Choosing proper investment destination is essential for the success of every company seeking expansion and growth; most companies fail because they do not take time to choose the right country for their investment. A number of economic factors are considered when determining the suitability of a country for investment. Such factors include GDP, economic growth rate, unemployment rate, labor force, income distribution, public debt, net export, inflation rate, and foreign currency exchange among others. This is a report to the financial advisors, portfolio managers, and mutual funds and ETFs about the suitability of South Korea as an investment destination. This paper considers only two economic conditions in South Korea namely inflation rate, and foreign currency exchange to determine her suitability for investment purposes.
South Korea is a small country geographically located in Eastern Asia bordering both Yellow Sea and the Sea of Japan. The country has a total land area of 96,920 square kilometers and a total population of 49,115,196 people with population growth rate of 0.14% per year. The country’s land usage is divided into forest, agricultural and other with percentage 63.9%, 18.1%, and 18% respectively. Data from CIA World Factbook shows that South Korea currently has favorable economic indicators. Over the past one decade, the country has demonstrated incredible economic growth in the region to receive global attention. In addition, South Korea has been globally integrated to become a leading technology driven industrialized economy in the world today. The following are the current economic condition in South Korea.
An increase in the overall prices and goods and services in an economy is termed inflation when it is sustained. When the inflation rate increases, the currency will decrease in value thus consumers experience reduced purchasing ability. As explained by Thornton and Ekelund (2004), inflation directly affects prices of many goods and services such as apparel, housing, food, fuel, and transportation among others. Inflation rates can vary radically from one month to another depending on various economic conditions such as supply of money. Inflation data are used both the government and business community in many ways in setting economic policies which makes it an important factor in determining the suitability of South Korea as an investment destination.
Inflation is a crucial economic indicator in South Korea; it determines the suitability of doing business as well as investing in the country. Moreover, it determines the real rate of return and the time value of money for companies investing in South Korea. Just like other countries, several categories of consumer price index are used to determine the inflation rate. In South Korea, the most commonly used categories are water, housing, electricity, gas and fuel, as well as foods and non-alcoholic beverages (Hossain, 2015). Other important categories used include education, health, transportation, restaurants and hotels as well as clothing and footwear. Therefore, the computed inflation rate is a reflection of the performance of consumer price in these categories.
Historically, the inflation rate in South Korea has been steadily decreasing for the past two decades, which is an indication of favorable economic and business conditions. In essence, a decreasing inflation rate is an indication of an increasing time value of money. The South Korea’s inflation rate is calculated based on the value of consumer price index. Although there has a general long-term decrease in inflation, October 2015 show a slight increase in consumer prices by 0.9% calculated on a year-to-year basis. The October figure hit the highest since 2014. Since 1966, the average inflation rate in South Korea has been maintained below 7.68%. However, inflation reached all-time highest in October of 1980 with a recorded figure of 32.50%. On the other hand, the lowest inflation was recorded in February of 1999 at 0.20%. The graph below gives a summary of the inflation rates in South Korea for the past 20 years.
Graph 1: Inflation Rate in Republic of South Korea between 1967 and 2015
Source: World Bank 2015
Graph 2: Inflation Rate in Republic of South Korea between Jan 2014 and Oct 2015
Source: Trading Economics Statistics
Analysis of the two graphs above indicates that South Korea exhibit a falling inflation, which is an indicating of improving economic conditions that favors investments and business activities. From 1967, the inflation rate has been falling and reached the lowest in 1988. The falling inflation rate is economically described as deflation. Under deflationary condition, the prices of goods and services are generally decreasing thus improving the purchasing power of the consumers as well as the time value of money. As explained by Bresciani-Turroni (2008), investments in mutual funds and ETFs among others usually thrive well in deflationary economic conditions, which makes South Korea a suitable country.
Deflation in an economy is generally characterized by falling or stable prices of goods and services. In South Korea, the prices of goods and services have remained stable for many years, which is an indication of economic stability. The deflation implication is an indication that prices of goods and services in leading economic sectors in South Korea such as housing, transportation, gas, fuel, apparels and foods among others have remained stable for many years. It also indicates a general steady supply of money in South Korea, a key factor that influences investment decision. Further, it implies that the country has maintained stable fiscal and monetary policy that promotes economic growth and development, which is an essential element in promoting investments facilities in the countries. In essence, the falling inflation rates indicate that South Korea is a suitable investment destination.
