Index inclusion to draw inflows, but may act more as buffer than boost
Stacks of 50,000 won notes. (Newsis)
Korea’s government bonds begin entering the FTSE World Government Bond Index, or WGBI, on Wednesday, marking a milestone Seoul has pursued for years to broaden foreign participation in its bond market.
Inclusion in one of the world’s most closely watched sovereign bond benchmarks is expected to draw fresh foreign funds into Korean government debt, with around 80 trillion won ($52 billion) in inflows anticipated over the eight months through November as the country is phased into the index.
The timing, however, is far from ideal. Korean Treasury yields have climbed sharply in recent weeks as war in the Middle East has stoked concerns over oil prices and inflation, adding pressure across global fixed-income markets. That has made WGBI entry look less like a celebratory event than a potential buffer for a bond market under strain.
What does WGBI signal, and how will it happen?
Compiled by FTSE Russell, the WGBI tracks fixed-rate, local-currency, investment-grade government bonds across over 20 markets and is widely followed by major fund managers and institutional investors. Entry requires countries to meet standards on market size, minimum credit quality and market accessibility, making inclusion a widely recognized marker of advanced sovereign debt markets.
As of FTSE Russell’s February index profile, Korea’s eligible pool consisted of 65 won-denominated government bonds, representing 1.89 percent of the index and making the country the ninth-largest constituent. The WGBI is estimated to be followed by $2.5 trillion to $3 trillion in assets.
Korea will be added in eight monthly steps, with the government previously anticipating at least 75 trillion won in new foreign inflows.
How much money will actually come?
That headline figure captures the scale of the opportunity, but not necessarily what will arrive in practice.
As the WGBI includes only local-currency bonds, Korea’s weighting can shift with exchange-rate moves even if the underlying bond market has not changed much. With the won falling this week to its weakest level since March 2009 amid escalating tensions in the Middle East, analysts caution against treating the projected inflow as a certainty.
“Because the WGBI comprises only local-currency bonds, Korea’s weighting is vulnerable to exchange-rate swings,” said KB Securities analyst Lim Jae-kyun. “Given the won’s recent depreciation, Korea’s actual weight in the index is likely to be lower than 1.89 percent, which means passive inflows could come in below the projected amount.”
Lim added that the roughly $2.5 trillion pool of WGBI-tracking assets may itself have shrunk amid rising global yields and portfolio shifts, further capping the amount of money likely to flow into Korea.
Past additions to the index suggest headline forecasts often diverge from reality. Shinhan Securities analyst Kim Chan-hee found that Malaysia’s 2007 entry and Israel’s 2020 inclusion each drew about twice the expected amount under supportive market conditions. New Zealand, by contrast, attracted only about one-third of projected inflows after joining in 2022, as global rate hikes and the shock of the Russia-Ukraine war weighed on demand.
Against that backdrop, analysts broadly expect monthly inflows of about 7 trillion won to 9.5 trillion won during the phase-in period, depending on market conditions and how much money was prepositioned ahead of inclusion.
The clearest effect is likely to be on bond-market supply and demand. With Korea set to issue 225.7 trillion won in Treasury bonds this year, fresh foreign demand is expected to absorb part of that supply and ease pressure on the market.
Officials have framed WGBI entry in those terms. Earlier government estimates suggested that $50 billion to $60 billion of inflows could shave 20 to 60 basis points off yields across maturities by broadening the buyer base and lowering funding costs.
In the current market, though, the more realistic outcome is not a rally, but a partial offset to the upward pressure created by war-driven inflation fears. Korean Treasury yields have climbed more than 50 basis points over the past month, reaching their highest level this year.
Kim said that while inflows from index-tracking funds alone are unlikely to determine the direction of yields, they could help stabilize rates by around 20 to 30 basis points in the second and third quarters.
The currency effect is real, but secondary. Officials and analysts say steady foreign demand for Korean government bonds should improve foreign exchange liquidity and lend some support to the won. But with much of the inflow routed through hedging channels rather than directly into the spot market, WGBI entry is unlikely on its own to reverse a war-driven dollar surge.
“Geopolitical risks and renewed inflation concerns are raising doubts about the scale of the effect,” said Kim, adding, “If some of the Middle East-related risks ease, the inclusion could help reinforce a pullback in yields. But if inflation pressures keep markets wary of further rate hikes in the next two quarters, WGBI inclusion may instead serve as a buffer that caps the upside in yields.”
jwc@heraldcorp.com