CREDIT ANALYSIS REPORT

South Korea - 2014

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Report Date Jun 2014 Product  
Company / Issuer South Korea Sector Country
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Rationale

MARC has assigned a foreign currency sovereign rating of ‘AAA’ with a stable outlook to South Korea based on the rating agency’s national rating scale. The government of South Korea (GoK) has no debt rated by MARC; the country ceiling applies to ringgit-denominated issuances by entities domiciled in South Korea to reflect the transfer and convertibility (T&C) risk in ringgit-denominated debt issuances by foreign issuers. The rating is based solely on an analysis of information in the public domain.

The rating reflects South Korea’s macroeconomic conditions which are characterised by a high level of economic development with a strong industrial base, a well-diversified and high-income economy; sound fiscal policies; and political, institutional and regulatory stability and continuity. The rating also takes into account South Korea’s vulnerability to external trade conditions and capital flows, fading growth potential, and a history of financial fragility.

The rating is underpinned by South Korea’s status as one of the world’s most advanced industrial nations. Manufacturing has been the traditional driver of growth for the economy, accounting for 31.7% of gross domestic product (GDP) in 2013, although the services sector is taking an increasingly important role (59.1% of GDP).

Also supporting the rating is South Korea’s track record of sound fiscal policies with the budget balance in surplus in all but four of the last twenty years. Central government revenue collection has gradually increased to an average of 22.1% of GDP (2008-2013), while debt ratios are well below developed country norms. The Great Recession caused government debt to rise slightly from 27.0% of GDP in 2008 to about 32.5% of GDP in 2013, largely due to slowing growth in nominal GDP, while still providing substantial fiscal space to the government. The general government’s external debt is also well in hand at 13.6% of total external debt and 4.3% of GDP in 2013. MARC expects to see some short-term deterioration in the fiscal situation over the next couple of years due to prevailing economic conditions, but MARC opines that the GoK has considerable leeway in managing the situation given the generally stable monetary conditions and trade-weighted exchange rate.

Inflation has moderated further to 1.3% in 2013, allowing the Bank of Korea (BoK) to loosen its monetary policy to sustain economic growth, cutting policy rates from 3.25% to 2.5%. While the US dollar (USD) exchange rate has been somewhat volatile, the trade-weighted exchange rate has been much less so. BoK’s credible record in dealing with past economic challenges such as escalating real estate prices prior to 2009 and economic downturn during the Great Recession is a plus point for the economy.

On the external front, South Korea also runs a substantial current account surplus, driven by a large positive balance on trade in goods despite the challenging global trade environment. The slow but steady recovery of developed economies, particularly the US, and the recovery of European economies will likely enable South Korea to sustain a positive current account balance despite the general slowdown in emerging economies such as China and South East Asia.

Having undergone general elections recently, South Korea benefits from continuity in its political and regulatory regime. In addition, governance metrics are generally good with a better-than-average ranking in the World Governance Indicators, and the country ranked seventh in the World Bank’s Ease of Doing Business Report (2014). Corruption remains a challenge for policy makers, but corruption scores have generally improved over the past decade.

There are, however, notable challenges for the South Korean economy. Uncertainty in the global economy, despite the steady recovery of advanced economies, will continue to weigh on South Korea’s economic expansion due to its high exposure to external conditions. While global economic recovery was swift, South Korea’s expansion has since been sub-par, averaging just 2.6% between 2012 and 2013 in contrast to around 5.0% growth before the Great Recession. Poor investment growth and high external trade exposure suggest persistent volatility in external trade performance, hence the headline growth.

There are also challenges to the long-term growth prospects of the economy due to South Korea’s ageing population. The bulk of the working population is currently in the prime 40-50 age bracket, but the fertility rates are below replacement levels and the population is expected to begin declining by 2030-2035. As a result, headline growth should continue to drop from current levels, paralleling the Japanese experience.

As for the banking system, while it remains resilient with rising capital ratios and low non-performing loans (NPL), the high level of household debt averaging 87.1% of GDP in the five years through 2012 makes the banking system vulnerable to any deterioration in the household credit profile. As the country had undergone a credit card crisis a decade earlier, we continue to evaluate this segment of the system as a potential source of vulnerability. Notwithstanding this, MARC expects any deterioration in asset quality should be manageable given the banking system’s strong capital position and fully provisioned loan losses.

The stable outlook reflects MARC’s expectations that the generally favourable fiscal and debt matrix position will prevail while institutional and regulatory stability will continue in the foreseeable future.

Major Rating Factors

Strengths

  • Well-diversified and high-income economy;
  • Sound fiscal policies;
  • Political and regulatory stability; and
  • High global institutional ranking.

Challenges

  • Vulnerable to external conditions;
  • Fading growth potential; and
  • High household debt.
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