South Korea’s serial financial health scares

September 14, 2015 2:23 PM (UTC+8)

 

Foreign investors turned net sellers of Korean bonds and stocks in August, with the MSCI index losing 15%, as exports fell 15% for the month continuing a record collapse with the economic growth forecast pared to the 2.5% range. The won sold off to the 1200/dollar level between the vise of China’s small devaluation and possible widening of Japan’s much larger yen move as Abenomics moves into a new monetary phase. Korea’s central bank already has the benchmark rate at a low 1.5% and hesitates to ease further on increasing household debt, now at 150% of disposable income beyond regional and OECD norms, according to the IMF.  The government declared an end to the MERS health crisis and resolved a brief exchange of border gunfire with the North, and President Park Guen Hye tried to restore confidence with an expansionary budget, which will raise public debt to 40% of GDP. Halfway through her term she called for “major economic surgery,” even as previous reforms to boost business and consumer sentiment floundered.

Finance Minister Choi Kyung-hwan acknowledged “considerable pressure” from China’s 2% depreciation, but pointed out the currency effect could be neutral since half of the $150 billion in Korean exports to the mainland are intermediate goods. However the chaebol conglomerates have been losing share in recent years to both Chinese and Japanese firms across a range of industries, including autos, electronics and shipbuilding. Profits at Samsung and Hyundai have slid for consecutive quarters, and rating agencies have downgraded corporate debt. Bad construction and shipping loans from private and state-owned banks are 5% of the total, and the central bank estimates that 15% of all companies are “zombies” unable to service debt out of income and instead depend on special post-2008 crisis programs.

Photo taken during recent SK MERS outbreak
Photo taken during recent SK MERS outbreak

Poor corporate governance has been another issue, traditionally discounting Korean shares versus global emerging markets, but bargain hunters were attracted earlier this year at single-digit price-earnings ratios. They were also motivated by new laws intended to loosen the chaebol grip on the economy through raising dividend payouts. Samsung and Hyundai with their worldwide investor base responded, but most stock exchange listings continued cash hording. Samsung’s brief goodwill was likewise eroded by a headline battle with activist US fund Elliott over a proposed intragroup merger to ensure founding family ownership control. It described the challenge as “foreign attack for short-term profit” in rhetoric reminiscent of the early 2000s post-IMF rescue period. Independent specialists agreed that breach of fiduciary duty may have occurred, but the company handily won the deal vote with the National Pension Fund’s backing.

Another signature presidential initiative to realize her campaign platform was mortgage relief, which boosted household credit outstanding to almost $1 trillion at end-June. It offered cost and tax incentives to convert floating-rate interest-only loans to fixed-rate amortizing ones, and banks then transferred them to the state housing finance corporation which issued mortgage-backed securities. The scheme deepened the bond market but helped push the fiscal deficit to 2% of GDP, and re-triggered a real estate boom that had abated with stricter prudential regulation. In a related category, university student debt also was a record $10 billion in the first half as youth unemployment stood at a steep 400,000, a multiple of the 4% national rate.

Inflation is less than 1% and the current account surplus is still strong due to lower energy imports, but short-term external debt has crept up to one-third of the $375 billion in international reserves. Despite manipulation and discrimination warnings from the US Treasury Department, the central bank has hinted at more currency intervention and tighter non-resident limits in local bond and derivatives markets. Pyongyang’s excitement over reopening of special economic zones has faded with a burst of hostilities and nuclear threats, again souring relations. Foreign investors previously considering Seoul a safe haven may reconcile more readily, but first its own excess leverage and corporate misbehavior minefields must be cleared.

Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.

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