"If Trade Deficit Occurs, Probability of Foreigners Selling Korean Stocks Rises by 28.3%"

'Deficit → Possible KRW Depreciation → Concerns over Exchange Losses → Sell-off' Vicious Cycle
"Calls for Overseas Resource Development and Supply Chain Measures + Tax and Regulatory Improvements"

[Image source=Yonhap News]

[Asia Economy Reporter Moon Chaeseok] As South Korea has fallen into a trade deficit for five consecutive months, significant statistics have emerged showing that the trade deficit negatively affects the investment sentiment of foreign investors holding a quarter (26.2%) of the shares of domestic listed companies. Analysis indicates that the probability of foreigners turning to net selling in the domestic securities market increases by 28.3% in the month following a trade deficit. When large sums of foreign capital exit, the fundamentals of the Korean economy weaken accordingly.

On the 21st, the Korea Economic Research Institute under the Federation of Korean Industries argued that when the trade balance worsens, foreign currency inflows decrease, lowering the value of the Korean won and causing the exchange rate to rise. The institute explained that by performing a Granger causality test, they statistically confirmed that a worsening trade balance leads to depreciation of the won. Examining trade balance and exchange rates over three years from August 2019 to last month, they found a significant causal relationship between the two. For example, in August last year, when the won-dollar exchange rate was 1,161.1 won per dollar, the trade balance recorded a surplus of $1.58 billion (approximately 2.2017 trillion won), but last month, with an exchange rate of 1,320.4 won, a trade deficit of $9.49 billion (approximately 13.2243 trillion won) was recorded. The exchange rate rose, and the trade balance worsened.

The problem is that when the exchange rate rises (the won depreciates), foreigners may exit the Korean stock market due to concerns over foreign exchange losses. The Korea Economic Research Institute explained that if the trade balance was in deficit last month, the probability of foreigners net selling domestic stocks this month increases by 28.3%. Based on monthly data from January 2004 to last July, the institute captured the fact that trade deficits weaken foreign investors' sentiment. According to this model, the probability of foreigners net selling domestic stocks this month was measured at a high 75.6%, the institute added.

The institute diagnosed that the cause of the worsening trade balance is the surge in international raw material prices increasing import costs, while global economic recession sharply reduces exports. According to the Ministry of Trade, Industry and Energy, South Korea's export growth rate plummeted from 34.7% in August last year to 6.6% last August. The gap between export growth rate and import growth rate last August reached 21.6 percentage points, marking the highest since August last year. While the export growth rate was 6.6%, the import growth rate was as high as 28.2%.

To reduce the trade deficit, the Korea Economic Research Institute diagnosed that it is essential to mitigate the impact of international raw material price fluctuations and secure companies' export competitiveness.

Choo Kwang-ho, Director of Economic Policy at the Korea Economic Research Institute, explained, "Since foreign investors have a considerable influence on the domestic stock market, managing the trade balance is a very important issue not only for the real economy but also for stabilizing the domestic financial market." Director Choo emphasized, "The government should make every policy effort to enhance export competitiveness, including expanding trade finance, strengthening R&D tax support, improving regulations, and supporting the securing of new growth engines, while striving to stabilize supply chains through overseas resource development and resolving logistics bottlenecks."

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