Net Increase in Government Bonds to Drop by 13 Trillion Won Next Year... "Bond Market Faces Upside Risks to Interest Rates"

Total Issuance to Remain Similar at 222.8 Trillion Won
Refinancing Issuance to Surge to 110.7 Trillion Won
Focus on December Decision for Reducing Share of Ultra-Long-Term Bonds

Although the net increase in government bonds next year will be about 13 trillion won less than this year, some analysts believe that the bond market will still be dominated by unfavorable factors when considering the total issuance volume and the record-high level of fiscal spending. They stress that unless the share of ultra-long-term bonds is drastically reduced in the annual government bond issuance plan—set to be announced in December—there remain significant upside risks to interest rates.

According to the iM Securities report, "2027 Budget Proposal: Relief of 96 Trillion Won, Reality of 223 Trillion Won," released on September 2, next year’s total government bond issuance is set at 222.8 trillion won, with a net increase of 96.3 trillion won. This is a reduction of 2.9 trillion won (1.3%) and 13.1 trillion won (12.0%), respectively, compared to this year. The amount for deficit-financing bonds will be 100.1 trillion won, which is about 10 trillion won less than the approximately 110 trillion won in the 2026 budget proposal.

Kim Myung-shil, an analyst at iM Securities and the report’s author, said, "Although total expenditure is set to increase by 93 trillion won, the main reason for the decrease in net government bond issuance is a 194.2 trillion won increase in national tax revenue." He added, "Additionally, 12.5 trillion won of extra tax revenue will be allocated from the Future Response Fund to reduce new government bond issuance. In other words, because the increase in revenue far exceeds the increase in spending, the government was able to formulate an expansionary budget while still reducing the supply of new government bonds."

Annual Total Issuance and Net Increase Trends of Government Bonds. iM Securities

However, iM Securities points out that a decrease in net issuance does not directly translate into improved supply and demand conditions for the bond market. Kim said, "A net increase of 96.3 trillion won is not a small figure in absolute terms," noting, "While the supply burden will be eased compared to the previous year, it remains historically high."

Next year’s total government bond issuance will amount to 222.8 trillion won, a mere 2.9 trillion won decrease from this year’s 225.7 trillion won. In contrast, the portion issued for maturities and for market-making will rise by 10.3 trillion won to 126.6 trillion won. Within this, bonds issued to refinance maturing debt will sharply increase by 20.2 trillion won to 110.7 trillion won.

Accordingly, the average monthly total government bond issuance will remain nearly unchanged, at about 18.6 trillion won next year, compared to approximately 18.8 trillion won this year. Although the increase in the government bond balance will slow, the total amount that markets must absorb via auctions will hardly change. Kim explained, "Since funds for maturing bonds are paid to existing holders, a significant portion may flow back into the government bond market, so it may not exert the same supply-demand shock as net issuance alone. However, there is no guarantee that foreign investors, insurers, and banks will reinvest redemption funds into government bonds of the same maturity." He also pointed out, "Depending on the reinvestment rate and the reinvestment maturities, specific segments could face even greater auction pressure."

From a fiscal perspective, negative factors persist for the bond market. Next year, the government plans to spend 820.9 trillion won in total, an increase of 93 trillion won, or 12.8%, over this year’s main budget—marking the highest growth rate on record. The report notes that if this fiscal expansion stimulates domestic demand and investment, it could boost economic growth and inflation, leading the Bank of Korea to remain cautious about further rate hikes at least through the first half of next year.

In particular, the annual government bond issuance plan set for December is expected to be a key inflection point for the bond market. While the total and net issuance volumes have been finalized in the current budget proposal, the allocation by maturity has yet to be decided. Kim explained, "Although total issuance will be cut by only 2.9 trillion won, if the share of 20-, 30-, and 50-year bonds is reduced, the supply of ultra-long-term bonds could decrease by more than 10 trillion to 20 trillion won."

2027 Long-Term Bond Issuance Ratio Scenario. iM Securities

iM Securities presented four scenarios regarding the share of long-term bond issuance: maintaining the current level, a slight reduction, the base scenario, and a sharp reduction. If the long-term bond share is maintained at 35% as in this year, next year’s long-term bond issuance will be about 78 trillion won, which is virtually unchanged. In contrast, under the base scenario, reducing the long-term share to 30% would lower issuance to 66.8 trillion won—a decrease of about 11 trillion won. An aggressive reduction to 25% would cut issuance to 55.7 trillion won, a decrease of more than 22 trillion won. Kim estimated, "Depending on the maturity distribution, the supply of ultra-long-term bonds could decrease by anywhere from four to eight times that amount."

He cited weakened insurance company demand for ultra-long-term bonds compared to previous years, and the need to finance 110.7 trillion won of maturing bonds next year, as reasons for proposing the 30% long-term share as the base scenario. He noted that the government may reallocate supply to the more solid 5- and 10-year bonds and the 2- and 3-year bonds.

By maturity, the 2- and 3-year bonds are expected to be the most sensitive to expansionary fiscal policy and additional rate hikes by the Bank of Korea. For the 5- and 10-year bonds, a key issue is how well foreign demand, particularly from those tracking the World Government Bond Index (WGBI), will fill the gap. For the 30-year bonds, the future will depend on whether the share of long-term issuance is reduced in December.

In addition, if the share of long-term bonds falls below 30%, the 30-year bonds could perform more strongly relative to the 10-year bonds, narrowing the yield gap between 10- and 30-year maturities. Kim suggested a relative value buying strategy for 30-year bonds compared to 10-year bonds if the long-term share drops to 30%, and a pre-announcement buying strategy if it is cut sharply to 25%. Conversely, he advised refraining from chasing 30-year bonds if the long-term share remains at 35%.

Kim said, "There is an uncomfortable mix: fundamentals are weak, net issuance is a positive factor, but total auction supply is neutral. Until there is confirmation of a drastic reduction in the share of ultra-long-term bonds, it is more prudent to emphasize upside risks to interest rates rather than expecting a market rally." He also cautioned, "If the long-term bond share falls to 30% or less, it could be a major positive for the bond market in 2027; on the other hand, if it does not, uncertainty surrounding expansionary fiscal policy and supply could become entrenched as term premiums in longer-dated bonds."

This content was produced with the assistance of AI translation services.