Korean CDS debt spread widens most since 2009

By Kim Tong-hyung

The cost of bankruptcy protection on Korean debt has been climbing at an alarming pace on the fallout from the turmoil in the eurozone and investor anxiety over the stability of Korea’s banking system.

Credit default swaps (CDSs) measuring risk on five-year sovereign debt touched 220 basis points as of the end of September, up 92 basis points from a month earlier, according to data by the Korea Center for International Finance (KCIF).

It represented the biggest monthly spike since the gain of 106 basis points in the month to January 2009, when pain from the Lehman Brothers collapse was still fresh. Korea’s CDS debt spread has been rising twice as fast as the rates in major European nations that are at ground zero of the current economic turmoil, highlighting the country’s vulnerability to external factors.

The spread of Korea’s foreign exchange stabilization bonds (FESFBs) also increased steeply, with the figure for bonds that mature in 2014 reaching 242 basis points at the end of September, up 75 basis points from the preceding month.

The CDS debt spread reflects the cost of hedging credit risks on sovereign debt and an increase indicates deteriorating confidence of credit market investors in a country’s financial system, which in turn ups the cost for bond issuance.

``CDS premiums are an indicator of investors’ sentiment rather than a measurement of the risks of sovereign debt default, so the numbers could easily come down should the problems in Europe and U.S. start to show signs of improving. That said, there are a lot of uncertainties that remain, including the Greek debt rescue plans that will see some critical moments in October, and there is definitely more room for Korea’s CDS spread to worsen,’’ said Kim Yoon-gyeong, a KCIF researcher.

The CDS spread on 15 Western European economies, including Britain and Denmark, gained 49 basis points from August to September, according to the Markit iTraxx SovX Western Europe Index. The iTraxx SovX Asia Pacific Index showed that the average CDS premium of 10 countries in the Asian Pacific climbed 81 basis points over the same period.

Korea’s high dependence on exports, openness of its capital markets, and high concentration of European investment makes it arguably the weakest among major Asian economies in withstanding a potential financial meltdown in Europe.

A blizzard of bad data from inside and out has been increasing concerns that Korea’s fragile recovery now faces an imminent threat of being knocked off course.

A skidding Korea Composite Stock Price Index (KOSPI) and aforementioned surge in CDS debt spread indicate that foreign investors are bailing on Korean stocks and bonds.

The value of the Korean won has been tumbling to its lowest level since the financial crisis triggered in 2008 as the heightened uncertainties surrounding Western economies appear to be prompting frenzy among investors to sell off the risk-sensitive local currency.

Korea’s foreign exchange reserves sustained their sharpest decline since the 2008 global financial crisis, measured at $303.38 billion at the end of September from the historic high of $312.19 billion a month before, as the authorities apparently spent billions of dollars defending the won, the Bank of Korea (BOK) said. The latest data rekindles debate on whether the country has enough ammunition to defend against another full-blown financial turmoil.