[Inside Chodong] Korean Capital Market Risks Becoming a Nominal Developed Index

Raise Capital Market Transparency to Eradicate Securities Crimes
True Modernization Starts with Restoring Trust

Morgan Stanley Capital International (MSCI) inclusion in the Developed Markets (DM) index has once again failed this year. To be included in the developed markets index, a country must be on the watchlist as a candidate for more than one year. This time, South Korea did not even make it onto the candidate list. The opportunity to challenge for inclusion in the developed markets index has been postponed until June next year.

Considering South Korea’s economy ranks among the world’s top 10, the status of its capital market is underwhelming. South Korea, selected by the Organisation for Economic Co-operation and Development (OECD) as an ‘OECD High-Income’ country, is clearly recognized as a developed country by anyone. However, the capital market tells a different story. No one evaluates it as developed. MSCI, which is referenced by 30% of global funds when making investment decisions, classifies South Korea as an emerging market.

The government is making efforts to modernize the capital market by improving accessibility for foreign investors and revising related systems. MSCI stated, “We welcome the measures proposed to improve foreign investors’ access to the Korean stock market” and added, “We will monitor the effectiveness of the implementation of these measures.” Financial authorities expect that if market accessibility is improved as planned, South Korea will be placed on the watchlist in June next year and subsequently included in the developed markets index.

Will this mean that the domestic capital market will also join the ranks of developed markets? If various securities crimes that have stained the capital market are not eradicated, the modernization of the capital market will only be half successful. Currently, the domestic market is suffering from suspected market manipulation crimes, including the stock price crash triggered by Soci?t? G?n?rale (SG) Securities and a series of five stocks hitting the lower price limit.

Various securities crimes erode trust in the capital market and diminish its status, ultimately leading to a market crisis. When trust in the capital market is damaged, investment activities shrink and fundraising is hindered. This eventually becomes a negative factor for national economic development. Even if South Korea barely makes it into the developed markets index, if the transparency of the capital market declines, it will inevitably remain a ‘nominal developed index’ status.

Moreover, the weighting of the Korean stock market in the MSCI Emerging Markets index has been continuously decreasing. At the end of 2012, Korea’s share in the emerging markets index was 15.4%, but by the end of 2022, it had dropped by 3.4 percentage points to 12.0%. Korea’s ranking within the emerging markets index also slipped to fourth place, behind China, Taiwan, and India. If Korea’s weighting in the emerging markets index continues to decline, foreign investment funds may flow out. This is another reason why inclusion in the developed markets index is necessary.

Foreign investors, who had consistently been buying Korean stocks this year, have turned to net selling since this month. While there may be reasons such as currency gains or profit-taking, there is likely also a lack of confidence in the Korean market. Following the failure to be included in the global bond index’s developed markets category in March, the failure to be listed as a watchlist country by MSCI, and various unfair trading practices, the attractiveness of the Korean capital market inevitably diminishes.

If the Korean stock market is included in the MSCI developed markets index, foreign capital inflows can be expected in the mid to long term. The government and financial authorities hope this will resolve the ‘Korea discount’ (undervaluation of the Korean stock market). However, before that, market transparency must be improved by eradicating various securities crimes. Fortunately, an amendment to the Capital Markets Act, which strengthens criminal penalties and administrative sanctions for unfair trading practices such as stock price manipulation, is about to pass the National Assembly. Once implemented, the likelihood of ‘light punishments’ will greatly decrease. This is expected to have a deterrent effect on various securities crimes. It is hoped that this will be the first step toward achieving capital market modernization that matches the scale of the economy, rather than boasting a nominal developed index.

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