Analysis: South Korea’s huge pension fund, a homegrown force, gained lower

A rating won by South Korea is seen in this illustrative photo from May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

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SEOUL, July 21 (Reuters) – South Korea’s dogged attempts to defend a badly weakened currency have come up against an unstoppable internal force working in the opposite direction: the national pension fund.

The National Pension Service (NPS), the third largest such fund in the world, has a huge and growing appetite for overseas stock and bond investments, which it can only feed by selling won against foreign currency.

It made net purchases of about $10 billion in foreign bonds and stocks in the first five months of 2022, central bank data showed. As a cause of won sales this year, its activity came on top of a record $10.36 billion trade deficit in the first half of the year and the $12.53 billion that foreign investors had drawn from the stock market. country in June.

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All of this downward pressure has made the won the worst performer against the US dollar among emerging Asian currencies this year. His losses exceed 9%.

“Besides global factors, such as high oil prices, for 90% of the time in recent weeks, it was the continued NPS outflows that drove the won down,” a local bank trader said.

“It wasn’t concerns about the health of the Korean economy that pushed the won down. The NPS essentially pushed up the dollar/won level with skewed demand for dollars from the onshore market.”

Created in 1988, the NPS is the main public pension scheme in Asia’s fourth-largest economy.

It manages 919.6 trillion won ($702.03 billion) in assets, or about 40% of annual gross domestic product. Being so important to the local economy, it had to invest aggressively overseas, where it also earned higher returns.

While the fund struggles to meet the retirement needs of the world’s fastest-aging population, finance and central bank officials have no authority to ask it to keep more money at home.

In addition, the fund compensates little for its demand for currencies by hedging, which it limits to 5% of the value of its foreign assets.

Asked to comment on the outsized role it now plays in the onshore foreign exchange market, the NPS said it “responded flexibly to market conditions by strategically hedging currency risks, as a rise in the dollar/won rate affects negatively the return on foreign assets.”

STRUCTURAL UPWIND

South Korean exchange authorities are unhappy as the won, currently near a 13-year low, is on course for its biggest annual decline in 14 years. Perched on the weaker side of 1,300 to the dollar, the currency is at levels previously seen only during economic crises.

The Bank of Korea made net dollar sales of $8.31 billion to stem the decline of the won in the first quarter alone.

The downward pressure from NPS won sales will only grow as the fund continues to expand, as will the share of foreign assets in its portfolio. It plans to hold 50% of its assets overseas by 2024, up from 44% at the end of last year and 27% five years ago.

That, coupled with the trade deficit and growing appetite among Korean retail investors for foreign stocks, could send the won into a long-term downward trend, officials said.

“As the NPS steadily increases its foreign investment ratio, structural depreciation pressure (on the won) may follow,” a Bank of Korea board member told a policy meeting. money in May.

A Ministry of Finance official said: “As the NPS is a big player in the market, it should seriously consider how to reduce its impact when considering when to buy (in dollars) and how He buys.”

Even the US Treasury Department has noticed the growing influence of the NPS.

In its semi-annual currency report, the department cited the fund’s foreign assets increasing “by about $60 billion in 2021,” primarily due to valuation changes. This was a rare mention of local, not international, factors driving the won’s decline.

At least a quarter of the increase came from purchases of stocks and bonds, according to a Reuters calculation.

($1 = 1,309.9100 won)

(Corrects currency unit in penultimate paragraph to US dollar from South Korean won)

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Reporting by Jihoon Lee, Cynthia Kim and Yena Park; Editing by Vidya Ranganathan and Bradley Perrett

Our standards: The Thomson Reuters Trust Principles.

Dolores W. Simon