After 2015’s 8% MSCI Index drop, South Korea’s geopolitical pall again descended with the North’s claim of a hydrogen bomb launch as Seoul and the international community prepared new diplomatic ruptures and trade sanctions. The poor stock market start, on $825 million in foreign investor outflows the first week of January, had also been previewed by December’s 10% export slump, particularly in mobile phones and semiconductors to China and the EU.
Business sentiment surveys worsened with the manufacturing PMI at the flat 50 reading. Economic growth was 2.5% last year and the official 2016 forecast was shaved to 3% with consumer demand throttled by almost $1 trillion in household debt, prompting central bank warning about potential financial alongside border instability.
The mood was briefly brighter toward end-2015 as Moody’s raised the sovereign credit rating on “fiscal prudence,” but almost 70 corporate debt issuers had been downgraded by that time, more than during the late 1990s crisis.
Korean flagship industries like shipping are in trouble from global slowdown and producer price deflation, and servicing may become more costly if the central bank follows the US Federal Reserve in raising the benchmark 1.5% interest rate. It may tighten monetary policy to help defend the exchange rate, which has dipped below 1200/dollar despite regular intervention from over $700 billion in international reserves.
Depreciation set in after China unveiled its new peg against a basket of currencies in December, following Seoul’s issuance of an inaugural almost $500 million Yuan-denominated “panda bond” to diversify funding sources. With the weak trend, the national pension plan has kept its policy of 100% dollar hedging in parts of its overseas portfolio.
A positive equity market development last year was a 20% rise in chaebol conglomerate dividend payouts following tax incentives in new legislation. Samsung Electronics and Hyundai Motor broke with previous aversion, and steelmaker Posco will soon be the first Korean company to offer quarterly dividends.
However, the portion of eligible firms participating and yields lag far behind Asian neighbors, with the latter at the very bottom of a dozen countries recently surveyed by fund manager Matthews International. Foreign activist investors such as Elliott Associates in the US, which unsuccessfully opposed a Samsung intragroup merger, have pressed return and restructuring demands to unlock value. They helped fuel record corporate acquisitions in 2015, as third generation chaebol family owners began to divest non-core assets.
The new Finance Minister, Yoo Il-ho and the central bank have cautioned on worsening household balance sheets as the debt load equals 80% of GDP. Mortgage loans have grown at an annual double digit pace aided by a special government refinancing program which was a signature campaign promise of President Park Guen-hye, whose party should easily retain its majority in April parliamentary elections. She had originally hoped to secure two-thirds control to ensure passage of business and labor reforms, but opposition lawmakers have thwarted the agenda by attacking the administration’s economic and financial strategy.
Housing prices have risen for over two years straight but regulators will more strictly enforce loan-to-value limits and monitor borrowing in Seoul and other booming urban areas beginning in February, as the OECD reported Korea’s 165% in debt/disposable income figure was 30 points above the group average.
Real estate correction looms as a paramount stock market threat alongside Pyongyang’s H-bomb scare, which came after leader Kim Jong-un gave speeches hinting at his own economic and financial distress with calls to “improve living standards and banking system functioning.” He alluded to the need to diversify foreign investment from overreliance on ally China, as scholars point to the latest test incident as another example of the “byungjin line” combining nuclear deterrence and greater market orientation.
They note the proliferation of special export zones and informal trading centers and family permission to retain a greater share of farm output, as both sides look for firmer commercial footing despite another ratcheting up of the North-South launch and sanctions cycle.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.