Ireland’s debt woes renew fears of capital flight

By Kim Jae-kyoung

With Ireland’s debt trouble showing signs of spilling over into other European countries, shares in Europe and the U.S. plunged sharply, sending a shudder through emerging markets.

The local financial markets have also turned highly volatile on renewed fears of another debt crisis in Europe, raising concerns that the country may face a sudden capital flight. The benchmark KOSPI lost more than 80 points over the last five days, closing at 1,897.11 Wednesday, down 2.02 points from the previous day, while the Korean won lost 15.40 won to end at 1,144.9 won.

U.S. stocks plummeted Tuesday as investors turned attention to Ireland’s debt troubles and China’s inflation concerns. The Dow dipped 178.47 points to close at 11,023.50, after falling below the 11,000 mark for the first time in more than a month. The dollar gained against the euro.

“Chances are that the debt trouble in Ireland will have repercussions for the local financial market and economy,” LG Economic Research Institute Managing Director Oh Moon-seok told The Korea Times.

“It is premature to worry about another financial crisis in Europe as Ireland’s debt trouble is considered an isolated problem. However, if a crisis in Ireland spreads through other European countries, it could have a ripple effect on the global recovery, which will in turn shake local market,” he said.

Local investors and policymakers are concerned about foreign capitals’ sudden flight as more than 4 trillion won worth of foreign funds has flowed into the local stock and bond market over the past month on massive dollar supply from the U.S.’s quantitative easing.

“With the dollar losing value, foreign capital has rushed to emerging markets. If Ireland’s trouble spreads to other countries and turns into a Europe-wide problem, it will force investors to pull their money out of emerging markets for safer assets,” an official at the Bank of Korea said, asking not to be named.

“However, the debt problem in Europe was not born yesterday. The Ireland case is just one piece of more bad news. I don’t think that it will have a serious impact on the local financial market,” he added.

Fears over another debt crisis are mounting after Euro zone ministers agreed Tuesday to send a joint European-IMF mission to Ireland for a bailout to prevent its debt crisis from spreading to other countries.

According to the Korea Center for International Finance (KCIF), the premium on credit default swaps (CDS) of the so-called PIIGS countries — Portugal, Ireland, Italy, Greece and Spain — have been soaring. In particular, the CDS premium for Ireland and Portugal rose to record highs of 599 basis points and 467 basis points on Nov. 8, respectively, compared to 395 and 344 on Oct. 18.

CDS are tradable, over-the-counter derivatives that function like a default insurance contract for debt. CDS premium rate gives a sense as to the investors’ view of which countries are riskier than others.

The KCIF said that the government should stay alert over the development of Europe’s debt trouble as the trouble in Ireland and Portugal may spill over into Spain and Italy, eventually sending contagion effects into financial firms.

“A series of negative developments in Europe — sluggish industrial production in Spain, growing political risks in Italy and the rising possibility of an IMF bailout for Ireland — have combined to imply that the financial malaise created by Ireland is spreading across the region,” the center said in the report.

“So far, Asian countries are not likely to be hit hard by Europe’s debt woes thanks to strong economic fundamentals. However, given that external shocks caused a sudden capital flight in the past, the government should keep a close watch on the situation overseas,” it added.