Summary of Key Points
This article discusses South Korea's foreign exchange reforms and the classification of "emerging markets": In an attempt to be included in the MSCI Developed Markets index, South Korea has implemented the most significant foreign exchange liberalization measures in 30 years (such as 24-hour trading and simplifying procedures for foreign investment), but it has not yet succeeded. The article challenges the misconception that "emerging markets" equate to developing economies, pointing out that they are essentially capital games determined by index companies like MSCI based on the ease of foreign capital inflow and outflow. It also explores the pros and cons of being reclassified as a developed market, traces the origin of the concept of emerging markets, and reveals how these markets have evolved into tools influenced by the US dollar cycle and the chip industry.
I. South Korea's Foreign Exchange Reforms: Why the Delayed Liberalization?
During the 1997 Asian financial crisis, the Korean won was targeted by speculative capital, causing its value to plummet by nearly half, and it only stabilized with IMF assistance. Since then, South Korea has imposed strict restrictions on foreign exchange transactions, such as limiting trading hours, to prevent another market downturn. This latest reform represents the first major relaxation in 30 years:
- 24-Hour Trading: Previously, the Korean won could only be traded during business hours; now it can be bought and sold globally at any time, solving the problem of foreign investors not finding buyers when they wish to trade.
- Simplified Procedures for Foreign Investment: Overseas institutions can register more conveniently without having to go through complex procedures to convert funds into Korean won; they can simply hold the currency directly.
- Clear Purpose: The goal is to get South Korea upgraded from an "emerging market" to a "developed market" by MSCI. Despite several previous attempts failing, this reform aims to gain an advantage through improved capital accessibility.
II. "Emerging Markets" Are Not About Economic Development Level, but About Capital Access
Many people think "emerging markets" refer to stages of economic development, but in reality, they are criteria set by index companies for foreign investment:
- MSCI's criterion: Whether it is easy for foreign capital to enter and profit or withdraw has little to do with GDP or technological strength.
- South Korea faces barriers, such as the Korean won not being directly tradable overseas, forcing investors to use costly indirect methods to hedge exchange risks. Investor identification processes are also rigid, limiting over-the-counter transactions. In short, if foreign investors find it difficult to make profits or withdraw capital, South Korea will not be upgraded.
III. The Benefits and Challenges of Being Reclassified as a Developed Market
The benefits of being reclassified as a developed market are significant:
- Increased Capital Inflow: Passive funds that track the index will automatically invest in South Korean assets, potentially bringing in billions of US dollars.
- Reduced Discount on South Korean Assets: Foreign investors often view emerging markets as higher-risk, leading to lower valuations; being reclassified could eliminate this discount.
However, there are also drawbacks:
- Change in Status: In emerging markets, South Korea held a significant weight (20%); in developed markets, its weight would be much lower (only 2%), potentially making it less attractive to active funds.
- Short-Term Volatility: As the index weight decreases, some passive funds may withdraw, causing stock prices to fluctuate.
- Vietnam's Experience: Vietnam was downgraded from a developed market to an emerging one in 2013 due to capital flow issues; it has since been reclassified because its settlement systems have aligned with European standards.
IV. The Origin of "Emerging Markets": A Fund Manager's Marketing Strategy
The term "emerging markets" was not coined by economists but by a fund manager in 1981 to promote his product:
- Initially called "Third World Stock Funds," it was unappealing to investors.
- The manager renamed it "Emerging Markets," which conveyed a sense of progress and advancement, leading to a surge in sales.
- Later developments, such as the launch of the first public emerging market fund by Templeton and the creation of the BRICs concept by Goldman Sachs, further popularized the term and sparked a bull market.
V. The Current State of Emerging Markets
Forty years later, emerging markets have changed significantly:
- Shift from Risky to Index-Based: Investing in emerging markets once required counting containers at ports and dealing with political risks; now, it is mainly driven by MSCI indices, with passive funds playing a dominant role.
- Dominance of the Chip and Dollar Cycles: Taiwan, China, South Korea, and India account for 80% of emerging market assets, with companies like TSMC, Samsung, and Hynix having a significant impact. In essence, currency fluctuations (due to US interest rates) and the AI chip industry drive market trends, rather than economic growth.
- Low Graduation Rate: Only Portugal, Greece (which was later downgraded), and Israel have successfully transitioned from emerging to developed markets in the past 40 years. South Korea and Taiwan have been in the "emerging" category for over 30 years with no clear exit strategy.
Conclusion
"Emerging markets" are essentially rules established by European and American capital, designed to ensure that foreign investors can profit easily and withdraw their funds smoothly. South Korea's efforts to be reclassified as a developed market are a challenging journey, as the criteria set by these indices are not always aligned with economic realities.