South Korea's Reserves Dilemma: Can the Won Hold Steady Amid a Five-Year Low?

South Korea's foreign exchange reserves have slipped to a five-year low, raising questions about the stability of the won and the attractiveness of Korean assets. As of May 2025, reserves stood at $404.6 billion—a decline of $70 million from April and the lowest level since April 2020. While the Bank of Korea (BoK) dismisses immediate risks, the sustained drop underscores vulnerabilities in an economy reliant on global capital flows and export-driven growth. This article examines the implications for the won and identifies investment strategies to navigate the shifting landscape.

The Reserve Decline: Causes and Context

The reserves' slide is driven by a mix of structural and cyclical factors. Key components include:
1. Currency Swap Agreements: The BoK and National Pension Service (NPS) expanded their foreign exchange swap line to $65 billion in late 2024. This allows the NPS to borrow from central bank reserves for overseas investments, temporarily reducing reported reserves.
2. Capital Outflows: Foreign currency deposits held by financial institutions fell by $3.55 billion in May, signaling reduced liquidity or repatriation of capital.
3. Weakening USD Dynamics: A declining U.S. dollar—down 0.5% in early 2025—reduces the valuation of dollar-denominated reserves, though this effect is offset by increased holdings of securities (up $3.48 billion in May).

The BoK emphasizes that the $400 billion threshold is not a red line. However, the reserves now sit at a level last seen during the early stages of the pandemic, when global uncertainty spiked. With securities (89% of reserves) heavily weighted in U.S. Treasuries and corporate bonds, the portfolio remains exposed to interest rate and geopolitical risks.

Risks to the Korean Won

The won has been volatile in 2025, pressured by declining reserves and broader macroeconomic trends:
- External Debt Exposure: South Korea's external debt-to-reserves ratio is around 70%, leaving it vulnerable to sudden capital flight.
- Trade Deficit Pressures: A slowdown in semiconductor exports—a key pillar of trade surplus—has reduced foreign currency inflows.
- Political Uncertainty: Though President Yoon Suk Yeol's impeachment has stabilized, lingering governance concerns may deter foreign investors.

The won has depreciated 3.5% against the dollar year-to-date, and further declines could strain import costs for energy and raw materials. The BoK's accommodative stance—potentially cutting rates to support growth—adds to downward pressure on the currency.

Investment Strategies: Hedging and Opportunistic Plays

Investors face a dilemma: the won's weakness could amplify losses in unhedged Korean assets, while the BoK's policy flexibility offers opportunities in select sectors. Here's how to navigate:

1. Currency-Hedged Equities

South Korea's equity market (KOSPI) offers compelling valuations, but the won's volatility demands hedging. ETFs like the iShares MSCI South Korea ETF (EWY) or its hedged counterpart HEWY provide exposure while neutralizing currency risk.

Focus on sectors insulated from won weakness:
- Technology: Companies like Samsung Electronics (005930.KS) and SK Hynix (000660.KS) benefit from global semiconductor demand, though supply chain risks linger.
- Renewables: Hyundai Energy Systems (004270.KS) and LS Green Energy (071460.KS) are positioned for Asia's energy transition, supported by government subsidies.

2. Sovereign Bonds: Yield Pickup with Caution

South Korea's 10-year government bonds offer yields of ~3.2%, higher than German bunds (~2.1%) or Japanese JGBs (~0.3%). However, investors must weigh the won's depreciation risk.

• Hedged Bond Funds: Instruments like PGIM Korea Bond Fund provide yield protection through currency hedging.
• Short-Term Maturities: Stick to 2–5-year bonds to minimize interest rate risk if the BoK eventually hikes rates.

3. Emerging Markets Alternatives

If the won's decline accelerates, consider diversifying into regional peers with stronger fundamentals:
- Taiwan: A tech-driven economy with robust reserves ($560 billion) and a stable NT$.
- Vietnam: Benefiting from supply chain diversification and a 6.5% GDP growth outlook.

Conclusion: A Fine Line Between Opportunity and Risk

South Korea's declining reserves highlight structural challenges, but the BoK's management and the won's historical resilience suggest caution over panic. For investors, the key is to:
1. Hedge currency exposure in equity portfolios.
2. Prioritize defensive sectors with global demand ties.
3. Monitor central bank policy shifts—a BoK rate cut could trigger further won weakness, while geopolitical stability (e.g., U.S.-China trade) could stabilize reserves.

The won's fate hinges on external capital flows and domestic policy agility. In this environment, selective hedging and a focus on quality assets will be critical to preserving—and growing—capital.

Stay vigilant, but don't let short-term volatility obscure South Korea's long-term growth potential.