Despite a looming threat from the north, South Korea is set to perform well in 2014. The government focuses on broadening away from exports and reducing dependency on the yen.
Technically speaking, the Korean War never ended with a peace treaty between North and South Korea, so it could be considered the world’s longest ongoing conflict. We are often reminded of this fact by periodic outbursts from the North Korean leadership, including threats of war, nuclear tests, and covert kidnapping operations. It is natural to assume that the biggest political risk to the South Korean economy is its friction with the North.
However, earlier clashes with the North have had surprisingly little impact on South Korean business. The only notable exception occurred when the Clinton administration debated a surgical strike on North Korea in the early 1990s, sending South Koreans on a hoarding spree that jolted markets. However, even this scenario quickly resolved itself, and South Koreans have since learned not to panic.
Despite the media coverage, North Korea’s third nuclear test in early 2013 did not create much of an economic fuss either. Far from having long-lasting impacts on the South Korean stock exchange, as widely predicted, the KOSPI is performing slightly stronger than one year ago and even shows some upward pressures. Similarly, foreign direct investment has increased since January last year, and foreign companies such as GM have not fled the market.
A good explanation for the endurance of the South Korean economy vis-à-vis Northern worries is that the Kim regime’s threats are not very threatening. Rhetoric from Pyongyang is often seen as an attempt to ensure domestic regime support – rather than initiating battle with the South – and so conflict is considered improbable.
Actually, the biggest KOSPI drop in 2013 occurred several months after the controversial nuclear test, and was due to low export figures, tapering of U.S. quantitative easing, and the weakening Japanese yen. The real political risk to the South Korean economy stems from international trade and financial decisions, not North Korea.
This makes sense considering South Korea has such a strong reliance on exports – over 50 percent of GDP in 2013. This has been a great asset to the country’s rapid development for the past two decades, but means that South Korean markets are particularly exposed to how well exports are performing. In a world of fierce competition coupled with global economic volatility, this can pose a considerable risk.
The Korean government has taken steps to promote healthier exports in the future by diversifying its economy away from the giant conglomerates known as chaebol. Such decisions have also helped avoid long-term stagnation, and will give Seoul more room to restructure away from export-led growth in coming years.
For example, the Export-Import Bank of Korea is providing over US$70 billion in financial assistance to local exporters this year, with another US$70 billion set aside for loans and guarantees. Further, the government helped create a healthier startup ecosystem by revising its tax-code late in 2013. This included large tax deductions for angel investors, as well as increased allowances for innovative investment projects.
The main threat to South Korea’s exports is the yen depreciating against the Korean won (KRW). Not only is Japan Korea’s main export competition in vital industries such as electronics, but it is also one of Korea’s biggest export markets. Thus, a depreciating yen has the two-fold impact of diminishing export revenue as well as making Korean exports to third markets seem less attractive.
Luckily, global demand is slowly recovering, which helped South Korea claim multi-billion current account surpluses throughout 2013. Even better, domestic demand (and production) has gone through the roof, and growth estimates for South Korea have been rounded up. According to the IMF, the economy is predicted to grow at around 4 percent for the next couple of years, a sign that Korea is picking itself up along with the rest of the world.
As mentioned before, South Korea has also enjoyed increases in FDI. Ranked as the most innovative country in 2013 by Bloomberg, and 7th easiest for doing business according to the World Bank, it is unsurprising that companies are keen to invest in South Korea. However, certain policies are set to guarantee even further investment in the future.
For instance, the National Assembly passed the Foreign Investment Promotion Law on January 1, which removes significant red tape from foreign businesses entering the South Korean market. What is more, South Korea is currently investing billions into a hyper-modern 5G network in 2020 that will make it even more attractive to FDI. Such factors help explain why 5 or more new foreign companies will be listed on the Korean stock market later this year.
All things considered, Asia’s fourth largest economy is doing well and is set to do even better in the near future. Not only does South Korea appear physically safe (even considering the unpredictable, nuclear-armed dictatorship merely a few kilometers from its capital), but its economic performance is sounder than most other developed countries can hope for. With a steady recovery and long-term planning under way, we can expect South Korea to provide a lot of positivity in 2014.
