advanced countries. Considering China's market interest rates are higher than other major countries and the Chinese government's willingness to open capital markets to foreigners, foreign capital attraction to the Chinese financial market is high. Researcher Kim explained, "If the yuan continues to strengthen, it could act as a strengthening factor for the won, which has a high correlation with the yuan."

Internal factors regarding the KRW-USD exchange rate are also favorable. Domestic exports are expected to increase as global trade volume improves and import demand rises in 2021. The export boom raises expectations for corporate earnings, which could be favorable for foreign capital inflows into the domestic stock market. The domestic market interest rate level, combined with sound external stability, could act as an incentive for foreign purchases in the bond market. Researcher Kim said, "Based on the real effective exchange rate of the won considering trade volume and inflation, it is still below the 10-year average level." She added, "This means that the valuation burden of the won being overvalued is low, indicating that there is room for further won appreciation."

This content was produced with the assistance of AI translation services.