However, the deflationary economy can have implication of decreasing government, and to some extent, personal spending on investment (Eichengreen, Perkins, & Shin, 2012). Furthermore, it is associated with increased unemployment, which does not favor investments. The increased unemployment is caused by reduced levels of demands in the economy. If the government does not check the deflation in South Korea appropriately, it can lead to economic depression thus not favoring investments in the country. Investors must consider this factor before choosing South Korea especially the government’s policies in managing deflation.
(b) Foreign Currency Exchange
Foreign currency exchange rate is another significant factor in deciding the suitability of a country as an investment decision. Important factor to consider are the exchange rates and the stability of the local currency because they determine the value and return on the investment portfolio.
The local currency used in South Korea is Won as won and its code is KWN. It was introduced as the official currency in 1902. The currency was then pegged to US dollar at exchange rate of 15 during the initial stages of World War 2. However, this exchange rate was changed multiple times until 1951 during which the currency experienced drastic drop in value. Historically, the Won has been pegged to US dollar multiple times for many years until late 1997 when it was allowed to float freely in the market following an agreement signed by International Monetary Fund. Won subsequently devalued to nearly half its value due to a financial crisis that affected the Asian market.
Opening Won to the floating exchange rate allowed it to particulate freely in the global market. Since then, the exchange rate for Won has been determined solely by the global forex market forces (Heo & Roehrig, 2014). However, the central bank constantly attempts to influence the value of Korean won through its participation in the market. In particular, the central bank uses various tools such as open market operations, bond and treasury bills to influence the market’ value of the local Won currency. Even the central bank has some powers to influence the value and exchange of local currency this has not weighed in significantly in South Korea. Since 1997, its exchange is purely determined by forex market mechanisms only.
The Won exchange rate has relatively established after its sharp devaluation following the financial crisis in the Asian market. US dollar has been traditionally used as the basis of exchange for Won currency. For the past 10 years, the average exchange rate against US dollar has relatively stabilized at 1,108.29. However, it experienced a short-lived sharp increase in exchange in 2008/9 following the financial crisis that affected the global market. However, it has overcome the effect of that financial crisis and stabilized. The last five years have been marked by a general decrease in exchange, which is an indication that the currency is slightly gaining strength and value. The two graphs below indicate the historic exchange of Won currency against US dollar and euro.
Graph 3: South Korean Won to US dollar exchange rate
Source: St. Louis Fed FRED database
Graph 4: South Korean won to euro exchange rate
Source: St. Louis Fed FRED database
The stability of the exchange indicates that South Korea is a suitable place for investment. This is because investors will not lose a lot of money due to volatility of the exchange rates against foreign currencies such as dollar and euro. If there were high volatility of the exchange rate, the business and investment conditions would be significantly affected (Chung, 2007). For instance, there would be reduced investment returns is the exchange rates drastically reduced.
The current exchange rate against the US dollar is 1902, which is considerably high. The implication of high exchange against foreign currency is the devaluation of local currency thus weakening Won. In terms of investments, the implication of weak local currency is that it reduces the value of the investments in the local economy. However, this is highly beneficial because it reduces the investment costs in economy. As s result, investing in South Korea would be relatively cheaper as compared to other economies.
In conclusion, the analysis of both exchange rate and inflation shows that South Korea is a suitable country for investment. The low inflation rates in the country and stable exchange rates would significantly promote investment activities in South Korea. The investors will benefit from high rate of return and low initial investment costs (Hart-Landsberg, Jeong, & Westra, 2007). In essence, investing in South Korea is absolutely a wise decision to make.
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Chung, Y.-I. (2007). South Korea in the fast lane: Economic development and capital formation. Oxford: Oxford University Press.
Eichengreen, B., Perkins, D. H., & Shin, K. (2012). From miracle to maturity: The growth of the Korean economy. Routledge
Hart-Landsberg, M., Jeong, S., & Westra, R. (2007). Marxist Perspectives on South Korea in the Global Economy. Aldershot: Ashgate.
Heo, U., & Roehrig, T. (2014). South Korea’s Rise: Economic Development, Power and Foreign Relations. London: Cambridge University Press.
Hossain, A. A. (2015). The evolution of central banking and monetary policy in the Asia-Pacific. Cheltenham, UK: Edward Elgar Publishing.
Thornton, M., & Ekelund, R. B. (2004). Tariffs, blockades, and inflation: The economics of the Civil War. Wilmington, Del: SR Books.