Traders whipsawed by depreciating asset values from India to Brazil are plouwing funds into South Korea, taking advantage of a current-account surplus twice the size of China’s and turning the won into Asia’s best currency.
The won gained 2.3 per cent against the dollar this quarter, compared with declines of 11 per cent for India’s rupee and 6.6 per cent for the Brazilian real. One-month implied volatility on won options, which reflect the outlook for currency fluctuations, is falling the most among major peers, reaching a three-month low of 6.69 per cent on August 12, from 11.4 per cent at the end of June, data compiled by Bloomberg showed.
The stability is enabling South Korea to maintain the lowest interest rates in three years and support economic growth at a time when policy makers from India to Indonesia and Brazil are raising borrowing costs to stem currency depreciation. With a current-account surplus equal to 4.9 per cent of gross domestic product, more than China’s 2.6 per cent, South Korea is better positioned than its peers as the Federal Reserve’s plan to withdraw monetary stimulus lures cash from developing nations.
“The won is one of my conviction bets,” Edwin Gutierrez, a fund manager who helps invest about $12 billion of emerging-market debt at Aberdeen Asset Management, said in an August 19 interview from London. “After all, as a current-account- surplus country, they are not beholden to foreign inflows.”
Investors who bought South Korean debt would have earned 1.4 per cent in the year through August 22, including appreciation in bond prices and currency gains, according to Bank of America Corp’s South Korea Government Index. That compares with losses of 16 per cent on Brazilian notes and 10 per cent on Indian bonds.
Asia’s fourth-largest economy is emerging from the slowest growth in four years, fueled by an export rebound and fiscal stimulus that includes a $15 billion government-spending plan announced in April. GDP will increase 2.5 per cent this year and 3.5 per cent in 2014, which would be the fastest expansion since 2011, after slowing to two per cent last year, according to the median estimate of 34 economists surveyed by Bloomberg.
Exports, which account for more than 45 per cent of the nation’s GDP, have increased in three of the past four months as an economic recovery takes hold from the US to Europe, swelling the country’s current account to all-time highs.
The surplus reached an unprecedented $8.6 billion in May and was $7.2 billion in June, the second-highest on record, central bank data show, helping shield the nation from capital outflows triggered by speculation about the Fed’s stimulus reduction. As a percentage of GDP, the excess is more than double the two per cent average for Asia and compares with shortfalls of 3.6 per cent in India and three per cent in Brazil, according to data compiled by Bloomberg.
South Korea’s short-term external debt fell to $119.6 billion in the second quarter, the least since 2006, official data showed on August 21, reducing the amount of dollars needed for repayment.
“Economic growth is stable and investors are comforted in this environment by the current-account surplus that Korea enjoys,” Neal Capecci, who helps oversee $43 billion of Asian debt as managing director for fixed income at Manulife Asset Management in Hong Kong, said in an interview on August 19. “Korea can outperform other fixed-income markets in Asia in an outflow environment.”
The won dropped 0.3 per cent to 1,116.28 per dollar at the close of onshore trading in Seoul, though it outperformed many currencies caught in a rout of emerging-market assets.
Turkey’s lira plunged as much as 1.9 per cent to a record 2.0336 per dollar after the head of the central bank ruled out raising interest rates to bolster the currency. India’s rupee tumbled 2.8 per cent to an all-time low of 66.08 per dollar amid concern that mounting tensions in Syria will push up oil prices and increase the Asian nation’s current-account deficit.
The won’s gains this quarter helped pare its decline in 2013 to 4.9 per cent. The median forecast of 19 analysts surveyed by Bloomberg is for the currency to strengthen to 1,100 per dollar by the end of 2014. Option traders assign a 97 per cent probability to this happening, Bloomberg data show.
The one-month implied volatility of eight per cent on won options compares with 17.4 per cent in the rupee, 16.4 per cent in the real and 14.8 per cent in the lira, data compiled by Bloomberg showed.
Bucking the trend in most developing economies, overseas investors have scooped up South Korean assets over the past two months. Foreigners bought a net three trillion won ($2.7 billion) in stocks and bonds in July, the most since February, exchange data show. Global funds have withdrawn about $44 billion from emerging-market stock and bond funds since the end of May, according to data provider EPFR Global.
Outflows have prompted Brazil, India, Indonesia and Turkey to boost borrowing costs to defend their currencies, even as growth slows.
Turkey unexpectedly lifted its overnight lending rate for a second month in August, to 7.75 per cent, as the lira’s nine per cent drop since the start of the year fueled inflation. Central Bank Governor Erdem Basci said that raising the rate further would be “harmful” to the country.
In South Korea, policy makers kept the benchmark rate at 2.5 per cent on August 8. The Asian nation’s Finance Ministry said this month that it will take steps to stabilize the won if needed with its $330 billion in reserves, more than three times Turkey’s $109 billion.
“As the market has been very focused on the balance-of-payment dynamics, South Korea stands out as one of the strongest economies,” Rob Drijkoningen, the co-head of emerging-market debt at Neuberger Berman Group, which oversees $214 billion, including South Korean bonds, said in an August 19 phone interview from The Hague. “The won is on the cheap side.”
On an inflation-adjusted basis, the won is more than five per cent below its 10-year average against its major trading partners, and is the third most undervalued among emerging- market currencies after South Africa’s rand and the Argentine peso, according to data compiled by Morgan Stanley.
The won has already priced in the nation’s economic recovery, and room for further appreciation may be limited, according to Eastspring Investments, a unit of the UK’s Prudential.
South Korea’s household debt, which has risen to a record, restricts the economy’s growth potential, Bank of Korea Governor Kim Choong Soo said on July 29. The borrowings rose to 91 per cent of GDP last year, surpassing 85 per cent in the US, according to the International Monetary Fund.
“We see limited room for further outperformance from here, unless the Korean economy can show signs of a sustainable recovery,” Guan Yi Low, who helps oversee about $95 billion as the Singapore-based fixed-income investment director at Eastspring Investments, said in an e-mail on August 20. Low said she has turned “neutral” on the won from “bullish.”
Against the yen, the won has gained 26 per cent over the past 12 months, reaching a 4 ½-year high of 10.74 per yen in May. South Korean companies are increasingly relying on product innovation rather than cheaper prices to overcome the stronger exchange rate.
Hyundai Motor Co, South Korea’s largest carmaker, reported second-quarter profit of 2.4 trillion won in July, beating analysts’ estimates, as sales in China and Brazil grew. Samsung Electronics Co, based in Suwon, South Korea, had about 33 per cent of the global smartphone market in the second quarter, while the iPhone maker Apple Inc’s share fell to a three-year low of 14 per cent, according to Boston-based Strategy Analytics.
“The country is looking very healthy,” said Amanda Stitt, investment director at Legg Mason Investment Management Services Ltd in London., which counts South Korean debt among its $656 billion of investments. “It’s higher tech now and Samsung is more competitive with Apple, so remaining competitive relative to the Japanese yen level has become less of an issue.”
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