How South Korea's Bond Index Inclusion Will Transform Markets

Significant Boost for South Korean Bonds

The recent announcement regarding the inclusion of South Korean sovereign bonds in the FTSE Russell benchmark bond index has sparked excitement among investors and analysts alike. This unexpected move is anticipated to have a substantial positive impact, not only on the local markets but also on the South Korean won's value. With expected inflows totaling billions of dollars over the coming years, this inclusion could reshape the landscape of South Korea's $2.2 trillion bond market.

Projected Inflows and Economic Benefits

Analysts forecast that the inclusion in the World Government Bond Index could channel approximately 80 trillion won, equivalent to about $59.7 billion, into the South Korean financial system. This infusion of capital is particularly crucial for the country, which is facing rising welfare costs due to an aging population. Hence, this unexpected boost is viewed as a vital support for the nation's economic stability.

Market Sentiment and Reactions

With South Korea's financial markets closed for a public holiday, the immediate response will be measured once reopening occurs. Major analysts, including Kim Han-soo from the Korea Capital Market Institute, have expressed optimism regarding the ongoing inflows, which signify a steady infusion of foreign capital. According to him, this move signals a potential easing of the so-called 'Korea discount,' which has historically plagued South Korean companies, resulting in lower valuations compared to their international counterparts.

Understanding the Korea Discount

The Korea discount refers to the tendency for South Korean companies to attract less investor interest due to a combination of bureaucratic challenges, lower dividend yields, and the influence of large conglomerates, known as chaebols. However, following the FTSE Russell inclusion, there is a belief that the stigma may begin to fade, as global investors are encouraged by the reforms initiated by the South Korean government.

Government Reforms and Financial Market Access

The government, led by President Yoon Suk Yeol, has embarked on reforms aimed at dismantling barriers that have long hindered foreign investment. Key measures include the introduction of an omnibus account for Korean treasury bonds in collaboration with Euroclear, a clearing service, and adjustments to allow for overdrafts in the won through the International Central Securities Depository. Additionally, extended trading hours for the won aim to enhance market participation.

Challenges Amid Reforms

Even with these reforms, the South Korean won has faced difficulties in the market, having lost approximately 4% against the dollar this year. Meanwhile, the KOSPI index has dropped by 2.3%, underperforming against significant global benchmarks like the S&P 500 and the Nikkei. Last year’s reinstatement of a comprehensive ban on stock short-selling further tainted market confidence, leading MSCI to classify South Korea as an emerging market instead of a developed one.

Future Outlook for the Won

Goldman Sachs and Morgan Stanley have voiced concerns that South Korea’s addition to the FTSE Russell may experience delays due to insufficient global bond settlement volumes through Euroclear. A dealer pointed out that the decision has instigated some currency market movements, with a noticeable uptick in demand for won-denominated assets. This scenario presents an opportunity for the nation to position itself favorably on the global stage.

A Confidence Vote from Investors

According to Kwak Sang-hyun, who oversees fiscal policy at the finance ministry, the pitch made to FTSE Russell was built upon the expectation that Euroclear settlement volumes would rise following the country’s entry into the index. Kwak emphasized that increased participation from foreign investors would strengthen the local bond market, enhancing fiscal space even amid rising government debts.

Starting in November 2025, South Korean government bonds are set to represent 2.22% of the FTSE Russell debt gauge, with the inclusion phased over one year on a quarterly basis. This long-awaited development promises to usher in new dynamics for the South Korean financial landscape.

Frequently Asked Questions

What does the inclusion in the FTSE Russell bond index mean for South Korea?

The inclusion signifies a substantial influx of foreign investment into South Korea's bond market, enhancing market liquidity and stability.

How much capital is expected to flow into South Korea's markets?

The projected inflow is around 80 trillion won, which equates to approximately $59.7 billion, bolstering the local economy.

What challenges does the South Korean market face?

Despite positive changes, South Korea faces challenges such as currency depreciation and a ban on short-selling, which affects investor confidence.

How does the Korea discount affect market valuations?

The Korea discount results in lower valuations for South Korean companies due to regulatory hurdles and limited foreign investor access, impacting overall market performance.

When will the inclusion of South Korean bonds take effect?

The inclusion will begin in November 2025 and will be implemented gradually over a year on a quarterly basis.

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