'World's Lowest KOSPI' 30 Years as MSCI Emerging Market... Fourth Challenge for Developed Market Remains 'Bleak'

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Lee Seon-ae] Among the major stock markets worldwide, the Korean stock market, which boasts the largest decline and remains at the 'bottom,' is once again unlikely to be included in Morgan Stanley Capital International's (MSCI) Developed Markets Index. It has remained in the MSCI Emerging Markets Index since its inclusion in 1992, marking 30 years without change. Although Korea has challenged for promotion to the Developed Markets Index since 2008, it has repeatedly faced setbacks, leaving this long-standing goal still shrouded in uncertainty. Concerns are rising that if inclusion in the Developed Markets Index fails, downward pressure on the Korean stock market will intensify.

Preliminary Evaluation 'Failing Grade'... Watchlist Inclusion Likely to Fail

According to the financial investment industry on the 20th, MSCI will announce the list of countries under review for the Developed Markets Index (watchlist) on the 23rd (Korean time, June 24 at 5:30 a.m.). The securities industry places weight on the possibility that Korea will fail to be included in the Developed Markets Index. This is because MSCI gave Korea a practically failing grade in the market accessibility evaluation released on June 9, ahead of the announcement of the countries under review. Korea was pointed out as needing improvement due to insufficient information for foreign investors, corporate governance issues, restrictions on short selling, and dividend disclosures that differ from international standards.

Yeom Dong-chan, a researcher at Korea Investment & Securities, said, "Korea's goal in the market reclassification results scheduled for announcement on the 24th was not 'classification as a Developed Market' but 'inclusion as a Developed Market candidate.'" He added, "While the possibility of inclusion as a Developed Market candidate is not zero, the recent market accessibility evaluation results should be interpreted as a decline in probability compared to market expectations." He further explained, "This MSCI evaluation should be understood as MSCI's stance to change the evaluation only after confirming actual improvements, although the government's willingness to improve is also important."

Korea is classified as a Developed Market by other major global index providers such as Financial Times Stock Exchange (FTSE), Dow Jones, and Standard & Poor's (S&P), alongside MSCI. However, MSCI has classified Korea as an Emerging Market since 1992 and has repeatedly failed to promote it to Developed Market status.

The MSCI index, published by Morgan Stanley Capital International in the U.S., is a global stock index that most global funds use as a benchmark for managing investments, making it highly influential. MSCI broadly classifies countries into Developed Markets (DM), Emerging Markets (EM), and Frontier Markets (FM). Being classified as a Developed Market can lead to a large influx of foreign investment funds. In the Emerging Markets Index, a discount is inevitably applied during the valuation process.

The government's efforts to enter the Developed Markets Index aim to resolve the chronic undervaluation (discount) problem of the Korean stock market. The Korea Economic Research Institute forecasts that if the Korean stock market is promoted to the Developed Markets Index, foreign capital inflows of 18 trillion to 61 trillion won will enter the domestic market. Concerns about sudden capital outflows and inflows will also decrease, reducing volatility compared to when classified as an Emerging Market. In fact, Samsung Securities analyzed the volatility of MSCI Developed and Emerging Markets Indices from 1990 to 2019 and found that Emerging Markets were about 60% more volatile than Developed Markets. This means that during major shocks like the Lehman Brothers bankruptcy or Brexit, Emerging Market stock markets fell more sharply.

Therefore, inclusion in the MSCI Developed Markets Index is a long-standing government goal. This is the fourth attempt following challenges in 2008, 2015, and June last year. Korea was placed on the MSCI Developed Market watchlist in 2008 but failed inclusion due to insufficient market accessibility and was removed from the watchlist in 2014. If Korea fails to be included in the watchlist this time, it will have to reattempt in June next year.

