Seoul, South Korea – Foreign investors have been offloading Korean government bonds since the declaration of a state of emergency last month, marking a significant shift in sentiment towards what was once considered a lucrative investment destination. With the government planning a record-breaking bond issuance this year, concerns are mounting over potential financing difficulties.
Preliminary data shows that foreign holdings of Korean government bonds decreased by approximately 3 trillion won (US$2.3 billion) in December. This represents a net selling of 3 trillion won in bonds over the month.
While foreign investors' bond holdings had increased by about 19 trillion won in 2023, the year-end sell-off prevented the total from surpassing the 20 trillion won mark.
The sell-off in the spot market was preceded by a notable decline in the futures market, a leading indicator of future trends. According to the Ministry of Economy and Finance, foreign investors net sold 15.89 trillion won worth of Korean government bonds (3- to 30-year futures) in December.
Since the state of emergency was declared on December 4th, foreign investors have net sold a staggering 18.71 trillion won worth of Korean bonds, marking the largest monthly net selling since September 2021. This suggests that investor sentiment, which had previously bet on rising bond prices (falling interest rates), has turned bearish.
While the Federal Reserve's hawkish stance and expectations of delayed global interest rate cuts have contributed to the sell-off, analysts believe that political instability in South Korea has further exacerbated the situation.
If the political uncertainty persists and foreign investors continue to sell off Korean bonds, the government's financing plans could be jeopardized. The Ministry of Economy and Finance has set a target of issuing 197.6 trillion won in government bonds this year, the highest on record. Of this, 80 trillion won is earmarked for net issuance.
Apart from the issuance of 20 trillion won in foreign currency-denominated bonds, the government may need to issue additional bonds to fund a supplementary budget, further increasing the total amount of bonds to be absorbed by the market.
As the supply of government bonds increases, interest rates are likely to rise. With the government already planning a record-breaking bond issuance and foreign investors selling off their holdings, there is a significant risk of a sharp increase in domestic interest rates. Even if the market can absorb the increased supply, the government will face higher borrowing costs.
However, the government attributes the recent sell-off to seasonal factors, such as the concentration of bond maturities in March, June, September, and December, and year-end portfolio adjustments. They maintain that it is too early to conclude that foreign investors are systematically exiting the Korean bond market.
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