Kim Yong-bum: "High Inflation, High Exchange Rate Are Friction Noise of Economic Leap"

Amid escalating exchange rate volatility with the won falling past 1,520 against the dollar, Kim Yong-bum, Senior Secretary to the President for Economic Affairs, diagnosed high inflation and a high exchange rate as "friction noise of an economic leap." This analysis suggests these phenomena are inevitable in the process of economic advancement. The question remains: how long will this 'friction noise' persist?

Major global economies are reportedly channeling vast fiscal resources into future investments, increasing dollar demand. The U.S. is investing heavily in AI by big tech and expanding fiscal policy, while China is pursuing expansionary fiscal policies to escape deflation. Japan is also undertaking further fiscal expansion for economic stimulus. Europe has increased its spending on defense, energy transition, infrastructure improvements, and industrial competitiveness. The reconfiguration of global supply chains due to U.S.-China rivalry has reduced economic efficiency, leading to higher inflation and thus higher interest rates. The interest burden on governments in major developed nations, which have relied on debt to sustain their economies in a low-interest environment since the global financial crisis, has also increased.

In line with these global trends, Korea faces growing needs for fiscal expenditure on defense, energy transition, and enhancing industrial competitiveness. Urgent tasks also include preparing infrastructure and technological development for the AI era and devising countermeasures against low birth rates and an aging population.

Criticism has also surfaced regarding the government's fiscal management. Projections indicate annual deficits in the 100 trillion won range until 2029, with national debt as a percentage of GDP potentially exceeding the 60% threshold, considered a "close monitoring target" by the IMF, around 2029. However, estimates suggest that increased operating profits for Samsung Electronics and SK Hynix this year, coupled with higher corporate tax revenue, could partially improve fiscal conditions. The Presidential Office has previously stated that Korea's net debt ratio is low at 10% compared to other countries and that its national debt is at a sustainable level.

Against this backdrop, 'instability' in the dollar/won exchange rate and interest rates persists. As of the closing price on March 26th, the dollar/won exchange rate had risen 4.45% compared to the end of last year. Korea's 10-year government bond yield surged over 20% to 4.064% on March 22nd, up from 3.385% at the end of last year, showing a higher increase compared to major countries like the U.S. (4.5%) and the UK (4.90%). Foreigners have net sold 96.4 trillion won worth of KOSPI stocks year-to-date through March 26th. This large outflow of foreign capital has significantly impacted the exchange rate.

Nevertheless, some analyses suggest that the Korean stock market still holds considerable appeal. The earnings outlook for Korean companies is robust, and interest rates are lower than in the U.S. In terms of the yield gap, which indicates the relative attractiveness of stocks versus bonds, the Korean stock market offers higher appeal compared to the U.S. and Japanese markets. The KOSPI's forward price-to-earnings ratio (PER) is around 8-9 times, with an earnings yield of 11-12%, and the spread against the 10-year government bond yield is approximately 7 percentage points. Despite stock price increases, considering earnings projections, it is still considered an attractive investment destination relative to bonds.

While demand for overseas financial investments from the National Pension Service and individuals remains strong, the Bank of Korea estimated the won's sensitivity to capital outflow shocks at 0.65 in April. This figure is higher than the Japanese yen (0.38) and close to the emerging market average (0.71). This sensitivity indicates a lack of depth in the foreign exchange market, meaning insufficient trading volume for both buying and selling, and this shallow FX market depth is a major factor in increasing exchange rate volatility.