KOREA FOCUS

Investors around the world own Korean bonds guaranteed by the government. An insurance policy against the possible default risk of the bonds costs about $180,000 annually for five years. A similar insurance policy costs $36,000 for the U.S. government bonds and $49,000 for the Japanese government bonds. Toward the end of October 2008, when the global financial crisis was at its peak, the costs jumped to $699,000 for Korea, $100,000 for the United States and $65,000 for Japan. Such insurance policies are called “Credit Default Swap” (CDS). The cost of CDS is a good measure of how Wall Street assesses a country`s risk on a daily basis.

 

Private bonds can also be insured in the CDS market. For example, the premium for Bank of America is $214,000 and Citigroup $407,000. A French bank, BNP Paribas, sports a low premium of only $70,000.

 

How does Wall Street calculate the CDS risk premium? For a country, the CDS risk premium is the weighted average of political and economic risks even though nothing is spelled out in writing. For a developing nation like the Philippines, the political risk could be 80 percent of total risk. For a developed nation like the United States., the economic risk is dominant.

 

For Korea, economic risk is more important than political risk. However, the political risk is also a significant part. North Korea is at the top of the political risk. North Korea`s missile tests and nuclear programs make Wall Street nervous, adding to the political risk. Within South Korea, there are many other issues contributing to the political risk

 

The Korean economy is the most important part of Korea`s country risk. In Wall Street`s eyes, the fact that Korea is one of the largest economies in the world and has made excellent economic progress for decades are important factors limiting its economic risks.

 

While the U.S. CDS premium has been adversely affected by the acute financial crisis and housing prices, Korea`s economic risk has been hurt primarily by the collapse in trade. Recently, trade deficits have turned into trade surpluses as imports fell faster than exports. The trade surplus has helped economic growth. The GDP during the first quarter expanded slightly from the previous quarter.

 

However, the trade surplus and economic growth are not necessarily good for the CDS risk premium. During the first quarter, exports fell by 4.2 percent from the previous quarter and 10.5 percent from the previous year. Imports fell even faster by 8.7 percent quarter-to-quarter and 18.4 percent year-over-year, reflecting weak domestic demand. In the United States, every $1 billion in exports creates 25,000 jobs. There should be a similar relationship between jobs and exports in Korea, too. Falling exports and imports, even if beneficial for economic growth, can increase the CDS risk premium.

 

Consumer spending was weak during the first quarter. On balance, the unemployment rate could go higher, further limiting consumer spending.

 

The economic stimulus measures introduced by the Korean government since the world financial crisis have been positive as far as Wall Street is concerned. The supplemental budget designed to help strengthen the economy was positive. The economic policymakers have taken steps to stabilize the financial markets in Korea. The successful issuance of government-guaranteed bonds was a stamp of approval by Wall Street even though the risk premium was hefty.

 

Wall Street is generally positive on Korea`s monetary policy. Since October 2008, the Bank of Korea has cut the interest rate six times reducing the rate by 3.25 percentage points. The market expects the central bank to lower the interest rate again if necessary.

 

Without the turbulence associated with the global financial crisis, however, Korea`s CDS risk has been trending up and could rise further. Korea`s risk premium is more than five times that of the United States. What can Korea do to reduce the gap?

 

North Korea will continue to be a thorn in the eyes of Wall Street. Within Korea, the political parties must demonstrate to Wall Street that they can work harmoniously toward the goal of improving the nation`s economic climate. In the economic arena, the government must continue its economic stimulus program until the risk of global deflation is substantially reduced. The government must be ready and willing to stimulate the economy again if the need arises.

 

Finally, everyone from the president on down must devote more time to “investor relations,” frankly pointing out problems in the Korean economy and how they expect the economy will move forward in the future. It is not different from an investor relations program for a corporation. 

 

[ Maeil Business Newspaper, July 14, 2009 ]