Korea Joins FTSE WGBI: Index Inclusion Aims to Draw Inflows, But May Act More as Buffer Than Boost
South Korea’s government bonds are set to be included in the FTSE World Government Bond Index (WGBI) starting Wednesday, a significant achievement for Seoul’s efforts to attract greater foreign investment into its bond market.
The WGBI, a leading sovereign bond benchmark, is expected to generate new foreign investment in Korean government debt. Projections estimate around 80 trillion won ($52 billion) in inflows over the eight-month inclusion period ending in November.
However, the timing presents challenges. Recent increases in Korean Treasury yields, driven by Middle East tensions and concerns about oil prices and inflation, have added pressure to global fixed-income markets. As a result, WGBI entry might serve more as a buffer for a stressed bond market than a catalyst for substantial growth.
Understanding the WGBI and the Inclusion Process
The WGBI, compiled by FTSE Russell, tracks fixed-rate, local-currency, investment-grade government bonds from over 20 markets. It is widely used by major fund managers and institutional investors. Inclusion requires meeting specific criteria regarding market size, credit quality, and accessibility, making it a recognized indicator of advanced sovereign debt markets.
According to FTSE Russell’s February index profile, Korea’s eligible bond pool includes 65 won-denominated government bonds, representing 1.89 percent of the index and positioning the country as the ninth-largest component. The WGBI is estimated to be followed by $2.5 trillion to $3 trillion in assets.
Korea’s inclusion will occur in eight monthly phases. The government anticipates at least 75 trillion won in new foreign inflows as a result.
Projected Inflows vs. Reality
While the projected 75 trillion won represents the potential, the actual inflow amount may vary.
Since the WGBI only includes local-currency bonds, Korea’s weighting can fluctuate with exchange rate movements. With the Korean won recently weakening to its lowest level since March 2009 due to escalating Middle East tensions, analysts advise caution about the certainty of the projected inflow.
“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 also noted that the estimated $2.5 trillion pool of WGBI-tracking assets may have decreased due to rising global yields and portfolio adjustments, further limiting potential inflows into Korea.
Historical data from other countries’ WGBI inclusions reveals varying results. Shinhan Securities analyst Kim Chan-hee found that Malaysia’s entry in 2007 and Israel’s inclusion in 2020 each drew approximately twice the expected amount under favorable market conditions. In contrast, New Zealand attracted only about one-third of projected inflows after joining in 2022, due to global rate hikes and the impact of the Russia-Ukraine war.
Considering these factors, analysts generally anticipate monthly inflows of around 7 trillion won to 9.5 trillion won during the phase-in period, contingent on market conditions and the amount of funds prepositioned before inclusion.
The most noticeable impact is expected on bond market supply and demand. With Korea planning to issue 225.7 trillion won in Treasury bonds this year, new foreign demand should absorb a portion of this supply and alleviate market pressure.
Government officials have emphasized this aspect of WGBI entry. Previous estimates suggested that $50 billion to $60 billion in inflows could reduce yields across maturities by 20 to 60 basis points by expanding the investor base and lowering funding costs.
However, given the current market environment, a rally is unlikely. Instead, the inclusion may partially offset upward pressure caused by inflation fears related to the ongoing conflict. Korean Treasury yields have already risen by over 50 basis points in the past month, reaching their highest level this year.
Kim suggests that while inflows from index-tracking funds alone are unlikely to dictate yield direction, they could help stabilize rates by approximately 20 to 30 basis points in the second and third quarters.
The currency impact is considered secondary. Officials and analysts believe consistent foreign demand for Korean government bonds will improve foreign exchange liquidity and offer some support to the won. However, with a significant portion of inflows routed through hedging channels rather than direct spot market investments, WGBI entry is unlikely to reverse a war-driven dollar surge on its own.
“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.”
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