Will High Exchange Rates Become the New Normal? The ‘Won Discount’ Driven by Regulation and Weak Fundamentals

Q3 Record for Overseas Investment
Persistent Capital Outflows amid Weakened Korean Fundamentals
Reversal Requires Restoration of Investment Appeal

Korea’s economy is facing mounting concerns as the won-dollar exchange rate continues to surge despite repeated interventions by monetary authorities. The lack of attractive domestic investment opportunities and accumulating regulatory burdens have entrenched the weakness of the won, fueling a self-reinforcing cycle in which capital flight accelerates through overseas investment. Analysts warn that unless Korea’s productivity and capital returns improve, the country may follow Japan’s path—where a low-growth era coincided with a surge in outbound investment. The key to stabilizing the won, they note, lies in restoring the appeal of domestic assets and revitalizing corporate growth potential.

Won Weakness Fueled by Expanding Overseas Investment

As of 3 p.m. on the 21st, the won-dollar exchange rate was trading at $1,472.10, up 4.1 won from the previous day, with an intraday high of $1,473.9—its highest level since April, when U.S.-China tensions intensified. The rate has risen sharply since early last month, climbing from the $1,400 range and now approaching $1,500. The rally has been driven primarily by foreign capital outflows amid growing skepticism over the AI boom and delayed expectations for a rate cut at the Federal Open Market Committee (FOMC) meeting in December. The yen’s depreciation, triggered by Japan’s large-scale stimulus, has also been a factor. The yen-dollar rate has risen to 157, marking a ten-month high.

However, the persistence of a high exchange rate reflects more of a won depreciation than dollar strength. According to the Bank for International Settlements (BIS), Korea’s real effective exchange rate (REER) stood at 90.14, well below the baseline of 100, indicating diminished purchasing power relative to major trading partners. The structural driver behind this is the surge in outbound investment. Despite current account surpluses and steady foreign investment inflows, the stronger demand for dollars to fund overseas equity purchases has placed upward pressure on the exchange rate.

Financial Supervisory Service data show that individuals converted a total of $108 billion through nine major securities firms—including Mirae Asset, Korea Investment, NH, KB, Samsung, Kiwoom, Shinhan, Toss, and Kakao Pay—for overseas stock purchases as of mid-October. This figure exceeds last year’s record of $94 billion and is 61% higher than the 2023 total. The converted amount also surpasses the National Pension Service’s year-to-date increase in foreign equity and bond holdings ($42 billion) and the average daily transaction volume in Korea’s foreign exchange market ($86 billion). The Korea Securities Depository reports that domestic investors’ outstanding overseas assets reached $228 billion, a 43% increase from the end of last year, with 81% of that invested in U.S. stocks and bonds.

By the third quarter, the trend became more pronounced. According to the Bank of Korea’s international investment balance, Korea’s external financial assets reached an all-time high of $2.8 trillion (about $4.1 quadrillion) as of September. Broken down by category, portfolio investments (stocks and bonds) increased by $89 billion, direct investments by $8.7 billion, and reserve assets by $11.8 billion. In contrast, foreign holdings of Korean assets—external financial liabilities—rose to $1.7 trillion, up just $90 billion. As a result, Korea’s net external financial assets grew to $1.05 trillion, a quarterly increase of $25.8 billion. This rapid increase in overseas securities investment has become a major factor behind the won’s depreciation, as growing outbound capital raises demand for dollars even amid trade surpluses.

Capital Outflows Accelerating Amid Regulatory Overhang and Investment Drought

Multiple factors are driving this capital flight. Traditional investment channels such as real estate have lost their appeal under heavy regulation. The government has rolled out successive property-tightening packages—on June 27, September 7, and October 15—aimed at curbing Seoul-area price surges. These measures included stricter debt service ratio (DSR) caps, loan-to-value (LTV) limits, and tighter lending ceilings.

With property gains curtailed, investors have increasingly turned to leveraged overseas equity bets using unsecured loans. According to the Korea Financial Investment Association, margin lending balances stood at $17.5 billion as of November 4, near the all-time high recorded in September 2021. Much of this capital flowed into overseas tech stocks. The Korea Securities Depository notes that retail investors bought a net $6.8 billion of foreign shares last month—the largest on record—and another $2.1 billion in the first ten days of this month, focusing heavily on AI-related names such as Nvidia, Meta, and Iron.

Corporate capital flight has also intensified under expanding labor and business regulations. The controversial “Yellow Envelope Law,” an amendment to the Trade Union and Labor Relations Adjustment Act, broadens the scope of legal strikes and restricts employers from seeking compensation for damages. Economists warn that this will dampen corporate investment and competitiveness by raising labor costs. If prime contractors are held liable for subcontractor working conditions, labor expenses could surge across industries. The Korea Employers Federation estimates that average labor costs per firm could rise by at least 8.7% once the law takes effect.

The implications for market sentiment are equally negative. Global investors place heavy emphasis on labor stability when deciding on foreign direct investment destinations. Accordingly, heightened labor risks could deter FDI inflows. The American Chamber of Commerce in Korea (AMCHAM) and the European Chamber of Commerce in Korea (EUCCK) have both cautioned that expanded bargaining obligations and strike risks could worsen Korea’s business climate. Any slowdown in foreign investment in advanced industries such as semiconductors, they note, would pose a significant threat to Korea’s long-term growth trajectory.

Policy Limits Without Structural Reform

Market experts warn that outbound capital flows could become a new normal. While foreign investors have been net sellers in the domestic market, Korean investors’ appetite for overseas equities remains strong, sustaining demand for dollar conversions and perpetuating won weakness. For this reason, many traders no longer rule out the possibility of the exchange rate breaking above the $1,500 mark.

The government’s new “National Growth Fund” aims to draw domestic capital back home, but doubts persist about its effectiveness. Overlap with existing state-led funds and the lack of profitable investment targets undermine its potential. Analysts are particularly skeptical about returns in the AI sector. “Given the planned size of the fund, virtually every local firm with ‘AI’ in its name would need to receive investment,” said a research analyst at a domestic brokerage. “But in reality, only Samsung Electronics and SK Hynix are generating substantial AI-related profits, raising questions about the fund’s viability.”

According to the Software Policy Research Institute under the Ministry of Science and ICT, the total revenue of Korea’s AI industry amounted to just $4.3 billion last year—a 12.5% increase from 2023 but with slowing growth momentum (21.5% in 2023 and 53.6% in 2022). Compounding concerns are the poor performance of prior policy funds. The Korea Development Bank reports that the Innovation Growth New Deal Fund has recovered only 9.31% of its investments since its launch in 2020. The fund—initially established under the Moon Jae-in administration—was later downsized by half under the Yoon government.

The greater risk, experts warn, lies in what happens after policy momentum fades. The current KOSPI hovering around the 4,000 level is not built on corporate earnings but on government-driven sentiment and expectations, leaving it vulnerable to abrupt corrections. Without new growth drivers and meaningful regulatory reform, short-term stimulus cannot restore market resilience. Sustained investor confidence, they emphasize, requires more than temporary boosts—it demands credible progress in stabilizing the foreign exchange market, restoring fiscal discipline, and strengthening corporate competitiveness. Only then can Korea transform the current rebound into a durable recovery and reverse the structural depreciation of its currency.