Strategic, market views for Korean peninsula in 2018
From the risk of armageddon to the possibilities of GDP growth, our outlook for the two Koreas in the year to come
The key question facing the Korean peninsula in 2018 is existential: Will there be war – possibly nuclear war? Not since 1994, when the Bill Clinton administration planned strikes against North Korea’s then-nascent nuclear program, has peril appeared so imminent. And now, with North Korea now in actual possession of nuclear weapons, the risks are steeper than ever.
Yet few expect Pyongyang to attack the United States – a suicidal move given the relative sizes of their respective arsenals. Hence, virtually every war scenario is contingent upon a US pre-emptive strike. Given that containment and deterrence has, for over half a century, kept the peace (largely) in Korea and should continue to do so, the key questions US policymakers must address are: “Does the United States have a need or right to strike North Korea on the basis of its possession – not use – of nuclear weapons? Particularly given the risks such a strike entails for ally South Korea?”
The risk-reward appreciation for any strike appears bleak. The US could destroy some facilities and launchers, but is unlikely to significantly attrite Pyongyang’s fissile material stockpiles or destroy all its launchers. In short: North Korea would continue to possess strategic weapons. Short of all-out invasion and/or regime change, this dynamic looks set in stone.
However, even if the US gives North Korea a “bloody nose,” a Pyongyang retaliation is no certainty. The last significant period of back-and-forth fighting in Korea was the cross-border skirmishing of 1967-69. Since then, every Pyongyang provocation – from terrorist attacks and ax murders, to torpedo attacks and artillery barrages – have been one-offs: The modus operandi is fast de-escalation, not escalation. As a result, Seoul and Washington have not responded to deadly attacks with deadly force. Pyongyang’s MO indicates fear of a spiral of escalation, so it might not retaliate for fear of a drawn-out fight.
Still, it could respond with deniable operations – such as terrorist attacks, possibly using chemical or biological weapons. Or, Pyongyang might launch a limited retaliation simply to roil global financial markets. This means the risks of US military action remain colossal, but it is notable that the recent US National Security Strategy document, in its chapter on nuclear risk, mentions no pre-emptive strikes.
The period of maximum danger looks set to be after the Pyeongchang Winter Olympic Games (February 5-29). Then, US assets will converge on the peninsula for annual spring war games – always a tense time. With South Korean President Moon Jae-in emphatically saying “No” to any war scenario, the US could opt for offshore strikes, rather than utilizing peninsula-deployed troops. Even in this case, a key red light to watch for would be the evacuation of US civilians and military family members from the South.
On the bright(er) side: Once North Korean finalizes strategic arms development (with mastery of ICBM re-entry vehicles and targeting systems – and possibly the atmospheric testing of a nuclear weapon), it may be willing to negotiate a freeze on nuclear and missile tests, though not a total abandonment of nuclear arms. But even this is uncertain, as is timing. For the near future: Prepare for alarmist news and high risk premiums. Meanwhile, recent reports of Chinese and Russian vessels refueling North Korean ships on the high seas suggest that the country still has friends helping it beat global sanctions.
South Korean Politics
Approval ratings of the liberal President Moon remain high. His first significant domestic test will come with local elections in June (National Assembly elections are set for 2020). With conservatives still divided and in disarray following the impeachment of Park Geun-hye, his political base looks firm for the near term.
South Korean Diplomacy
The diplomatic outlook is challenging. Despite reported agreements in October and December 2017, it is far from clear that Beijing has finished its economic retaliation against US anti-missile systems deployed in South Korea. Moreover, Moon’s recent remarks following a probe into the 2015 Seoul-Tokyo agreement on wartime “comfort women” signal that Seoul will unilaterally overturn the deal – possibly after the Winter Olympics – which is bound to infuriate Tokyo. And Seoul and Washington are set to hold the first round of talks on Jan. 5 to amend their bilateral free trade agreement – at US insistence.
The pact grants Korean players tariff advantages against Chinese and Japanese competitors in the US; the Koreans agreed to the US demand for a renegotiation only with reluctance. Further questions hang over the planned transfer of wartime operational control of Korean troops to domestic command: There is no clear benchmark for this process.
South Korean Macro Economy
The Bank of Korea and nine global investment banks forecast 2.9% growth for 2018; the IMF, OECD and the Korean Finance Ministry anticipate 3%. Growth will be driven by a 4% rise in exports, piggy-backing on a steadying global economy, and upgraded domestic consumption on the back of the Winter Olympics leading a 6% rise in imports, and ministry said. The ministry anticipates annual per capita income to surpass US$30,000 by year-end, though strategic tensions could erode the won. The current account surplus is expected to fall from $481 billion in 2017 to $79 billion in 2018.
Risk factors for 2018 year include a 16% minimum wage hike, a shrinking workforce, a chronic low birthrate and perennially high household debt. The ministry expects 2017’s growth to come in at 3.2%.
South Korean Market and Sectors
The outlook for cosmetics and healthcare looks positive; analysts are also upbeat on electronic components, but mixed on consumer electronics. Petrochemicals continue rosy, given upturns in oil prices and global trade. Autos are also positive, with Hyundai-Kia making a big (if belated) push into electric vehicles through 2025.
However, shipbuilding’s long crisis simmers on: debt is high and orders are low, as the sector faces Chinese over-investment and a dearth of orders for high-end carriers and offshore structures. Regulatory risks have fallen, with good stewardship codes promoting sound governance. The benchmark KOSPI index ended 2017 on 2,467 points, following a 24% annual rise. Brokerages forecast that the KOSPI could scale highs of 2,900-3,000 points in 2018.