By Park Hyong-ki
The interest rate gap between the United States and Korea is expected to widen further as the Federal Reserve is likely to raise its key rate twice, while the Bank of Korea (BOK) is projected to keep its rate unchanged for the rest of the year.
This would raise concerns about the possibility of foreign treasury bond traders exiting their local investments in droves amid forecasts that the Korean economy will get weaker and the value of the dollar will fall, analysts say.
Foreign bond investors will be able to gain higher returns after they exit and exchange their local currency to dollars as a stronger won would leave them with a bigger amount of dollars in their accounts.
Analysts say the country should be more worried about foreign investors, who came to stay in this market for a long period, leaving town as soon as they see a sign of economic trouble ahead.
"I'd be more worried about them exiting this country as the rate remains the same due to a weak economic outlook," said Sung Tae-yoon, an economist at Yonsei University.
"There will always be investors who would come and go, looking for short-term gains through currency exchanges. However, long-term seekers could leave when the economy does not show signs of growth."
Foreigners have been net buyers of Korean 10-year treasuries, investing 2.3 trillion won ($2 billion) as of August this year, despite the widening rate gap, according to the Financial Supervisory Service.
The BOK rate is 1.5 percent, while the Fed's federal funds rate is 1.75 percent to 2 percent. The U.S. central bank is expected to hike it to 2.25 percent later this month, and 2.5 percent in November.
Fed Chairman Jerome Powell recently signaled two more rate hikes this year and next year as the U.S. economy is growing strong with decreasing joblessness. But there are risks stemming from trade wars and a slowdown in emerging markets, he noted.
Some analysts viewed his comments at the Fed's annual retreat in Jackson Hole, Wyoming, as dovish, contrary to initial expectations of at least one hike per every fiscal quarter next year. The dollar has turned a bit weaker following this event, coupled with President Donald Trump's fight for a weak currency policy in response to China's alleged devaluation of the yuan.
By the end of this year, the rate gap may widen to 75 basis points if the BOK raises its rate just once in November _ the last month of the year for the local central bank to hold a policy board meeting.
And the value of the Korean won per dollar is expected to get stronger, with the currency swap rate for future exchanges remaining in negative territory. This means the dollar is projected to weaken.
Moon Hong-cheol, an analyst at DB Financial Investment, agreed with the prospective exodus of short-term funds after achieving their target gains.
But he said considering the current and future level of the rate gap and the country's sound foreign exchange management, it does not pose a risk to the financial market.
"Korea is not an economy that is in serious debt like it was before the Asian financial crisis. Foreign investors look at the currency volatility rate before making investments over the interest rate gap," Moon said.
"With a stable credit rating, the market here can manage its exchange rate well to a level that does not raise capital outflow concerns."
The last time the rate gap widened to 75 basis points was in 2006 when Korea's rate was 4 percent and the Fed's 4.75 percent. Even then, there were not any alarm bells ringing at the sign of foreign capital exiting this market, analysts say.