The Key Issue: Absence of Offshore Spot Foreign Exchange Market

MSCI classifies countries based on three criteria: economic size, stock market size and liquidity, and stock market accessibility. Korea meets the conditions for Developed Market entry in terms of economic and stock market size but has remained an Emerging Market due to failure to meet stock market accessibility conditions. MSCI has consistently stated that for the Korean stock market to be classified as Developed, it needs to open the foreign exchange market, improve foreign investor accessibility, and enhance market data accessibility for the development of various financial products.

MSCI announces market accessibility evaluation results about two weeks before the market reclassification announcement, and most of the items previously pointed out as needing improvement received the same evaluation as in 2021. No items were evaluated as having improved. In fact, the score for the item related to SK Telecom's foreign ownership limit was downgraded due to the limited remaining capacity.

Repeatedly criticized issues include the absence of an offshore foreign exchange (spot FX) market (foreign exchange market liberalization), lack of English disclosure materials (information flow), restrictions on stock market data usage limiting product development (investment product availability), difficulties in spot transfers and over-the-counter trading (transferability), cumbersome foreign investor registration requirements (investor registration), inability to settle securities with borrowed funds (clearing and settlement), and the lack of full allowance for short selling.

The most critical issue is the 'absence of an offshore spot foreign exchange market.' Global investors consider not only stock valuation gains but also foreign exchange gains when investing in a country's stock market. For example, even if a 5% profit is made on stocks, a 10% foreign exchange loss results in an overall 5% loss. Therefore, the existence of a market where the local currency can be freely converted into dollars at any time is very important when investing in a country's stocks. Korea currently has only an onshore spot FX market (interbank market) and an offshore non-deliverable forward (NDF) market. Offshore spot FX trading, which allows free exchange of won and dollars after the onshore market closes, is not permitted. The establishment of an offshore spot FX market would weaken the government's 'control' over the exchange rate, potentially leading to macroeconomic instability during crises.

To improve foreign investors' information accessibility as required by MSCI, mandatory English disclosures would require amendments to the Capital Markets Act, and changes to the dividend payment process would require amendments to the Commercial Act. Among MSCI's improvement demands is the rigidity of trading outside the exchange. This fundamentally relates to Korea's tax system, which uses securities transaction tax and imposes capital gains tax on off-exchange transactions, suggesting that tax law changes may also be necessary. Researcher Yeom noted, "There are still many hurdles for Korea to be classified as a Developed Market by MSCI," adding, "Looking at MSCI's requirements, the path to becoming a Developed Market is not smooth."

[Image source=Yonhap News]

Concerns Over Downward Pressure

If the failure to be included in the Developed Markets Index is confirmed this time, concerns are growing that downward pressure on the Korean stock market will intensify. Han Ji-young, a researcher at Kiwoom Securities, said, "If Korea fails to be registered as a candidate for the Developed Markets Index on the 24th, there will be disappointment," adding, "Even if Korea is included as a candidate, considering that actual inclusion and related rebalancing of tracking funds will take at least 1 to 2 years, it will only act as a neutral factor."

Last week, the KOSPI ultimately broke below the 2400 level during trading and plunged. The decline in the Korean stock market stands out among major global markets. The KOSPI's decline from its post-COVID-19 peak (compared to the 17th) is -35.41%, the highest. The U.S. Nasdaq recorded -33.70%, followed by the Hong Kong stock market at -32.94%. The KOSDAQ also recorded -24.65%. In contrast, neighboring countries China and Japan recorded -11.57% and -13.82%, respectively, showing better performance than the domestic market.

Experts point out that due to Korea's structural economic characteristics, which heavily depend on manufacturing and exports, investment attractiveness inevitably declines if inflation and economic slowdown worsen. Especially with the ongoing interest rate hike trend, efforts to minimize risk assets have strengthened, reducing foreign investors' preference for the domestic stock market. Jeong Yong-taek, senior researcher at IBK Investment & Securities, said, "As interest rate hikes accelerate and upward pressure on the won-dollar exchange rate increases, foreign investors are accelerating their exit," adding, "Korea's market has had abundant liquidity, but its appeal as an Emerging Market has diminished, resulting in a larger decline compared to other stock markets."

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