Korea Capital Market Institute

This paper introduces the perspective of foreign investors and intermediaries regarding the market accessibility of Korea’s capital markets. Korea’s capital markets, by quantitative measures, belongs alongside developed markets. However, in major market indices, mainly the MSCI stock market index and FTSE Russell bond market index, Korea is classified as an emerging market. The discrepancy between the quantitative and qualitative aspects of Korea’s capital markets comes from the market accessibility assessment, used by MSCI and FTSE Russell. In both the MSCI and FTSE Russell market accessibility assessments, foreign financial institutions play an important role in providing feedback that is used as input for market classification. To better understand why Korea’s market accessibility is regarded as being below developed country standards, interviews were conducted with major financial firms that invest and intermediate investment in Korea. The group includes global asset managers, banks, custodians, boutique investment banks, hedge funds, market makers, system traders along with ASIFMA and GFMA. The results of the interview reveals that various issues related to market accessibility are interconnected. In particular, areas of market accessibility that Korea falls behind in are not just rules and regulation, but process and practice. Interview participants emphasize that in order to improve Korea’s market accessibility, rules and regulations need to be applied more transparently and consistently. In addition, the most effective measure suggested to enhance Korea’s market accessibility is to improve communication between Korea’s financial regulators and industry with the foreign investor community.

As the sales of complex and high-risk financial products, such as Hong Kong H-index ELS and interest rate-linked DLF, have increased, the amount of damage to financial consumers due to mis-selling has also risen. Despite substantial financial losses suffered by consumers due to mis-selling by financial companies, recovering damages often involves lengthy processes and high legal fees. In response, major countries like the U.S., U.K., and Japan have introduced various alternative dispute resolution systems to reduce the legal costs and time associated with civil litigation and to support quick compensation. In the U.S., organizations such as the CFPB, FINRA, and AAA provide various forms of financial dispute resolution, including settlement, mediation, conciliation, and arbitration. In the United Kingdom, the Financial Ombudsman Service (FOS), an independent non-profit organization, is responsible for resolving financial disputes. The FOS’s conciliation decisions are unilaterally binding, meaning that once a financial consumer accepts a decision, the financial firm must comply. Additionally, the UK’s Financial Services Compensation Scheme (FSCS) has established a system allowing financial consumers to receive compensation from a pre-established fund if they are unable to recover their investments due to mis-selling or poor advice on funds, structured products, etc. In Japan, each financial industry operates a designated dispute resolution organization. For the financial investment industry, FINMAC handles financial complaints and disputes. FINMAC is independent of the Financial Services Agency and mediates disputes between financial consumers and financial companies related to investment products, crypto assets, STOs, and more. FINMAC’s conciliation decisions are conditionally binding, meaning that if a financial consumer accepts a decision, the financial company must comply. In Korea, financial dispute resolution is managed by the Financial Supervisory Service Dispute Resolution Committee, the Korea Exchange Market Monitoring Committee, the Financial Investment Association Dispute Resolution Committee, and the Consumer Dispute Committee of the Korea Consumer Affairs and Consumer Services Commission. Among these, the Financial Supervisory Service Dispute Resolution Committee plays a significant role in cases involving the incomplete sale of financial investment products. Historically, general financial consumers in Korea have experienced lower compensation rates compared to other major countries, longer compensation times, and lower acceptance of settlement decisions by financial companies. Korea’s financial dispute resolution system is somewhat limited in diversity, operating primarily through dispute mediation. There are many opinions that it needs to be more independent and specialized. Specifically, the Financial Supervisory Service’s Dispute Mediation Committee is inadequately staffed, leading to ineffective dispute resolution. Additionally, the mediation decisions of the FSS are not unilaterally binding, and financial companies often do not accept these decisions. Furthermore, there is no collective dispute settlement system for cases of mis-selling, which limits the ability of many victims to receive appropriate relief. Therefore, it is necessary to improve the Korean financial dispute resolution system to provide quick compensation to financial consumers and reduce legal costs. First, the independence and expertise of the Financial Supervisory Service’s Dispute Mediation Committee should be enhanced, and its staffing and budget should be expanded to strengthen its practical functions. Second, to improve the effectiveness of the financial dispute resolution system, introducing a Japanese-style limited one-sided binding mechanism should be considered. For one-sided binding to be effective, it is essential to enhance the independence and professionalism of dispute resolution organizations and ensure access to justice. Third, the introduction of a consumer protection relief fund system should be considered in the medium to long term to provide direct relief to ordinary financial consumers in financial disputes. Fourth, the introduction of a collective dispute mediation system should be considered to strengthen the relief available to general financial consumers, including the elderly and financially vulnerable.

