Can semiconductors tame the won? What's behind forecasts for a weaker dollar

By Kim Byeo-ri, The Herald Business

The won-dollar exchange rate has been stuck in the 1,500-won range with no sign of breaking free. The average rate for the first half of this year hit its highest level in 28 years since the 1997-98 Asian financial crisis — surpassing even the levels seen during the global financial crisis.

Despite this entrenched high-rate environment, South Korea's foreign exchange authorities and global investment banks are forecasting that the rate could fall in the second half of the year. What is the basis for their prediction?

Chief among the reasons is an expected rise in demand to convert dollars into won, driven by chipmakers' expanding domestic investment and tax payments. If the National Pension Service — a heavyweight asset manager — increases its currency hedging and raises its domestic equity allocation, downward pressure on the rate is expected to intensify further. Some analysts also expect the extension of forex market hours to 24 hours a day to contribute to exchange rate stability.

On the other side, persistent net selling of domestic stocks by foreign investors and growing expectations of US interest rate hikes amid inflation concerns are adding uncertainty to the exchange rate outlook.

According to the Bank of Korea, the average won-dollar rate for the first half of this year — through Friday — stood at 1,483.1 won, the highest first-half reading in 28 years since 1998 (1,494.8 won), when South Korea was in the grip of the Asian financial crisis. It is 132 won higher than the 2009 level (1,351.1 won) during the global financial crisis. The rate has closed above 1,500 won on a weekly basis for 29 consecutive trading sessions since May 15.

Analysts expect that expanded domestic investment by major chipmakers such as Samsung Electronics and SK hynix, along with their need to convert dollars into won for tax payments, will exert downward pressure on the exchange rate in the second half.

According to corporate data firm CEO Score, Samsung Electronics' capital expenditure last year reached 52.15 trillion won ($33.7 billion). Combined with SK hynix's 28.58 trillion won, the total exceeds 80 trillion won. Given surging semiconductor demand, capital spending is expected to grow further. The Ministry of Land, Infrastructure and Transport said construction contract values in the first quarter of this year reached 74.1 trillion won, up 23.4 percent from a year earlier. Private-sector investment — led by semiconductor production facilities and data centers — jumped 35.6 percent to 49 trillion won.

At a national briefing on Sunday titled "Korea's Three Mega Leap Projects," which President Lee Jae Myung is set to chair at Cheong Wa Dae, investment plans by Samsung Electronics and SK hynix in the Honam and Chungcheong regions — including the creation of a semiconductor cluster in the Honam area — are expected to be unveiled. Some forecasts put the total investment at hundreds of trillions of won. Kim Yong-beom, the Cheong Wa Dae policy chief, said Friday on the YouTube channel "Kim Eojun's Humility Is Hard News Factory" that the event would present "a program built through joint efforts by the government and businesses in three sectors — semiconductors, AI data centers and physical AI," adding that "the numbers coming out will feel very unfamiliar."

Chipmakers are also expected to convert large volumes of dollars into won soon to pay their mid-year advance corporate taxes. Among global investment banks, some estimate the combined conversion by major semiconductor firms could reach up to tens of billions of dollars by mid-August. Buoyed by this year's semiconductor boom, annual national tax revenue is projected to reach around 431 trillion won — some 20 trillion won above the government's own forecast.

"Domestic chipmakers will need to convert the dollars they earned overseas into won to fund factory construction, equipment investment and massive tax payments," a government official said. "When export dollars flow back into the domestic economy, it simultaneously increases demand for won and boosts dollar supply, which should exert downward pressure on the exchange rate."

The current account has been posting record results this year, driven by strong semiconductor exports. The current account surplus reached $37.93 billion in March, an all-time high, and followed that with a $28.29 billion surplus in April, the second-largest on record.

A shift in the National Pension Service's investment strategy is also cited as a potential downward factor for the exchange rate in the second half.

The National Pension Service has set a currency hedging target ratio of 15 percent for its overseas assets — which exceed 900 trillion won — and plans to execute the strategy flexibly depending on market conditions. Currency hedging locks in the current exchange rate for future transactions, eliminating the risk of rate fluctuations. When the pension fund hedges its overseas assets, it floods the market with dollars, pulling the exchange rate down.

Some estimates suggest this could release up to $90 billion into the market. The fund's current hedging ratio is understood to be in the low single digits.

The pension fund's move to trim its annual overseas investment target and raise its domestic equity allocation is also seen as positive for the exchange rate. The National Pension Service has decided to raise its domestic equity target allocation this year from 14.9 percent to 20.8 percent. As the fund reduces overseas investment, demand to convert won into dollars will fall accordingly, adding downward pressure on the rate.

