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Title 1%-Point Interest Rate Differential: A Tipping Point for Massive Capital Outflows?
Author KANG Tae Soo
Date 2018-07-25
File KIEP opinions_no139.pdf 

On June 13, the U.S. Federal Reserve raised its benchmark rate by 25 basis points. Central banks in emerging markets raised their policy rates swiftly prior to the June FOMC meeting to heed the pressure of capital outflows. The Bank of Korea’s policy rate has frozen in the range of 1.50 percent during the past seven months. There has been a strong argument that capital outflows are unavoidable in situations where the interest rate gap between the Fed and Bok widens to over 1%-points. It seems quite natural that a portion of foreign capital would leave the Korean market back to its origin. However, the Korean market has served as a destination for "flight-to-quality" at times of rising uncertainty in the global financial markets. The Taper Tantrum speech by then-Fed Chairman Ben Bernanke (May 2013) is a good case in point. Foreign investment in Korean bonds has consistently expanded. Seven billion dollars of bond funds have flowed into Korea between January to May. Most of these inflows (6.3 billion dollars) are from foreign central banks and sovereign funds. They are less sensitive to interest rate differential and exchange rate fluctuations. The recent negative swap spread (-1.70% points) at the FX funding market gives an arbitrage opportunity to foreign investors. This strongly indicates that foreigners’ investments in Korean bonds look profitable as ever. That a 1%-point rate interval would provoke huge capital outflows out of Korea seems too blunt and unilateral a claim. 

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