The swift advancement of aging populations combined with declining birth rates is increasingly highlighting the critical role of pensions. Growing skepticism about the long-term viability of public pension systems is fueling a shift toward reinforcing private pension schemes. This shift is notably evident in key nations including South Korea. A pivotal factor in bolstering private pensions is the structure of the pension tax system. Indeed, tax incentives are the primary motivators for private pension plans. The configuration of this tax system profoundly affects how individuals allocate their pension assets and can also influence the evolution of capital markets. In South Korea, the pension framework is broadly categorized into public and private systems. The public pension system encompasses national pensions and occupational pensions, while private pensions comprise employer-based retirement plans such as Defined Benefit (DB) and Defined Contribution (DC) schemes, along with individual retirement plans like IRP and pension savings. The taxation approach for pensions predominantly adheres to the EET method. This method entails exemption (non-taxation) at the contribution phase, exemption on earnings at the management phase, and taxation at the pension income distribution phase. Challenges within the domestic private pension tax system include a lack of diversity in tax-advantaged pension plans, insufficient tax incentives to encourage the pensionization of retirement benefits, and relatively low limits on income deductions (or tax credits) compared to overseas, with inflexible limit adjustments. This study undertook a comparative examination of pension tax systems in key international jurisdictions to investigate the evolving trends in these systems. Through the analysis of pension tax systems in the United States, Japan, Australia, and Germany, it was confirmed that various tax incentives are being provided for the development of the private pension market. A critical observation from studying these international pension tax systems is the recognition that the essence of an effective pension tax system hinges on the strategic design of tax benefits for pensions. In the case of private pensions, while there are some retirement plans where enrollment is compulsory like retirement pensions, many retirement plans operate based on the voluntary will of the subscribers. The most powerful incentives to induce voluntary subscription of the participants are tax benefits. This study of international pension systems suggests several key legislative measures to develop the domestic pension tax system. Firstly, bolstering private pensions requires increasing the limits on tax benefits. Legislative reforms should allow for periodic adjustments to these limits, using economic indicators like the growth rate, inflation, and average wage increases. Secondly, to discourage the trend of opting for lump-sum withdrawals of retirement contributions, there's a need to consider higher tax rates on such lump-sum withdrawals. This approach would promote the receipt of retirement income in the form of pensions. Thirdly, the mechanism for offering tax benefits on pension contributions should shift from a tax credit method to an income deduction method. Fourthly, a variety of methods for providing tax benefits ought to be allowed. Specifically, introducing a TEE pension system could offer a new framework, where contributions are taxed, but earnings and withdrawals are exempt. Lastly, it is recommended to consider implementing a refundable tax credit system or a matching subsidy scheme for pension contributions made by socially vulnerable groups, ensuring a more inclusive and equitable pension system.

