Korea remains vulnerable to external shocks

By Chung Min-uck

Lackluster investment in foreign financial assets could make Korean investors more vulnerable to external factors, capital flows and exchange rate fluctuations, the Korea Institution of Finance (KIF) said in a recent report.

Foreign assets accounted for 8.4 percent of the value held in Korean investment portfolios at the end of last year, representing an increase of 3 percentage points over an eight-year span. Korean investment in domestic stocks reached 600 trillion won ($554 billion), while their foreign stocks were valued at just 46.5 trillion won in 2010, the KIF said.

Lim Hyung-joon, a KIF researcher, said that even American investors, known for their homeward appetite, dedicate 27 percent of their stock investment in overseas markets.

``It’s natural that domestic assets take up the majority of their portfolio since most investments are made with local currency,” said Lee Ji-eun, a senior researcher at KIF.

``Yet, it’s hard to deny that Korean investors aren’t investing enough in foreign assets, and this could make the country more exposed to changes in the movement of foreigners’ financial assets invested in Korea.’’

The Korean financial market is currently experiencing an enormous influx of foreign capital due to a wave of quantitative easing at the developed countries. According to Financial Supervisory Service (FSS), foreign investment in Korean stocks increased by 30.5 percent in May compared to the same month of last year to a record 402 trillion won ($374 billion), accounting for 30.8 percent of the aggregate market value of listed stocks in Korea.

Speculators anticipate that the U.S. Federal Reserve could opt for another round of quantitative easing soon, following the expiration of the second round initiated last year, in an attempt to boost the weakening American economy.

With foreign investment in Korean liquid assets such as stocks and bonds growing larger and larger, Korea is becoming more vulnerable to the inflow and outflow of foreign assets.

Lee said that if foreign investment flows out rapidly as a result of changes in economic conditions in developed countries or in the global financial market as a whole, it can have a powerful effect on the Korean economy.

By increasing the portion of foreign assets, not only Korean investors can hedge their risks but the foreign assets can play a significant role as a source of foreign currency in case of a liquidity crisis.

The report also suggested that investment in developing countries’ stock markets is the best choice because for foreign investment to be nation’s source of foreign currency it needs to be in liquid assets where it is easy to cash out.

For individuals, investing in developing markets such as Indonesia and Philippine is much more favorable than other markets including Korea since the earnings rate is higher.

As for ways to encourage foreign stock investment, the KIF suggested that the government offer inducements such as giving a deduction in income tax when investing in funds associated with foreign stock markets or imposing no taxes on trading profits generated from investment exposed to foreign currency fluctuation.

“Measures such as income tax deductions and tax exemptions disappeared after the financial crisis in 2008. The purpose (of writing the report) is to help revive those inducements and encourage domestic investors to invest (in foreign stocks),” said Lee.