Investors welcome President Lee

Peter S. Kim

In one of the most convincing wins in history, South Koreans elected Lee Jae-myung of the Democratic Party of Korea (DPK) as president, by a margin of 8.3 percentage points.

During his acceptance speech, the newly elected Lee named economic growth as his top priority, immediately boosting stock market sentiment. The strong market rebound reflects investors' hope after a six-month leadership vacuum.

Long before the martial law incident, the gridlock between the National Assembly and President Yoon Suk Yeol's office resulted in one of the most ineffective periods of policy-making. During his election campaign, Lee also pledged a KOSPI target of 5,000 points, spurring hopes that he will be more market-friendly relative to the former Moon Jae-in administration. Lee's promise to prioritize economic growth over a social agenda would require a departure from the DPK's previous term in power under Moon.

To achieve this, there are three key factors. In the immediate term, continuation of the Corporate Value-up Program (CVP) would be a good start. Second, to attract foreign investors, the passing of the revision of Commercial Act 382 would be an advancement in corporate governance reform. Third, and a broader mission, is labor market reform. Traditionally, the DPK has been focused on job protection and the rights of the working class. With the country's plummeting demographics, the need to pursue labor productivity is the most important domestic policy for addressing Korea Inc.'s waning competitiveness. A shift from job protection to job creation is likely the most critical driver for KOSPI to not only reach 5,000 points, but also sustain it.

Though it was a right-wing party initiative, the CVP could be sustained under the Lee administration because the DPK has not directly opposed it since its introduction. The CVP was originally designed based on the success of the Tokyo Stock Exchange initiative launched many years ago as part of Abenomics, though the Japanese version did not gain traction from global investors until recently.

Thus far, the impact of the Korean version has been restricted to a few sectors, most notably domestic banks. Some attribute the limitations to a lack of legislative support for the relevant tax reforms. Korean investors' appreciation for dividends over trading gains is a trend that is desperately required for its aging population in the coming decades. And yet, taxation on dividend income in Korea is one of the highest in the world. The CVP represents one of the first recognitions that dividends should be seen in a favorable light and should be encouraged. A revision to dividend income tax would extend the positive impact of the CVP beyond just the Korean banking sector.

In the long term, the CVP's role is to generate income growth via capital market investments rather than leveraging on traditional economic growth, an increasingly urgent issue for Korea. Korean retail investors have invested aggressively in U.S. equities, reflecting not only Korea's momentum fervor but also a lack of growth opportunities at home. Further boosts to CVP momentum would require additional tax incentives for domestic stocks compared to overseas stocks (or even cryptocurrencies). With more than $100 billion shifted to overseas stocks, led by the U.S., and another $80 billion into cryptocurrencies, Korean retail investors have led the global trend of capital flight into the U.S. stock market. While this is a growing trend in many countries, Korea's retail investors' penchant for growth trading and their use of mobile trading has pushed their outbound capital flight to exceed local stock trading volumes in just a few years. If even a fraction of the overseas funds were to return home, it could lead to a powerful boost for the local stock market.

Narrowing the so-called Korea Discount could depend on support from both foreign investors and increasingly important retail investors. Lee has mentioned the revision of Commercial Act 382, which would empower the minority shareholder, as one of his key agenda items. The revision was passed by the Assembly early this year only to be vetoed by the interim president, citing the scope of the revision as being too broad. According to the People Power Party and business lobby groups, this broad definition would be disruptive to management and raise risks of litigation. The key question will be how to amend the law without undermining Lee's pledge to prioritize economic growth and increase the powers of minority shareholders.

Perhaps even greater reform is needed in labor market productivity. A shift in labor market reform from job protection to job creation will be critical for an economy weighed down by increasing export competition and a plummeting birth rate. Under Moon, government policies emphasized workers' rights — policies that were considered anti-business by many investors. Moon's mission to equalize income and wealth for workers was marked by a minimum wage hike to a record level, one that was higher than most emerging economies. Moon also restricted working hour flexibility while reducing working hours. The policies came as China was transforming from Korea Inc.'s customer to a competitor and intensifying export competition. Hence, the well-intentioned policy's consequence was an acceleration in the erosion of Korean companies' competitiveness just as Chinese companies were closing in.

The biggest difference between the current DPK and the prior policies under Moon is that the Korean public is now fully aware of the structural issues facing the country. With Korean jobs rapidly being threatened by competition from China and a tariff war, a flexible labor policy is an essential part of survival for Korean industries. While labor market flexibility may not be the DPK's traditional policy approach, the pledge to prioritize growth over income equality could be a policy shift that may well be received positively not only by investors but also by the working class.

Despite the political chaos of the past six months, the Korean stock market is one of the best-performing markets in Asia this year to date. The benchmark KOSPI has even outperformed the U.S. stock market despite consistent foreign selling. The positive market reaction following Lee's election reflects a firming of local investor sentiment, helped by the Bank of Korea's dovish stance. Korea's central bank just cut this year's GDP growth forecast to 0.8 percent, marking possibly the first time Korea's economic growth will fail to achieve more than 1 percent without a major economic crisis. The pro-growth stance from the new administration is not only needed for the stock market but arrives at a critical time, and Lee's call for national unity cannot come soon enough.

Peter S. Kim is a managing director at KB Securities. The views expressed in this article is his own.