Presidential Office Director Kim Yong-bum Diagnoses Economy Amid High Exchange Rates and Inflation

With the KOSPI recovering to 8,000 points and forecasts of exceeding 10,000, concerns over an economic crisis are mounting due to unstable prices and exchange rates. The surge in the dollar is attributed primarily to increased demand, partly fueled by the conflict in Iran. Currency instability can ripple through the entire economy, making the impact of high prices and exchange rates on the stock market and the Korean economy a critical focus. On May 22nd, the Korean won fell past 1,520 against the dollar.

Presidential Office Director Kim Yong-bum described high interest rates, high inflation, and high exchange rates as an unavoidable 'cost of success' and 'friction of progress' during the Korean economy's advancement to a new level. Rising interest rates signal high demand for money, and dollar strength, coupled with the weakness of other major currencies, reflects a massive increase in funding needs globally.

In the United States, tech giants are making astronomical investments in AI, and the Trump administration favors economic stimulus through tax cuts and fiscal expansion. A request for $1.5 trillion in defense spending for fiscal year 2027 has been submitted to Congress. China, the world's second-largest economy, is also pursuing expansionary fiscal policies to escape deflation, while Japan is also increasing fiscal spending to boost its economy. European nations are also increasing their budgets for defense spending, energy transition, infrastructure improvement, and enhancing industrial competitiveness. These global investments generate substantial demand for funds, and this long-term investment and fiscal expansion are likely to continue for a considerable period.

The reshaping of global supply chains due to US-China rivalry has led to higher inflation by reducing economic efficiency, which in turn has driven up interest rates. Furthermore, major developed nations that have sustained their economies through debt during the post-global financial crisis low-interest rate environment are now facing increased interest burdens.

The Korean economy is positioned to benefit from an era where 'what is well-made sells well.' Its competitiveness in the semiconductor sector, which accounts for the largest share of AI investment, is paramount, and there are competitive companies in energy infrastructure and defense. The goods sought by countries worldwide largely align with the items Korea excels at producing and exporting. Korea also faces a significant need for fiscal expenditure due to future investments, and it must accelerate efforts in building infrastructure for the AI era, technological development, and addressing low birth rates and an aging population. While the debt-to-GDP ratio has risen to the 49% range, it remains low compared to other countries. The surge in corporate profits due to the semiconductor boom also increases the potential for government revenue growth. In this era of investment, the Korean economy is closer to being a beneficiary than a victim.

Amid the sharp rise in the KOSPI, large-scale foreign net selling stands out. As of the closing price on May 26th, the dollar-won exchange rate had risen by 4.45% compared to the end of last year. A higher exchange rate increases the risk of currency losses for foreign investors in Korean assets. Although the KOSPI surged 75% last year, it has climbed another 90.96% this year. From a foreign investor's perspective, a sudden increase in the proportion of Korean assets in their portfolio provides a clear reason to take profits. From January 1st to May 26th of this year, foreign net selling on the KOSPI reached 96.4 trillion won, marking an all-time record and significantly impacting the exchange rate.

Korean companies' profit outlooks are exceptionally strong, and interest rates are lower than in the US. In terms of the relative attractiveness of stocks versus bonds, known as the yield gap, Korea's appeal is distinct. The KOSPI's yield gap is significantly higher than that of the US and Japan. Even with the KOSPI's rapid ascent, its forward price-to-earnings (PER) ratio remains around 8-9 times, with earnings yields at 11-12%, and the difference with the 10-year government bond yield is about 7 percentage points. Considering the profit outlook, it remains attractive compared to bonds.

A surge in trade surpluses, driven primarily by semiconductors, could improve foreign exchange supply conditions. However, companies tend to delay converting export proceeds to fund overseas investments. Demand for foreign financial investments in countries like the US from the National Pension Service and individuals remains strong. The issue is not market valuation but exchange rate volatility. In April, the Bank of Korea estimated the sensitivity of the won to capital outflow shocks at 0.65, citing factors such as insufficient depth in the foreign exchange market.