South Korea Tackles Offshore Speculation to Stabilize Weak Won

The South Korean won has experienced a sharp decline, surpassing 1550 won against the dollar, despite a robust economic forecast and the establishment of a new government in June 2025. This persistent weakness, even after a period of political instability, has puzzled observers, as macroeconomic indicators suggest a strong Korean economy with upward revisions to GDP growth projections. Bank of Korea Governor Shin Hyun-song has publicly stated that the current exchange rate is "excessively high" relative to Korea's economic fundamentals, signaling a potential shift in the central bank's approach to currency management.

Governor Shin has identified several factors contributing to the won's depreciation. While geopolitical tensions in the Middle East and the widening interest rate differential between South Korea and the United States are acknowledged causes, Shin has emphasized two less commonly cited reasons. Firstly, he pointed to the "rebalancing" of stock portfolios by foreign investors. As the Korean stock market has seen significant gains, foreign investors have reduced their holdings, converting the proceeds from selling Korean stocks into dollars. This increased demand for dollars in exchange for won contributes to the currency's weakness.

Secondly, and perhaps more critically, Shin highlighted the role of the offshore Non-Deliverable Forward (NDF) market. He argued that traditional factors like trade flows and stock movements do not fully explain the recent surge in the exchange rate. The NDF market, operating outside South Korea's regulated hours, allows speculative players to bet on the won's depreciation. When these bets are made, global banks that facilitate these trades engage in hedging activities, which in turn influence the Seoul spot market the following day. This phenomenon, described as the "tail wagging the dog," poses a significant challenge to currency stability.

To address this issue, the Bank of Korea is proposing a structural solution centered on official swap transactions. Currently, foreign investors often resort to NDFs because the Korean foreign exchange market is closed during their nighttime hours, making it difficult to acquire won. The proposed swap mechanism would allow foreign investors to deposit dollars and borrow won legitimately, thereby increasing the actual use and internationalization of the Korean currency. This would bring won transactions into the open, making them more transparent and less susceptible to speculative manipulation from offshore markets. By providing a legitimate channel for acquiring won, the central bank aims to curb the influence of NDF speculation and stabilize the exchange rate.