Analysts sound warnings on South Korea’s risks

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Flagging growth: South Korea’s economic risks could soon be hard to ignore

South Korea’s risk score deteriorated in Q1 2019, according to Euromoney’s crowd-sourcing survey of economists and other experts, with further downgrades likely to occur in the Q2 survey due for release next month.

Analysts have long remained unconvinced over the country’s longer-term credentials, despite its comparatively low-risk status.

Unlike numerous other markets across the region – including India, Japan, Indonesia, the Philippines and Thailand – this has seen gradual, but consistent, downgrades to economic, political and structural factors during the past five years.

They include economic growth, corruption, household debt and demographics, among other salient issues, including political stability and monetary policy/currency stability from time to time.

Recent polling suggests president Moon Jae-in’s political honeymoon is over, barely two years into a five-year term, as dissatisfaction grows.

It is far from a catastrophic slide, but with legislative elections in April, it increases the risk of a lame-duck presidency if his party, the Democratic Party of Korea (DPK) – already in a minority in the unicameral legislature – loses seats.

Concerns surrounding the stalling of talks with North Korea are one issue for voters that Moon is attempting to put back on track since appointing a new unification minister and courting China and Japan to restart negotiations – although a share of the electorate is clearly put off by appeasement with the North backtracking on denuclearization.

Another is the economy, which is tanking, with exports stalling – notably to China – unemployment creeping higher and the Bank of Korea (BOK, the central bank) reluctant to loosen the monetary strings for fear of causing more capital flight, despite very low, below-target inflation.

An interest-rate cut may be difficult to resist in the coming months, but this may only encourage risk taking and asset overvaluation, which – given that the household debt-to-disposable income ratio continues to rise, and is now above 160% of GDP – is another consideration for investors.

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Gloomier readings

The IHS Markit purchasing managers’ index had shown some improvement recently, but it moved back into negative territory in May, presaging declining output.

Last month, the IMF stated South Korea had strong fundamentals, noting its fiscal and current-account strengths, but also warned of economic decline – noting the slide in exports growth and increasing household leverage, as well as other structural problems, including unfavourable demographics, rising income inequality and slowing productivity growth.

And the risks remain firmly to the downside for the time being.

Indeed, barely weeks after the IMF published its latest economic outlook suggesting 2.6% real GDP growth in 2019, the BOK produced first-quarter national accounts revealing a 1.7% year-on-year outturn, with GDP declining at a quarterly pace of 0.4% (seasonally adjusted), putting this forecast in some doubt.

Of course, worry over Korean assets may be vastly exaggerated.

Economic growth may pick up, and electronics firms, such as Samsung, could benefit from the trade war between China and the US, as well as the ban on Huawei, enabling it to gain market share outside China.

The country has a central government surplus, a $76 billion current-account surplus (4.7% of GDP) and possesses more than $420 billion of foreign-exchange reserves, providing coverage for some 230% of short-term maturing liabilities.

This explains why South Korea has neither seen worsening capital access, nor has it endured a larger fall in Euromoney’s risk survey.

Currently it lies 25th in the global risk rankings, one place higher than Japan, sliding two places in the survey since mid-2018, but midway in the second of five risk categories into which Euromoney divides all 186 countries.

This makes South Korea a relatively low risk option in line with its unchanged sovereign borrower credit ratings of AA-/Aa2/AA from Fitch, Moody’s and Standard & Poor’s.

Chief concerns

However, risk experts are nevertheless concerned by recent trends and longer-term policy challenges, regardless of these current fiscal strengths.

Several have mentioned GDP growth and employment as their chief concerns, both of which have been downgraded on a five-year comparative basis.

Added to that, currency stability has more recently become a niggling concern for analysts and for the BOK, too, which is intervening in the forex market to mitigate the won’s decline against the dollar.

Structural indicators, including demographics and labour relations, have also become more concerning for experts, along with the full range of political indicators, signalling confidence (or otherwise) in government stability, policymaking and other related factors.

Euromoney’s survey still shows South Korea to be a low-risk option, but if trade wars intensify, the economic and political risks will be hard to ignore.

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