The South Korean Economy is seeing a red light. The nation has growing economic uncertainties, with belligerent war threats from North Korea coming on top of the lingering economic slowdown.
South Korea’s credit default swap (CDS) premium, which represents the nation’s credit risk in the global bond market, soared to 87.9 basis points (1bp=0.01% point) at market close on April 5 (local time) in New York. This is a 24.26 bp (or 38.1%) increase in from the month before and follows the U.N. Security Council adopting an additional resolution on March 7 that included strong criticism of North Korea’s recent nuclear test and expansion of sanctions against the North.
Two other Northeast Asian economies, China and Japan, have also seen their risk of state bankruptcy rise.
During the same period, the CDS premium of Chinese sovereign bonds increased 12.34 bp (or 19.8%) from 62.19 bp to 74.53 bp, while those of Japan increased 12.07 bp from 63.00 bp to 75.07 bp.
Market experts point to geopolitical tensions created by Pyongyang. Lee Jong-woo, in charge of the research center at I’M Investment & Securities said, “The CDS premiums of the three Northeast Asian Economies moved up in tandem. This is because of geopolitical risks involving North Korea.”
In particular, the CDS premium on South Korea’s 5-year sovereign bonds was 79 bp at the end of March, a 13 bp rise from a month ago.
“The CDS premium increased sharply due to inter-Korean and international factors, such as North Korea’s threatening statements, the US federal budget sequester (automatic budget cuts), the general election in Italy, and the Cyprus financial crisis,” a source from South Korea’s Financial Supervisory Service (FSS) said on April 7.
Indeed, South Korea’s CDS premium has jumped as inter-Korean tensions rise following Pyongyang’s heightened threats.
All of this implies the South Korean economy remains uncertain. The South Korean government estimates that the national economy will grow 2.3% this year, down from its original prediction of 3.0%. While it is aiming to call for a supplementary budget of 12 trillion won, general expectations regarding economic recovery are falling due to “North Korean risks.”
If the CDS premium continues to move up, there is a likelihood of foreign capital leaving Korea.
Foreigners sold off more than 4 trillion won worth of shares through South Korea’s major stock market from March 14 through last Friday. Experts say increased CDS premiums can cause even bigger damage to South Korea than to China and Japan.
Japan is trying to boost its economy through quantitative easing, while China showed a 7.8% economic growth last year and still remains strong. However, South Korea has not shown any signs of economic recovery as of yet.
With inter-Korean tensions rising and foreigners’ massive selling of local stocks, the atmosphere in the foreign exchange market is not good. Last Friday, the won-dollar exchange rate reached the year’s highest point, breaking through the 1,130 won line. The exchange rate closed at 1131.8 won per dollar on Friday in Seoul, an 8.0 won rise from the previous day. This is the highest record after September 6, when the won traded at 1133.8 won per dollar. North Korean risks were highlighted as a reason, while the Bank of Japan’s quantitative easing policy has also been reflected in the market, analysts say.
The problem is that the value of the Japanese yen moves downhill at a fast pace, which may lead to a negative situation in South Korea, a major exporter to Japan. The yen traded at over 97 yen per dollar at one point last Friday in Tokyo. It’s been three years and eight months since the exchange rate broke through the 97 yen line.
The dominant opinion is that the weak yen phenomenon will continue for a while due to the Bank of Japan’s quantitative easing policy. This means South Korean exporters’ goods will be more expensive than similar goods produced by Japanese competitors.