It is difficult to say a certain currency holds more value over others when exchange rates fluctuate constantly. Nonetheless, the Korean won (KRW) and US dollar (USD) can be compared in their values based on interest rates using a fixed exchange rate.
The Korea Federation of Banks in its data released in April 2018 reported that one-year term deposit rates on won accounts is around 2.0% on average, at a maximum of the 2.4% level. On the other hand, those on dollar accounts also went up significantly compared to the past. One commercial bank even posted as much as 2.5% on dollar accounts, which is higher than even the maximum rates offered to won based accounts. This is possible because the sales margins of dollar accounts are markedly higher. One can estimate sellers’ margins by examining the circumstances surrounding how dollar funds are managed in Korea.
The benchmark interest rate is now higher in the U.S. than in Korea with the US Fed raising the rate in March 2018. From a glance, it is easy to think that dollar savings accounts will give higher yields. It sounds fair but is not the case. Excuses for offering lower rates on dollar accounts in Korea ran out way before March this year.
Rather than the difference between the US and Korean benchmark rates, the difference in won vs. dollar savings interest rates should be compared by examining the won and dollar asset markets, that is through the KORIBOR and USD LIBOR rates.
According Yonhap Infomax’s data, USD LIBOR interest rates were generally higher than KRW KORIBOR rates for the 12 months starting the second half of 2016. The gap has been increasing further this year. As of April 10, the USD LIBOR rate was 2.70%, 0.7%p higher than 1.99%, the KRW KORIBOR rate. The rate has been soaring. Simply put, dollar savings accounts should yield 0.7%p more than KRW based accounts.
Of course, concerns can be raised on why foreigners do not pull their dollar funds out of Korea with its lackluster interest rates. But the truth is that they are bringing in more dollars into the country. According to the Bank of Korea in its March trend report on international financial and FX markets, a total dollar inflow was USD 2.18 billion in January and USD 2.35 billion in February. In March even with the Fed’s rate hike, a net amount of USD 960 million came into Korea as bond funds.
On top of interest proceeds, the yields that arise when exchanging the dollar to the won during a fixed period of time are the reason why foreign funds are coming in. In other words, additional bonus can be obtained through FX swap transactions. As much as 1.42% (Yonhap Infomax, as of April 10, 2018) can be earned in extra when the dollar is exchanged into the won during one year. For reference, the annual yield would be close to 3% when the calculation is made using only the March rate immediately after the Fed’s rate hike. This phenomenon occurs when the dollar holds a higher value when demand increases. In short, foreigners bringing in dollar funds can obtain additional yields through arbitrage buying and selling of dollar assets to profit from price difference.
Anyone having dollar assets can trade like foreigners but the number of Koreans having access to LIBOR rate funds is limited. Nevertheless, it is technically possible to secure over 3% APY by combining the KORIBOR and additional FX swap rates. According to the Central Bank of Korea, the total balance of dollar savings by Korean residents was close to USD 70 billion as of the end of March 2018. A potential market may be present in these dollar funds seeking higher yields. Now you know the margins, you may not want to grin with joy even if your bank offers 2.5% APY for your dollar assets.
As explained earlier, arbitrage is possible with dollar funds so to foreigners, it is clear that the US dollar holds more value than the won. The dollar is clearly the currency that gives a higher yield potential even to Koreans despite having no arbitrage privilege. This trend will probably be heightened further as the U.S. raises rates. As such, it can be said that the dollar is clearly more valuable to Korean people over the won from the perspective of interest rates.
Various dollar-based products are pouring into financial markets. MetLife Korea launched “USD Universal Life Insurance” which is a protection type product while the credited interest rate of 3.5% is applied to policyholder reserves. Even if the rate were to fall, a minimum of 3% is guaranteed so that high death benefits and surrender value can be expected. The high credited rate corresponds to high profits from asset management, which is also possible due to the dollar’s competitive rate advantage.
It is time to consider expanding the dollar portion in your portfolio with the dollar offering higher value than the won. 【The contributions from outside analysts are unrelated to the views of the publisher. They have been contributed in English and the wordings have been mildly edited.】
By Dae-Hwan Im, Investment Specialist, MetLife Korea NobleRich Center
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