Riding out Swings in Foreign Investment

South Korea prepares a contingency plan for the domestic bond market in anticipation of policy changes in the U.S. and Japan.

South Korea is “closely analyzing” volatility in foreign purchases of government bond futures and preparing a contingency plan should overseas investors yank money from the market, a senior Finance Ministry official said.

The swings may increase as Japan ramps up monetary easing and speculation grows that the U.S. Federal Reserve will roll back stimulus, Gwak Bum Gook, director general at the treasury bureau, said in an interview in Sejong yesterday. The contingency plan will include stronger cooperation with the Bank of Korea, financial regulators, and the stock exchange, Gwak said. He didn’t provide more details.

“Stimulus policies of the U.S. and Japan are likely to cause higher volatility in the second half in the bond market, and we will closely monitor and respond to such a case,” Gwak said. “Volatility may increase in the currency, bond, and stock markets, as debate over a U.S. exit from quantitative easing policies develops.”

Bank of Korea Governor Kim Choong Soo this week urged global coordination to limit the risk of financial instability that could be triggered by volatility in capital flows and exchange rates. South Korea’s government aims to drive a rebound after a slowdown in economic growth last year to the weakest pace since the global financial crisis, yesterday rolling out measures to boost employment as a sliding yen aids export rivals in Japan.

Overseas investors were net sellers of a record 42,295 three-year bond futures contracts on May 29, having on average sold 397 more than they bought per day so far this year. Net purchases of 24,727 contracts on April 30 were also the highest recorded in data going back to June 2004.

‘Biggest Concern’

The price of Korean government debt has fallen as investors speculate that a strengthening U.S. economy may prompt the Fed to reduce quantitative easing. In the U.S., Federal Reserve Bank of Dallas President Richard Fisher said yesterday that he sees the end of a 30-year bond-market rally, while calling for a reduction in the Fed’s $85 billion in monthly bond purchases.

In South Korea, the yield on benchmark three-year bonds jumped 29 basis points to 2.78 percent in May, the first increase in six months and the biggest gain since January 2011.

“The biggest concern in the market right now is whether there will be an outflow as bond investors take their money to the U.S. as rumors develop that the Fed will be reducing its monetary stimulus,” said Lee Jae Hyung, a Seoul-based fixed income analyst at Tongyang Securities Inc. “There is little the government can do about the rising yield and the volatility.”

Foreign investors bought a net 6.2 trillion won ($5.5 billion) of Korean Treasury bonds this year as of April 30, close to last year’s entire net inflow of 7.4 trillion won, Financial Supervisory Service data show. Investors from France were the biggest net investors this year, followed by those from the U.S. and Thailand.

Gwak said rising foreign ownership is “not a concern” as it’s natural for investors from other countries to play a bigger role as the market grows. The ministry is in contact with major participants in Korea’s bond market, he said.

Still, there are risks that come with the foreign ownership, as sudden changes in portfolio strategy could affect the market, said Lhee Jung Bum, a Seoul-based fixed-income analyst at Korea Investment & Securities Co.

Finance Minister Hyun Oh Seok and Governor Kim said in a joint statement yesterday that uncertainties were increasing amid a possible U.S. exit from quantitative easing. Hyun and Kim agreed to keep in close touch on any adverse effects from other central banks’ policies and to strengthen cooperation.

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