This study analyses the impact of economic structural variables, with a focus on globalisation and demographics, on the low inflation rate in Korea and the United States, and assesses whether changes in the inflation rate may occur in the future. This article examines the low inflationary conditions that have persisted since the 1980s from two perspectives: the flattening of the Phillips curve and the downward stabilisation of trend inflation. The flattening of the Phillips curve refers to the dampening of the sensitivity of inflation to the domestic economy, while the downward stabilization of trend inflation refers to the lowering of the underlying inflation rate, i.e. the long-term trend of inflation. From the 1980s to before the coronavirus pandemic, U.S.-Korean inflation was characterized by a downward stabilisation of trend inflation, while the flattening of the Phillips curve weakened the pro-cyclical nature of inflation, resulting in a stable low inflation rate. This study empirically examines whether this low inflationary trend can be attributed to structural changes in the economy, such as globalisation and demographic change, along with the stability of long-term inflation expectations due to successful inflation management by central banks. Before presenting the results of the analysis, we summarise the trends of globalisation and demographic changes in Korea and the United States from 1980 to 2020, the period of analysis. First, the world economy, including the Korean economy, entered the hyper-globalisation era in the 1990s, with significant progress of globalization. The U.S.-Korea globalisation entered the slowbalization phase around 2008 (U.S.) and 2013 (Korea), respectively. Next, this paper examines the demographic structure, focusing on the proportion of the working-age population (15~64 years old) and the elderly population (65+ years old) to the total population. The working-age population ratio in both countries has generally been on the rise since 1980, but it began to decline in the United States in 2008-2009 and in Korea in 2012-2013. In particular, the decline in the working-age population in Korea has been sharper than in the United States. As a result, the proportion of elderly people is increasing in both countries, but the proportion of elderly people in Korea is rising steeper than the United States. The impact of these globalisation and demographic changes on the low inflation rate in Korea and the United States is as follows. First, our analysis shows that globalisation has played an important role in the flattening of the US-Korea Phillips curve. This result is observed for both headline and core inflation. In the case of the United States, where we were able to examine the role of long-term inflation expectations, the stabilization of inflation expectations also contributed to the decline in the cyclical sensitivity of inflation. In our empirical analysis, globalisation is also found to have played a key role in the downward stabilisation of US and Korean trend inflation. After a large decline during the hyperglobalisation period, trend inflation in the two countries remained stable until the pandemic, suggesting that the decline in trend inflation during the hyperglobalisation period was largely driven by globalisation. This can be understood as a result of cost-efficiency improvements and increased competition among firms due to globalisation, as discussed in the existing literature. The impact of globalisation on trend inflation has been significantly lower in the US and Korea since around 2008 (US) and 2013 (Korea), respectively, reflecting the fact that globalisation in each country entered a plateau around the same time. In the United States, the stabilization of central bank-managed inflation expectations also contributed to the decline in trend inflation, with the impact mainly concentrated in the early to mid-1980s. Second, differences were observed in the impact of demographic change on trend inflation between the two countries. First, in both countries, trend inflation rose as the share of the working-age population declined. This can be understood as a decrease in labour supply in the economy leading to higher inflation. On the other hand, for the elderly population share, trend inflation increased as the share increased in the US, but decreased in Korea. In the US, the elderly population can be attributed to their role as net consumers, consuming more than they produce. The elderly in Korea have been steadily increasing their participation in productive activities, and their spending power is much lower, so they have not been able to act as an inflationary force, unlike in the US. The impact of demographics on trend inflation changed significantly when the baby boomers began to retire in each country (around 2008 in the US and 2013 in Korea). In both countries, the impact of demographic change on trend inflation was statistically significant, but economically limited compared to globalisation. In both countries, the impact of globalisation on trend inflation has largely outweighed the demographic effect. However, in both countries, the impact of demographics on trend inflation has increased significantly as the baby boomers have begun to enter the elderly population. In the U.S., the share of the elderly population has been rising since before 2008, which has contributed to higher inflation, while the share of the working-age population has been declining since 2008, which has added upward pressure on inflation. As a result, after 2008, the impact of demographics on trend inflation exceeded the effect of globalisation and became a significant inflationary factor. In Korea, the proportion of the elderly population has steadily increased since 1980, which has acted as a downward pressure on inflation. In addition, the share of the working-age population ended its upward trend around 2013 and entered a downward trend, turning it from a depressant to an inflationary factor. Until 2020, the period of empirical analysis in this study, the downward pressure on inflation due to the increase in the share of the elderly population was higher than the upward pressure on inflation due to the decrease in the share of the working-age population. However, using Statistics Korea's future population projections, it is estimated that from 2025 onwards, the upward pressure on trend inflation from the declining share of the working-age population will outweigh the downward pressure on trend inflation from the increasing share of the elderly population. This suggests that Korea's demographics are likely to be a structural driver of inflation in the future. Along with a possible retreat from globalisation in the future, both Korea and the US are expected to experience a demographic transition in which the share of the working-age population declines and the share of the elderly increases for a considerable period of time. Applying the results of this study's empirical analysis to these economic structural changes, it is assessed that the low inflation rate that has remained stable in both Korea and the U.S. is likely to end and inflation volatility is likely to increase structurally. The steepening of the Phillips curve as a result of globalisation is likely to restore the cyclical sensitivity of inflation, which could lead to a structural increase in inflation volatility. We also expect trend inflation to rise as globalisation recedes.

The recent surge in the US benchmark interest rate and an economic slowdown in China have instigated a sense of crisis in Korea’s capital market, which is heavily dependent on external factors. In addition, firms have experienced a sharp decline in operating performance due to sluggish exports in the first half of the year, intensifying market uncertainties related to worsening profitability and concerns about a debt default. Given a possible structural change in the interest rate trend, it seems challenging to swiftly dispel market uncertainties.       Despite these concerns, the risk of a corporate debt default spreading to the financial system level remains low. This article assesses liquidity and default risks based on the assumption of operating cash flow downturns and collateral value devaluation. The results indicate a moderate increase in default risk among listed companies within a relatively stable range. Overall, there is no major concern regarding the financial soundness in the corporate sector. However, it seems necessary to identify and urgently respond to micro-level issues, particularly in vulnerable sectors such as utilities and construction. Conversely, the persistence of slowed growth necessitates a more profound discussion. Korean companies have prioritized debt soundness after experiencing major crises like the 1997 Asian financial crisis and the 2008 global financial crisis. Although the cost of debt has been on the decline over the past decade, corporate financial structure policies have neither gone beyond securing soundness through debt reduction nor effectively utilized the low cost of debt to realize the opportunity for growth. It is commendable that Korea’s corporate sector has the capability to navigate the impending crisis systematically, especially through soaring interest rates and expanding credit risk in the private sector. However, it is also worth considering effective debt management strategies from a forward-looking perspective. Companies that maintained financial soundness and entered a growth phase have proactively reduced debt during the low interest rate phase. To harness debt effectively, they should comprehensively examine diverse internal and external factors for enhancing growth potential.