The South Korean won is likely to remain under pressure due to continuing risk-off ahead of the Brexit referendum next week. At the same time, the BoK’s (Bank on Korea's) surprise rate cut last week coupled with narrowing yield differentials and weakening growth momentum will also weigh on the currency’s strength.
Cyclical and structural growth constraints are resulting in capital outflows from South Korea at a record pace as domestic investors have turned to offshore assets for higher returns. Recently, the national pension service made significant adjustments to its asset allocation, boosting the desired weighting in overseas equities to 24.5 percent compared to 13.3 percent currently.
Moreover, the build-up in household debt remains another major area of concern for the authorities and will also weaken the KRW by keeping foreign investors away. The most recent money/credit data out last week showed that bank loans to households increased by KRW 6.7 trillion in May, to KRW 660.9 trillion, an indication of further depreciation. Also loose property buying rules and lower interest rates boosted demand for mortgages.
Meanwhile, continuing economic uncertainty is likely to subject highly leveraged emerging economies in Asia to financial instability, not only South Korea’s. Recently, BoK governor Lee pointed out that emerging economies in Asia have substantial external debt and are, therefore, vulnerable to external shocks. Moreover, if Brexit happens, this could tamper internal stability and allow volatile externalities to creep in.
Last week finance minister Yoo said the rate cut would have a "significant" positive impact on the economy. Further, a fortnight ago, the government announced plans to allocate 59.5 percent of full-year government spending in the first half of 2016, slightly higher than the initial target of 58 percent. Recently there have been reports suggesting that the government plans to announce KRW 7 trillion of additional spending in its economic policy plan for the second half of 2016.
