Author: Kyle Ferrier, Korea Economic Institute of America
Since the Asian Financial Crisis, South Korea has pursued a delicate balance between openness and stability in its domestic financial markets. While foreign investors have seen improved accessibility in certain areas, key safeguards limiting international capital flows remain in place.
In January, South Korea’s Ministry of Economy and Finance announced it was considering reforms that would extend the trading hours of the South Korean won and allow international traders to participate in the market, constituting at least a partial reversal of the ban on offshore trading. The move is part of a campaign to signal the country’s interest in being recognised as a developed market by Morgan Stanley Capital International (MSCI).
South Korea has been granted developed country status in all major international economic organisations and other financial indexes, but has consistently fallen short of MSCI’s high market accessibility criteria. Despite the prestige associated with the elevated status — and the subsequent financial gains — this shift is also accompanied by some risks.
Though the move is not enough to upgrade Korea’s classification, liberalising trade of the South Korean won constitutes a major step in that direction. First instituted in 1999, the ban on offshore trading has been upheld in support of the Bank of Korea’s ability to protect the value of the South Korean won through open market operations, especially during sudden market downturns.
Trading hours are currently open from 9am to 3:30pm, Korean Standard Time. Only domestic financial institutions can participate, with foreign investors required to carry out transactions through South Korean intermediaries. The possibility of extending trading hours to 24 hours a day and permitting offshore dealers to trade directly is under consideration. This change would address overseas investor concerns about the higher costs of trading in South Korean won and the difficulty of trading the currency after markets in Seoul close.
But South Korean government officials have not been as vocal about other issues blocking its MSCI ambitions. Longstanding issues such as the cumbersome registration process for foreign investors and the data restrictions that limit the availability of investment instruments have yet to be addressed. South Korea has also faced criticism for only partially lifting its short-selling ban last year. Continuing issues with past reforms make even optimistic investors cautious. Notably, the vaunted introduction of omnibus accounts for foreign investors in 2017 has not improved its MSCI rating in the relevant clearing and settlements category.
Should South Korea eventually overcome these obstacles, there are some predictions regarding how increased capital flows associated with elevated MSCI status might benefit domestic financial markets. A report from Goldman Sachs this year assessed that it could generate an inflow of US$44 billion. It could also lead to improvements in key underlying factors contributing to South Korea’s valuation discount — such as lower levels of corporate governance, high earnings volatility and low medium-term earnings growth — which could lift the Korea Composite Stock Price Index by 35 per cent.
But there are areas of concern for South Korea should MSCI upgrade it, especially due to the reforms needed to get there. Some in South Korea are worried about the stability of the South Korean won as a result of the proposed currency trading reforms — despite government officials’ claim that: ‘It is easier to manage volatility if we extend the market hours and bring the offshore trade to the local market’. An index upgrade is also likely to favour large-cap stocks at the expense of smaller caps, exacerbating the already substantial divide between major conglomerates and small companies.
While it appears that trade in the South Korean won will be liberalised soon, this cannot happen immediately. Even if South Korea were to implement the proposed changes before the MSCI Market Accessibility Review comes out on 1 June 2022, the country would need to stay on the institution’s watchlist for at least a year before it could be reclassified.
President Yoon Seok-yeol did not promote a policy of meeting developed country criteria in his campaign, unlike his competitor Lee Jae-myung. His outlook on deregulation could lead to the same outcome eventually, but rapidly pushing through reforms before 1 June is highly unlikely. Despite the recent attention, South Korea’s MSCI developed country status aspirations are poised to remain a long, drawn-out process.
Kyle Ferrier is Fellow and Director of Academic Affairs at the Korea Economic Institute of America.
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