Despite Record Current Account Surplus, Why Is the Exchange Rate Still Rising?... The Reason the Old Formula No Longer Applies

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The old formula of "current account surplus = strong won" has broken down. The impact of "financial shocks"-where increased overseas asset accumulation by the private sector, such as by "Seohak Ants" (individual investors investing overseas), drives up demand for dollars and pushes up the exchange rate-now outweighs that of "goods shocks," where companies boost exports, earn more dollars, and thereby strengthen the won (i.e., lower the exchange rate).

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According to the "BOK Issue Note-The Impact of Structural Changes in Korea's External Sector on the Exchange Rate" (by Kim Jihyun and Kim Min), released by the Bank of Korea on April 17, before 2014, Korea's current account surplus generally coincided with a declining exchange rate. This structure resulted from domestic companies expanding exports and boosting competitiveness, leading to increased dollar inflows and a lower exchange rate. However, since 2015, the trend has reversed: expanding current account surpluses have increasingly been accompanied by a rising exchange rate (a weaker won). In particular, since the second quarter of 2023, the current account surplus has widened while the exchange rate has continued to rise.

Kim Jihyun, Head of the International Finance Research Team at the Bank of Korea's International Department, explained that this is "a result of structural transformation in Korea's external sector." The rising share of private sector overseas assets means that capital outflows by residents have a growing impact on the external sector and the exchange rate. Since the global financial crisis, Korea's overseas asset accumulation has shifted from being centered on public sector reserve assets to private sector portfolio investments. Especially notable is the concentration of external assets in U.S. holdings. Korea invests 63.4% of its total external securities and 67.7% of its total external equity investments in the United States. These changes have coincided with an increase in savings due to population aging and a slowdown in domestic investment.

According to the report, in a financial shock scenario triggered by increased overseas investment, a one percentage point increase in the current account surplus relative to GDP raises the real won-dollar exchange rate by 0.65 percentage points. This means that even with a larger current account surplus, dollars flow out and the exchange rate rises. Over the full analysis period (2000-2025), financial shocks occurred 55.6% of the time, higher than the rate for goods shocks (44.4%). Notably, since 2015, the frequency of won depreciation shocks caused by capital outflows jumped from 21.4% to 34.9%. In contrast, the frequency of won appreciation shocks due to capital inflows dropped sharply from 35.7% to 18.6%. Kim noted, "While the impact of goods shocks, which drove down the exchange rate until 2014, has recently weakened, increased demand for dollar assets, rising savings due to aging, and sluggish domestic investment are increasingly exerting upward pressure on the real exchange rate."

It was also confirmed that, under identical dollar demand shocks, the won tends to depreciate more sharply than other currencies. Kim explained, "Korea's exchange rate response coefficient (regression coefficient) for capital outflows is 0.65-lower than the emerging market average of 0.71, but higher than those of major advanced economies: the United States (0.07), Switzerland (0.11), and Japan (0.38)." He added, "This means the won is more sensitive to financial shocks of equal magnitude."

He further explained that if residents' demand for overseas assets is concentrated in a short period, or if foreign capital rapidly exits due to external factors, the foreign exchange market becomes even more sensitive and supply-demand imbalances intensify. Kim stated, "During this structural transition, short-term factors such as changes in global trade structures, concerns about weakened international competitiveness in key industries, and prolonged sluggishness in the domestic stock market have all contributed to a rapid surge in demand for overseas assets." He added, "When demand for overseas assets increases suddenly in a short period, the FX market's sensitivity rises, short-term supply-demand imbalances worsen, and exchange rate volatility can increase." He also pointed out that "one-sided expectations of a strong dollar, as reflected in the high concentration of U.S. assets, can further amplify these effects."

As a result, the analysis suggests that policy responses to ease short-term supply-demand imbalances should be accompanied by measures to deepen the FX market, such as increasing trading volume and scale. Kim assessed, "Structural improvements to the FX market being pursued by the monetary authorities, as well as expanding the base for capital inflows and diversifying investors through inclusion in the Morgan Stanley Capital International (MSCI) Developed Markets Index and the World Government Bond Index (WGBI), are expected to enhance FX market depth. This will help buffer exchange rate volatility caused by short-term supply-demand imbalances and reduce the market's sensitivity to such shocks."

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