3 economic woes haunting South Korea

Will financial worries escalate amidst tensions in North Korea?

According to UBS, Korea faces three issues. First, house prices are falling and household delinquencies are rising in the context of excess leverage, second, the yen is weakening and the Bank of Japan’s policy means the end is not in sight, and third, North Korea tensions are elevated. 

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Let’s start with the latter. Our default position on North Korean provocations is that the worst case will be avoided. The risk of war seems extremely low. Yes, there may be missile tests, acts of aggression, or other provocations at some point but if history is any guide they will be tailored to fall short of provoking war.

The aim, in our opinion, is to strengthen domestic support by creating an external crisis and then claiming to have stood up to North Korea’s enemies and overcome them.

Maybe this time will be different, but we don’t have any information or insight to make that case. Historically, North Korean tensions rarely cause more than a blip in domestic financial markets.

Then why is the stock market down, Korean treasuries up, and the Korean won getting weaker? It’s the economic fundamentals, in our opinion. The cyclical recovery in exports and the economy have been disappointing.

Furthermore, the yen has weakened sharply against the USD and the KRW over the last six months and this threatens to reduce profit margins for Korean exporters given the Bank of Japan’s commitment to double base money as a share of GDP over the next two years.

Finally, falling house prices and rising household delinquencies threaten a large NPL problem given high household debt. We believe North Korean tensions will ease; however, the economy will need lower rates (our long-held view since last year) and fiscal stimulus.

We think the Bank of Korea will cut rates 25bps this week on the 11th and a fiscal stimulus is in the works. Policy support probably can sustain economic growth in the 2.5-3.0%. As for the yen there is not a great deal that can be done.