South Korea Lifts 14-Year Kimchi Bond Ban, Won Strengthens 1.2%

South Korea has recently lifted a 14-year ban on domestic financial institutions investing in kimchi bonds, a move aimed at attracting more foreign capital and stabilizing the won. This decision comes as the country grapples with economic challenges, including a speculative frenzy among investors in dollar-backed stablecoins.

The ban, initiated by the Bank of Korea in 2011, was put in place to prevent currency mismatches among local issuers. However, the central bank's concern over the won's weakness and the lack of foreign currency liquidity, exacerbated by retail investors' interest in overseas stocks and dollar-backed stablecoins, prompted the lifting of the ban.

The won responded positively to the news, strengthening by as much as 1.2% to 1,347 won per dollar, its highest point in eight months. However, it has since lost some of those gains. The appointment of a new president has also contributed to the won's strength, with an 8% appreciation against the dollar this year. The new government has pledged higher fiscal spending and is under pressure from Washington to boost its currency’s value in trade talks.

South Korea’s forex reserves fell to their lowest level in five years in May, prompting the government to take various measures to boost foreign currency inflows. These measures include raising hedging limits in currency derivatives, easing restrictions on foreign currency lending by domestic banks, and increasing the forex swap line between the BoK and the National Pension Service.

The latest move to lift the ban on kimchi bonds is expected to attract more dollars to the country and counterbalance the retail outflows. Before the ban was lifted, the main issuers of kimchi bonds were foreign subsidiaries of South Korean companies that required dollar funding. Now, analysts expect more domestic groups to issue kimchi bonds as they are allowed to sell foreign currency debt and convert it to won for domestic use.

Hwang Sei-woon, senior research fellow at Korea Capital Market Institute, noted that there is an increasing perception that the Korean won is too weak relative to its fundamentals. The new measure not only signals higher demand for the won in the long term but also reflects the government’s willingness to open up the forex market even more.