The balance of dollar-denominated repurchase agreements (RPs) in South Korea, which had expanded rapidly through last year, has fallen steadily since the start of this year. With interest rates now less attractive than before and the won-dollar exchange rate recently dropping below 1,400 won, analysts say demand for new investment and for reinvestment of maturing funds could weaken further.
The average daily balance of dollar RPs this month was $14.25 billion, down 34.9% from $21.90 billion in December last year, according to the Korea Securities Depository on the 21st. The monthly average has fallen for eight straight months without a single rebound this year. The decline has grown steeper in the second half, with more than $3 billion drained in less than two months.
The overall balance shrank as new investment and reinvestment failed to replace maturing positions being redeemed. An RP is a short-term financial product in which a financial firm sells bonds it holds to investors on the condition that it will buy them back after a set period, offering an agreed rate of return. Dollar RPs are used as a way to "park" dollars, since investors can convert won into dollars to invest or put existing dollar holdings to short-term use while earning interest.
Lower interest rates compared with last year are also cited as a reason for the falling balance. Because dollar RP rates are linked to U.S. short-term rates, they tend to fall when the U.S. benchmark rate declines. After the U.S. Federal Reserve cut rates late last year, securities firms lowered their foreign-currency RP rates one after another. At one point, major securities firms offered dollar RP rates in the high 3% range for on-demand products and around 4% for fixed-term products, but both types are now in the low- to mid-3% range.
The bond-lending market, which had grown alongside expanding RP trading, has also lost momentum recently. The bond-lending balance, which exceeded 240 trillion won in the first half, later turned lower and fell to 210.82 trillion won this month. Because rising RP trading increases demand for bonds to use as collateral, the bond-lending balance typically grows when the RP market is active.
On top of this, the recent sharp appreciation of the won has emerged as a new burden. Dollar RPs are considered relatively stable products because they pay agreed interest against bonds held as collateral, but as foreign-currency products they leave won-based investors fully exposed to the risk of losses from exchange-rate swings. For example, even an investor earning interest in the 3% range could post a loss in won terms if the dollar falls by more than that during the investment period.
An official in the financial investment industry said, "There are quite a few cases of investors mistakenly viewing foreign-currency RPs as safe assets with fully guaranteed principal." The official added that because interest income is taxed while individuals' foreign-exchange gains are tax-free, exchange-rate moves can have a greater impact on actual profit and loss than interest rates do.