The extension of forex market hours to 24 hours a day starting next month is another factor being watched for its potential to push the rate lower. From July 6, the won-dollar forex market will operate continuously from 6 a.m. Monday through 6 a.m. Saturday. Currently, trading runs only from 9 a.m. to 2 a.m. the following day. Outside those hours, trading takes place through the non-deliverable forward, or NDF, market.

NDF contracts are settled offshore in dollars based on the difference between the contracted and spot rates, without any actual exchange of won. Because they allow traders to profit from exchange rate movements with relatively little capital, speculative activity is common. Authorities say a recurring pattern has emerged in which rising dollar-buying demand in the NDF market prompts foreign banks operating in South Korea to purchase dollars in the domestic spot market to hedge their exposure — pushing the exchange rate even higher. This is what analysts describe as a "wag the dog" dynamic, where the tail (the NDF market) wags the body (the forex market).

Authorities expect that drawing some NDF trading demand into the domestic forex market will help stabilize the exchange rate. According to the Korea Capital Market Institute, after Seoul's forex market hours were extended from 3:30 p.m. to 2 a.m. the following day, gap volatility in the exchange rate fell 52.6 percent, as the impact of major overseas political and economic events was immediately reflected even during overnight hours.

Some remain skeptical. "Extending hours may ease the tendency for the rate to spike at the market open to some degree, but in a structural environment where inbound foreign investment is relatively limited, there will be limits to how much it can actually bring the rate level down," a financial industry official said.

Persistent net selling of domestic stocks by foreign investors — a key driver of the won's weakness — is expected to remain a major wild card.

As domestic stocks, particularly on the Kospi, surged recently, foreign investors have been selling in large volumes as part of portfolio rebalancing. Converting the won proceeds from those sales back into dollars has amplified downward pressure on the currency.

According to the Financial Supervisory Service, foreign investors maintained a net selling position for five consecutive months through last month. In May alone, they net sold 47.02 trillion won worth of listed domestic shares. Cumulative net sales through last month reached 114.22 trillion won — more than 10 times the full-year net selling figure for last year (11.08 trillion won).

The net selling trend appears to be lasting longer than authorities had anticipated. They had expected the selling to gradually ease from June onward. Yet this month through Friday, foreign investors recorded net selling on all but five of 19 trading sessions — just 26.3 percent of trading days.

What makes the situation more complex is that despite the sustained net selling, foreigners' share of total domestic stock market capitalization has actually grown. As of Thursday, foreign investors held 39.7 percent of the domestic stock market's total capitalization — up 6.5 percentage points from 33.2 percent at the start of the year. The increase is attributed to share price gains that outpaced the volume of stocks sold, suggesting that demand for further profit-taking could persist.

"The sharp rebound in share prices after a significant correction may have increased the need for foreigners to rebalance," Bank of Korea Deputy Governor Jang Jeong-su said at a financial stability report briefing on Wednesday. "But it is difficult to say when the selling will wind down."

The trajectory of US inflation is also expected to be a key variable shaping the exchange rate outlook. Since the US-Iran ceasefire agreement, the won-dollar rate has not fallen — it has risen, as expectations for US interest rate hikes driven by inflation have grown.

At its June 18 meeting, the Federal Open Market Committee held its benchmark interest rate steady for the fourth consecutive time but strongly signaled the possibility of future rate hikes, citing inflationary pressures. The dot plot released after the meeting showed a median year-end benchmark rate forecast of 3.8 percent, suggesting that one rate hike this year is the prevailing view among participants. According to the CME Group's FedWatch tool, as of Thursday (local time), the probability of at least one rate hike by year-end stood at 81.7 percent — up 13.8 percentage points from a month earlier (67.9 percent).

The growing likelihood of a rate hike has intensified the strong-dollar trend, leaving the won relatively weak. The dollar index — which measures the greenback's average value against six major world currencies — closed at 101.61 on Wednesday, its highest level since May 12 last year (101.79), a span of about 13 months. It edged down slightly to 101.43 on Thursday but remains elevated.

"The revision to the Fed's rate path will ease pressure to narrow the Korea-US rate differential by year-end, and the supply-demand factors that could drive the exchange rate lower are limited given the continued net selling of domestic stocks by foreigners," said Jeon Gyu-yeon, an economist at Hana Securities. "Upward pressure on the won-dollar rate will likely dominate for now."

Others believe the Fed will find it difficult to raise rates within the year. "Given that the dot plot distribution is highly polarized and that the labor market is not running as hot as feared, the probability of a rate hike materializing this year is not as high as the market fears," said Lee Jeong-hun, an economist at Daishin Securities.