RAM Ratings monitoring South Korea’s rising geopolitical risk

Published on 12 April 2013

Since the debut of debt issues by South Korean financial institutions in the Malaysian bond market, RAM Ratings has been publishing research reports on the Republic of Korea for the past 3 years. Our assessment of the nation’s underlying economic profile, external flexibility, regulatory quality, policy cohesiveness and sovereign finances forms the bedrock on which we base the ratings assigned to South Korean financial institutions.

The recent launch of RAM’s sovereign rating methodology and the announcement of sovereign ratings assigned to Indonesia, Thailand, Malaysia, Singapore and the Philippines signal the advent of more such ratings in the future. Although South Korea’s sovereign rating has yet to be published, we believe it is opportune to share our thoughts on the implications of the rising geopolitical tensions in the Korean Peninsula on the sovereign credit strength and also the ratings of its rated financial institutions.

In our research reports on the country, RAM has highlighted concerns regarding South Korea’s high level of household debt and the geopolitical risk stemming from its elusive and hostile northern neighbour. Both can have widespread implications on South Korea’s financial sector and economy.

Geopolitical risk has heightened in recent weeks, with the North’s preparations for a (possibly multiple) missile test in the next few days. This is widely speculated to coincide with the upcoming anniversary (15 April) of the birth of North Korean founder Kim Il-Sung. At the same, repeated provocations, warnings issued to foreigners to evacuate South Korea in case of hostilities and the closure of the joint industrial zone in Kaesong have spiked up alert levels. If history is anything to go by, however, such tensions should eventually fizzle. North Korea’s action of engaging foreign participation in events held in conjunction with the anniversary celebrations also goes against the threats meant to provoke discord.

All this begs the question of what will RAM’s rating action be on the sovereign? And how will that affect the South Korean institutions rated by RAM?

We have already factored geopolitical risk into our view of South Korea and its institutions’ debt issues. The outbreak of war (if at all) is treated as an event risk that can only be reflected in the rating after it occurs. Naturally, the rating direction can only go downwards. However, the timing and extent of the rating revision will depend on our assessment of the severity of the situation and how long the military conflict will last. Focus on South Korea’s monthly trade performance is paramount. Consumption indicators, spending patterns and various sentiment indicators will provide a gauge of the erosion of business confidence that can limit the growth potential of the South Korean economy. Governance - for the right or wrong reasons - may also prioritise defence and military issues ahead of economic considerations. How the war shapes the direction of economic policy could have far-reaching implications from a rating perspective.

From an economic viewpoint, South Korea is assessed favourably on account of its proven economic stability. The country boasts a very high level of human development, as classified by the United Nations. A highly educated and mature population is the cornerstone of its dynamic and prosperous economy, which charted a 2% real growth rate in 2012 relative to its 10-year average of 3.6%. Although external demand pressures have weighed on South Korea’s export-oriented economy, the country has remained resilient. Healthy and consistent current-account surpluses since 2000 and a vast foreign reserve of USD327.4 billion can amply deal with its external payments; South Korea has sufficient reserves to cover an average of 6.5 times of its current-account payments in the last 5 years. From the perspective of government finances, fiscal management is prudent while its balance sheet is manageable, with debts accounting for 33.5% of its GDP as at end-2012.

Although South Korea’s exports contracted 3% q-o-q in 1Q 2013, it is premature to attribute this solely to the rising tensions as both its business and consumer survey indices for March 2013 have remained steady. The economic sentiment index for March is also better than that of the previous month. Since the escalation of hostilities, RAM has been in constant dialogue with our rated entities in South Korea. We have been given to understand that life is as normal, on the premise that South Koreans have been living with such threats for several decades.

Under the circumstances, the ratings assigned to South Korean entities’ debt issues remain intact, as follows:

Rated Entity	Debt Issue	Rating/Outlook
Korea Development Bank	RM3.5 billion conventional and/or Islamic MTN programme	AAA/Stable/-/-
Industrial Bank of Korea	RM3 billion conventional and/or Islamic MTN programme	AAA/Stable/-/-
NongHyup Bank	RM3.3 billion MTN programme	AAA/Stable/-/-
Hyundai Capital Services, Inc	RM2 billion MTN programme	AAA/Stable/-/-

Media contact
Esther Lai
(603) 7628 1037
esther@ram.com.my