The Korean won has been on a tear as one of best-performing emerging-market currencies in 2014.1 And this has the Korean government and central bank officials worried that the rising Korean won is eroding the competitiveness of Korea’s exports.

While the currency has grown stronger, Korea’s equity markets have lagged other emerging markets this year, partly impacted by the currency’s strength.

• Korea exhibited a price-to-earnings (P/E) ratio below that of the MSCI Emerging Markets Index.2
Japanese Yen Factor: We have discussed Korea as a market focused on the weakening of the Japanese yen and a country most likely to take retaliatory actions to stem the relative currency strength of the won.
New Appointment Catalyst for Change: A new finance minister, Choi Kyung-hwan, took office in July, and some believe that his bias is to policies that accelerate economic growth. This could entail more aggressive intervention to stem the currency gains.3
• If the won were to stem or reverse its recent appreciation, currency-hedged Korean strategies could come into greater focus.

Rare Currency Warning

The Wall Street Journal published “South Korea Issues Rare Warning on Currency Surge” on July 2, 2014. This article described a message released jointly by the Bank of Korea and the finance ministry that reflected concerns “about the possibility of overly one-sided moves among market participants”.4 These concerns raise the possibility that the central bank will begin to intervene to stem the won’s gains.

A chart of the Korean won versus the U.S. dollar from July 21, 2009 to July 14, 2014 (approximately the last five years) shows the won at levels close to 1,000 won per dollar, which is among the strongest levels observed in this period.

Korean Won vs. U.S. Dollar, Last Five Years

Another key currency cross rate is the Korean won versus the Japanese yen because Japan and Korea have many companies that export very similar, in some cases even substitutable, products. On this basis, Japan has become more competitive since the middle of 2012, when the won-to-yen rate was as low as 6.6. The rate has recently passed 10.1.5

Korean Won vs. Japanese Yen, Last Five Years

A comparison of equity-market returns between Japan6 and Korea7 over the last two years, measured in their local currencies, the yen and won, might offer evidence that the won’s strength is affecting relative performance: Japan’s equity markets are up almost 70 percentage points cumulatively, while Korea’s equity markets are up only 6 percentage points.

Equity Market Returns, Japan vs. Korea