Analyst warns against overestimating short selling’s influence, pointing to foreign investors' broader risk assessments
Amid foreign investors' months-long selling streak of Korean stocks, market watchers are closely monitoring whether the resumption of short selling could drive capital inflows or further dampen investor sentiment.
Since September, foreign investors have been net sellers in the Kospi for seven consecutive months, offloading a total of 27.7 trillion won ($19.1 billion). This marks the third-longest foreign net selling streak in history and the longest since the 2007 financial crisis.
Foreign capital flows play a pivotal role in shaping the direction of Korea’s liquidity-constrained stock market, with foreign ownership accounting for over 30 percent of Kospi's outstanding shares.
Yet, the foreign selling trend that began in the second half of last year has persisted. Domestically, weakened productivity and the continued political turmoil have tempered expectations for valuation improvements, while externally, escalating trade tensions from US-led tariff risks and a strengthening dollar have compounded the pressure.
A key factor in revitalizing the Korean stock market is the impending end of the country’s longest short selling ban. The ban, in place since November 2023, is set to be lifted on March 31.
Short selling is a trading strategy where investors bet on a stock price's decline.
Though the ban has not triggered a massive capital outflow, it has been highlighted as a major barrier to market accessibility. In June 2023, Morgan Stanley Capital International cited the ban as a reason for withholding Korea's upgrade to developed market status.
"The short selling ban has been a factor behind declining price efficiency and lower trading turnover, contributing to foreign capital outflows. With its resumption, a positive impact on foreign investment flows is expected," said Yoo Myoung-gan, an investment strategist at Mirae Asset Securities.
Lee Sang-yeon of Shinyoung Securities echoed this sentiment, stating, “When short selling was reinstated in the past, market returns improved, foreign ownership increased and cumulative net purchases by foreign investors expanded. Likewise, we can expect the resumption of short selling to help attract investment inflows and revitalize the stock market.”
South Korea has implemented short selling bans three times previously: from October 2008 to May 2009, from August to November 2011, and from March 2020 to April 2021.
When the bans were lifted in 2009 and 2011, market returns generally improved, while foreign ownership and net purchases increased. However, these trends were absent following the resumption of short selling in 2021—an outcome that analysts largely view as an outlier, shaped by exceptional conditions such as high retail investor participation and massive global liquidity driven by the COVID-19 pandemic.
The return of global hedge funds utilizing long-short strategies — taking both long and short positions in the same stock to profit from price fluctuations — is also anticipated. With short selling banned, these funds are believed to have reduced or exited their positions in the Korean market.
However, some experts remain skeptical that the resumption of short selling will directly trigger an immediate and substantial inflow of foreign capital.
Shinhan Securities analyst Noh Dong-gil noted that inflows from overseas investors are influenced by multiple factors, making it overly simplistic to attribute the increase solely to short selling. “Foreign capital flows in the Korean stock market are part of broader global fund movements, shaped by factors such as manufacturing sector performance, exchange rates and liquidity conditions,” Noh said, adding that inflows from overseas are currently also affected by "risk premiums stemming from (US President) Trump's tariff threats."
Noh's comments suggest that the additional risks from US tariffs are making foreign investors even more cautious about investing in Korea than before, increasing the likelihood that they may either refrain from increasing or reduce their investments, regardless of whether short selling is possible again.
The weak correlation between short selling restrictions and foreign investment, particularly during periods of heightened volatility in global and domestic markets, became evident during the ban. Foreign investment in the Kospi remained largely unaffected. Foreign ownership is currently at 31.6 percent, near the 32.7 percent level when the ban was implemented in November 2023, after peaking at 36.1 percent in July 2024. The market capitalization of foreign ownership rose from 618 trillion won in November 2023 to 850 trillion won in July 2024 before dropping to about 660 trillion won last week.
Most analysts remain optimistic about the long-term impact of short selling’s return. For one, it could improve Korea's chances of being included in MSCI’s developed market index, potentially boosting foreign capital inflows.
Analysts also anticipate enhanced price efficiency, a key benefit of legally conducted short selling.
“In the long term, short selling can improve price efficiency, thereby reducing volatility and extreme profit fluctuations, as well as boosting turnover,” Noh said. NH Investment & Securities analyst Na Jeong-hwan added, “Improved price formation efficiency makes undervalued stocks more attractive and could increase overall trading volume in the Korean market.”
On March 31, short selling will resume in Korea, supported by a new centrally controlled detection system and regulatory enhancements. The previous limit on short selling to 350 stocks will also be lifted, allowing short selling on all 2,700 stocks, marking the return of short selling across the entire market since March 2020.
By Choi Ji-won (jwc@heraldcorp.com)
