Recently, it has been reported that the National Pension Service has suspended its strategic currency hedging with the Bank of Korea due to the declining won-dollar exchange rate. There are forecasts that the exchange rate may rise again during the process of the National Pension Service unwinding its sell positions.
Currency hedging refers to transactions designed to eliminate the risk of exchange rate fluctuations. The National Pension Service has defended its asset value through forward contracts (contracts to sell dollars at a predetermined exchange rate on a future date) whenever the exchange rate exceeds its established benchmark. This is because the value of foreign currency assets denominated in Korean won could drop if the exchange rate continues to fall.
◇ Exchange rate drops sharply by over 100 won… Requirements for strategic currency hedging waived
According to foreign exchange market officials on the 24th, it is reported that the National Pension Service has stopped selling dollars in accordance with its internal investment guidelines. The National Pension Service has previously conducted strategic currency hedging whenever the exchange rate maintained a level higher than its historical average for a certain period, but the recently plummeting exchange rate has fallen below its benchmark.
Due to increased expenses related to currency hedging, the National Pension Service did not conduct strategic currency hedging for overseas assets from 2018 until it temporarily resumed such hedging for up to 10% of its overseas assets in December 2022 when the won-dollar exchange rate skyrocketed.
Even during the early part of this year when the exchange rate surpassed 1450 won due to the state of emergency, the National Pension Service conducted strategic currency hedging. However, after the impeachment, as the won-dollar exchange rate steadily declined, dropping from the 1400 won range to the mid-1300 won range, the currency hedging requirements were rapidly waived. The decision to end strategic currency hedging by the National Pension Service seems to reflect this trend.
Although this is a measure for managing the National Pension Service's foreign currency assets, it has a significant impact on the market. As of the end of March this year, the National Pension Service's overseas investment assets amount to $487.2 billion, and up to 10% of this can be hedged. This amounts to approximately $48.7 billion. Considering that the average daily dollar trading volume at foreign exchange banks last year was $19.5 billion, this volume is considerable.
The industry reports that the National Pension Service has been conducting strategic currency hedging worth $15 billion. If combined with the tactical currency hedging amount (up to 5% of foreign currency assets) where the National Pension Fund (National Pension Fund) has discretion, the sell positions will increase further. As of March this year, the National Pension Service's tactical currency hedging amounts to $15 billion. Including this, the total sell positions of the National Pension Service are expected to reach $30 billion.
◇ Key to unwinding sell positions… Pressure for exchange rate increases may grow
The market predicts that pressure for the exchange rate to rise will increase as the National Pension Service stops its strategic currency hedging. Once the strategic currency hedging ends, the National Pension Service may buy dollars in the market to unwind its sell positions. This could reduce the supply of dollars in the market while increasing the demand for dollars, potentially decreasing the value of the won.
On January 2nd, when Yoon Kyung-su, the head of the International Division at the Bank of Korea, noted that "the National Pension Service's currency hedging volume will come out soon," expectations for an increase in dollar supply led to the exchange rate, which had exceeded 1472 won, falling to around 1466 won at weekly trading close. The end of currency hedging is expected to move the exchange rate in the opposite direction.
Of course, even if the National Pension Service reduces its sell positions, exchange rate volatility may not increase. Looking at past cases, the National Pension Service concluded that in late 2015, its fund management committee decided to change the currency hedging ratio for all overseas investment assets to 0%, and then lowered this ratio to 50% at the end of 2017 before finally changing it to 0% in 2018. It actually took three years to completely end the currency hedging.
Another reason it is difficult to actively buy dollars is due to U.S. scrutiny. The U.S. Treasury recently stated in its currency report that "the total overseas assets held by the National Pension Service increased by approximately $46 billion over the past four quarters to record $470 billion," and mentioned examining the potential for exchange rate depreciations by trading partner countries utilizing pension funds in the future. Given that the Treasury is closely watching the situation, it is unlikely that the National Pension Service will readily engage in dollar purchases.
Park Sang-hyun, a researcher at iM Securities, said, "If the won weakens again and the exchange rate rises to 1450 won, the end of strategic currency hedging could impact the market, but currently, the sentiment for a strong won is dominant, so there will not be a rapid spike in the exchange rate." He added, "Even if there is a temporary increase in dollar demand, it is unlikely to be a sustained factor affecting the overall market."