InterviewPresidential election could lead to deepened division, stalled economic recovery: Fitch affiliate

The June 3 snap presidential election will provide closure to months of political uncertainty and leadership vacuum. However, this election could lead to dissatisfaction among supporters of either camp and in turn lead to organized protests, according to an analyst at a Fitch affiliate.

“A prolonged period of domestic political instability will further keep a lid on the recovery of business and consumer sentiment in Korea, compounded by U.S. President Trump’s fickle policymaking that dampened global direct investment flows,” Caroline Wong, country risk analyst at BMI, a Fitch affiliate, said in a recent interview with The Korea Times.

Beyond tariffs, however, a key challenge for Lee Jae-myung, presidential candidate for the main opposition Democratic Party of Korea (DPK), would be ensuring consistency in his commitments.

A case in point is his pledge to foster the artificial intelligence (AI) industry.

In a bid to position Korea as one of the top three AI powerhouses globally, Lee pledged to invest 100 trillion won ($72.6 billion) into AI over the next five years.

However, this was in stark contrast to a year ago when the DPK unilaterally blocked a budget that included computing support for AI, calling into question the party’s long-term commitment to technological advancement, Wong said.

Similarly, Lee has pledged to increase government support for defense-related industries, which he deemed “a necessity.”

This was another inconsistency since the DPK cut the defense budget by 340.9 billion from 61.6 trillion won proposed by the ruling People Power Party (PPP) in August 2024, according to the analyst.

All in all, Lee’s victory for a fresh five-year term would greatly improve the policymaking environment, as the DPK holds a large majority in the National Assembly.

“The presidency and legislature would be ideologically aligned for the first time since former President Yoon Suk Yeol came to power in 2022, which would allow the unilateral passage of laws,” she said.

"Still Korea’s fiscal consolidation plans will likely be delayed under Lee’s leadership. This is not least because his other pledges would probably entail significant fiscal costs.”

Raising the basic income tax deduction would keep a lid on Korea’s already-lackluster tax revenue collection.

This together with Lee’s proposal to raise the age limit for child allowance benefits to the age of 18, up from the current 13, would limit the government’s room to maneuver in allocating sufficient expenditures to serve its rapidly aging population, in her view.

“It is difficult for Korea to achieve such levels of social spending without risking fiscal sustainability,” she said. “We think the government will probably resort to using the national housing and urban funds and public capital management funds to make up for the shortfall. In a less ideal scenario, the government could cover the shortfall by holding back tax subsidies originally allocated to local governments.”

Also notable to her is the moderate friction in relations between Korea and Japan.

The DPK generally adopts a more assertive stance toward historical disputes with Tokyo, as illustrated by Lee’s frequent opposition toward the Yoon administration’s efforts to work with Tokyo on regional security.

Still, on a positive note, an improvement in relations with North Korea is expected.

“Lee’s conciliatory stance toward Pyongyang would be more in line with U.S. President Trump’s expected outreach to the North,” she said.

Meanwhile, a variety of factors will influence the trajectory of the Korean won, she said.

“While we had previously expected the U.S. Federal Reserve to cut the rates by 100 basis points from 4.5 percent to 3.5 percent by end-2025, we now see upside risks to this forecast and might only see 50-basis-point cuts instead,” Wong said.

This scenario would mean that interest rate differentials will no longer narrow in favor of the won.

Equally concerning is the expected decline in the country’s current account surplus this year, a headwind for the Korean currency.

Still, the Korean won has room to strengthen, she said.

The won has appreciated by less than the Taiwan dollar, which has appreciated significantly due to sudden hedging of foreign exchange exposure by Taiwanese insurers.

“This indicates that hedging ratios did not move up as much in May and leaves greater room for further gains against the U.S. dollar. For now, we see upside risks to our forecast for the Korean won to end the year around 1,430 won relative to the U.S. dollar," the analyst said.