By Kim Da-ye
After Standard & Poor’s (S&P) downgraded the U.S. credit rating on Aug. 5, the Korean stock market skidded fast, losing 150.44 points or nearly 8 percent in a week.
Some of the foreign capital, however, flew into the country’s bond market, helping the value of safer securities and the Korean won stay afloat.
Economists and policymakers alike said that foreigners, especially Europeans, withdrew from stocks to finance themselves out of their own problems in Europe, and investment into bonds tells of foreign investors’ confidence in the Korean economy.
While a downgrade of Korea’s credit rating, which hasn’t returned to the pre-Asian financial crisis level, may be considered a remote possibility, a closer look into major credit rating agencies’ criteria for determining sovereign risks shows Korea may face hurdles amid rumors that France might face a downgrade.
Korea is rated A by S&P, the same as the Czech Republic and Israel but below Japan’s AA- and Hong Kong’s AAA, while Moody’s Investors Services upgraded the rating to A1 April last year. Fitch Rating has kept it at A+ since 2005.
Following the U.S. credit rating cut, S&P said in a statement that countries in the Asia-Pacific region wouldn’t be immediately affected, but that another global recession would leave them vulnerable.
“We have a stable outlook on the Korean rating. At least, in the near future, we don’t expect any changes,” Kim Eng Tan, the director of sovereign ratings at S&P.
“But the major concern is the weak economic situation that contributed to the rating downgrades in the U.S. and parts of Europe… If the market loses confidence, we could see a global recession again. In this case, ratings in Asia may come under more pressure.”
Credit rating agencies look at not only the sovereign government’s ability to pay back debt but also its willingness to do so, which has much to do with effectiveness, stability and predictability of its policymaking and political institutions.
Standard & Poor’s weighed political factors heavily in cutting the U.S. credit rating from AAA to AA+. As the Obama administration and Congress had fought a prolonged tug of war to raise the debt ceiling to avoid a default, S&P said that the resulting fiscal consolidation plan “falls short of what would be necessary to stabilize the government’s medium-term debt dynamics.”
The Korean government doesn’t face debt-ceiling issues in the near future, but the ruling party, which enjoys a majority with 169 seats out of 297, and the opposition, are in fierce confrontation over policy.
As President Lee Myung-bak ends his term next year, friction within the ruling party have been observed, and Korea’s top rating agency NICE Investors Service said Friday that it is paying attention to difficulties in political decision-making due to the upcoming general election and the weakened capacity for crisis management.
Korea also constantly suffers from geopolitical risks. S&P’s Tan said that most of the criteria considered in the Korea’s rating he considers remain strong, but the biggest risk comes from North Korea.
“Even if North Korea collapses, leading to a reunification without a war, the South Korean government will have to spend a lot of money to rebuild the North,” Kim said.
Moody’s also takes “event risk,” a direct and immediate threat to debt repayment that could cause a sudden multi-notch downgrade particularly seriously, counting it as one of the four major criteria.
In April 2010, upgrading Korea’s rating, Moody’s pointed at two factors for rating concerns, rising debt by state-owned corporations and the event risks posed by North Korea, although its shelling of Yeonpyeong Island and the sinking of the frigate Cheonan didn’t affect Korea’s rating.
The country’s GDP per capita and growth prospects are the primary economic factors credit rating agencies look at because citizens’ income is the revenue base for the government.
The national income per person reached nearly last year $20,800 as the GDP rose 6.2 percent, according to the Bank of Korea (BOK).
The Ministry of Strategy and Finance initially forecast this year’s GDP growth at five percent, but cut it down to 4.5 percent in July while the central bank lowered it from 4.5 to 4.3 percent.
The figure could drop even further as exports to the U.S. and Europe face challenges.
Lee Chang-seon and Lee Geun-tae, researchers at the LG Economic Research Institute, said Monday in a report that the growth rate might not reach 4 percent because of a possible slowdown in exports, which leads Korea’s economic growth.
The global trading volume dropped 6.5 percent in 2008 and 2009 during the financial crisis, but the trading volume for durable goods including electronics and vehicles, Korea’s major exports, fell much further by 13.9 percent, the researchers said.
Standard & Poor’s is well aware of the issue, pointing out that “significantly weaker U.S. demand … could place strong pressures on the profitability of large exporters from China, Korea, Japan, Singapore and Hong Kong.”
Standard & Poor’s calls it the “external score” that reflects the status of the country’s currency and the ability to generate the foreign exchange to pay back public and private sector debts.
In the past, the Korean won has widely fluctuated in difficult times as foreigners withdrew the currency in a massive scale and exchanged it on their way out.
This time, despite a huge selloff of Korean stocks by foreigners, the Korean won moved relatively little, dropping from 1,050.8 on Aug. 2 to 1,078.5 against the U.S. dollar Friday.
Market observers said that the inflow into the domestic government bonds alleviated capital flight, stabilizing the currency.
In terms of foreign exchange reserves, Korea has been doing well, rising as the world’s seventh largest foreign exchange holder.
The reserve has increased from $270 billion at the end of 2009 to $291.6 billion in 2010, and up to $311 billion in July this year.
Korea recorded a current account surplus for sixteen straight months up to June thanks to more exports to emerging markets, keeping the foreign exchange reserve at a high level.
Experts remain watchful over the export issue because it has been an Achilles’ heel of the Korean economy.
While keeping the country’s sovereign rating at AA for now, NICE said that it would pay attention to liquidity of foreign exchange as some capital flight isn’t avoidable.
“The government should fortify its financial health while the public and private sectors should strictly manage foreign exchange reserves against overseas factors hiking up volatility,” NICE said.
As of the end of 2010, the government owed 392.8 trillion won including the central government’s 373.8 trillion and the municipal authorities’ 19 trillion won, the finance ministry disclosed in April.
The total debt stands at 33.5 percent of the GDP, and it represents a 0.3-percentage-point decrease from 2009.
The 367.2 trillion won out of the total have been borrowed in the form of government bonds.
The rate is much healthier than other large economies. The International Monetary Fund (IMF) estimates Japan’s 2010 debt-to-GDP ratio at 225.8 percent, with the U.S. at 92.7, Italy at 118.4, France at 84.2 and Greece at 130.2 percent.
The last criterion S&P looks at is the monetary authority’s ability to support sustainable economic growth and soothe financial shocks.
The central bank and the finance ministry have been credited for reducing the impact of the global financial crisis on the Korean economy, but challenges may have become steeper.
Before the downgrade of the U.S. credit rating, the BOK had been fighting against inflation. Consumer prices rose 4.7 percent in July from a year ago despite the goal set at 3 percent, plus or minus 1 percentage point.
With the possible slowdown of the global economy, the central bank has to consider economic growth, which would leave monetary policies trickier.