Latest Publictions
2023 Nov/17
Interest Rate Reversals between Home and Abroad: Impact on Capital Outflows and Financing Costs of Foreign Capital, and Implications
Issue Papers 23-24
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- Research Topic Macrofinance
- Page 24
- Summary
- This article delves into the recent interest rate reversal between Korea and the US, analyzing its characteristics and potential implications. It also explores the impact of this rate reversal on the possibility of capital outflows and the associated cost of financing foreign capital.
A historical analysis of capital outflows during periods of rate reversals since the 2000s reveals that such rate reversals have not led to significant capital outflows. Regression estimates indicate a minimal impact on bond fund flows, with some influence on stock investment funds. The observed phenomenon is more closely linked to external uncertainties arising from US rate hikes and a shift in risk preferences than to rate reversals between home and abroad. The result highlights that rate reversals have a limited impact on the outflows of domestic and foreign securities investment funds.
However, persistent rate reversals drive up the costs of financing foreign capital and foreign exchange hedging for foreign investments, which requires caution. When residents issue Korean Paper (foreign currency-denominated bonds in Korea), rising coupon rates of issuing bonds are leading to mounting interest payment burdens. It is also noteworthy that most domestic investment institutions pursue an FX hedging strategy when investing in foreign bonds, which contributes to increased FX hedging costs and diminished investment returns.
The implications drawn from this article are as follows. First, efforts should be put into reinforcing economic fundamentals and maintaining external soundness to safeguard the resilience of the Korean economy against prolonged rate reversals coupled with global external shocks. Second, economic agents are encouraged to establish effective systems and strategies for financing foreign capital to prepare for the rise in borrowing costs. To this end, it is also crucial to diversify foreign capital financing instruments and manage foreign currency liquidity. Lastly, domestic investors should develop systematic FX hedging policies that align with the characteristics of individual investment institutions or funds, rather than adopting routine FX hedging practices when investing in foreign securities.