Foreign investment in Korean bonds dropped to its lowest level in five months last month mainly because of a historic disparity in policy interest rates between the U.S. and South Korea, which led to reduced demand for arbitrage trading.

On Thursday, the Bank of Korea announced that foreign investment in Korean bonds saw a net inflow of $600 million last month, down by $3.23 billion in the previous month, reaching the lowest point in five months.

There has been a substantial net inflow of foreign investment in Korean bonds this year despite the reversal in the interest rate gap between the U.S. and Korea. In May alone, there was a record net inflow of $8.96 billion, reaching the highest level in two years and three months. However, last month, when the Federal Reserve raised its policy interest rate to 5.25-5.50 percent, the interest rate gap between the U.S. and Korea widened to a historic high of 2 percentage points. This unprecedented interest rate gap is believed to have weakened the allure of bond investments in Korea.

Investment funds, including bonds and stocks, saw a net inflow of $1 billion in July, which was a third of that seen in June ($2.92 billion). Stock investment also rebounded, with a net inflow of $440 million, reversing a net outflow of $310 million in the previous month. This rebound is largely attributed to foreign investors flocking to the semiconductor and electric vehicle battery industries due to their improved outlook.

The slowdown in foreign investment has also contributed to a depreciation of the Korean won. On Thursday, the exchange rate was 1,316 won per dollar, down by 0.3 won from the previous day. This is lower than the average rate of 1,274.6 won from the previous month. The strengthening of the greenback and concerns about China’s economic weakness are interpreted as factors behind the slowdown in foreign investment inflows in Korea.

By Ryu Young-wook and Minu Kim

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