[Seocho Forum] The Meaning of the Rise in Won Value

Recently, while the value of the dollar is declining, the value of the won is rising significantly. As the undervaluation is resolved, the value of the won is expected to rise further, which will have a significant impact on our economy and financial markets.

In April, the won-dollar exchange rate exceeded 1480 won, but by the end of May, it had fallen to the 1360 won range. Considering the factors determining the won-dollar exchange rate, the value of the won is expected to rise further. Variables affecting the determination of the won-dollar exchange rate include the dollar index and the exchange rates of counterpart countries such as Japan's yen or China's yuan. In addition, the interest rate differential between Korea and the United States and the current account balance are factors that cause exchange rate fluctuations.

By using these as explanatory variables and the won-dollar exchange rate as the dependent variable, a regression analysis can be conducted to estimate the appropriate level of the won-dollar exchange rate. The analysis period is from January 2001 to April 2025. The won-dollar exchange rate may deviate from the estimated appropriate level, but it has fluctuated close to it in the long term. At the end of April 2025, the estimated appropriate won-dollar exchange rate based on these variables was 1169.7 won. The actual exchange rate was 1426.9 won, indicating that the value of the won was undervalued by 22%.

In the short term, the won-dollar exchange rate will not plummet to the appropriate level. However, considering the factors determining the exchange rate, the value of the won is likely to rise further. The economic variable that has the greatest impact on the determination of the won-dollar exchange rate is the dollar index. The dollar index fell from 110 at the beginning of the year to 99 by the end of May. Considering the economic situation in the United States, the dollar index is likely to fall further. The U.S. economic growth rate is expected to slow significantly this year. As the growth rate of consumption, which accounts for 69% of the U.S. GDP, slows, this year's growth rate is expected to be around 1%, lower than last year's 2.8%.

In the medium to long term, the value of the dollar is likely to decline. First, the International Monetary Fund (IMF) predicted in its April World Economic Outlook that the U.S. share of global GDP would fall from 26.4% in 2024 to 25.7% in 2030. Considering that the U.S. GDP share and the dollar index have moved in the same direction in the past, this implies that the dollar index will decline over the next six years. Additionally, the expansion of internal and external imbalances in the United States is also a factor in the decline of the dollar index. The proportion of the U.S. net external debt to GDP increased from 16.7% in 2020 to 89.3% in 2024. During the same period, federal government debt also increased from 89.9% to 124.1% of GDP. One of the main reasons Moody's recently downgraded the U.S. credit rating from 'AAA' to 'Aa1' is due to this.

Moreover, the proportion of dollars in the foreign exchange reserves of central banks worldwide decreased from 71.1% in 2000 to 62.2% in 2010, and to 57.8% in 2024. In particular, China is selling U.S. Treasury bonds and buying gold. If the inflow of foreign direct investment or securities investment funds into the United States decreases even slightly, the dollar index will fall.

Considering these factors, the dollar index is likely to fall, and the value of the won is likely to rise further. When the value of the won rises, manufacturing production centered on exports in our economy has slowed with a lag of about one year, while domestic demand such as the service industry has increased.

During periods when the dollar index falls, the KOSPI has risen relatively more than the S&P 500. In fact, analyzing statistics from January 2000 to April 2025, there was an inverse correlation (correlation coefficient -0.83) between the relative index of KOSPI/S&P 500 and the dollar index. During the same period, when the won-dollar exchange rate fell by 1%, the KOSPI rose by 0.79%. By industry, when the value of the won rises, the stock prices of domestic demand-related industries such as finance rose relatively more than the electrical and electronics industries. For stock investors, it seems advisable to increase the proportion of domestic stocks centered on domestic demand industries rather than U.S. stocks.

Kim Young-ik Sogang University Graduate School of Economics Adjunct Professor