[INTERVIEW] South Korean economy won't enter recession: Moody's

S. Korea has enough FX holdings to prevent further slide of won

By Kim Yoo-chul

While fears of a global economic recession are directly hitting South Korean equity and currency markets prompting investors to flee the export-driven country, the likelihood of recession here, Asia's fourth-largest economy, is low, according to Moody's Analytics.

All negative investor sentiment has been factored in. The won, South Korea's currency, has been by far one of the worst performers among major currencies. The won has fallen about 17 percent against the dollar since the beginning of this year and it is feared to reach the 1,500 won level against the greenback this year because the country is not in a strong position to defend against the U.S. Federal Reserve (Fed)'s moves to hike interest rates.

Dave Chia, associate economist, Moody's Analytics, left, and Anushka Shah, vice president, Moody's Investors Service / Korea Times file

Government bond yields rose quite rapidly across the board. Rising benchmark rates, deepening geopolitical risks, a stronger greenback, increasing inventories and tepid end-user demand are threatening the bottom lines of the country's leading exporters with Samsung Electronics seeing a drop of more than 30 percent in operating profit year-on-year for the three months that ended Sept. 30, economists and company officials said.

"We do not expect the South Korean economy to enter a recession in the near term," Moody's Analytics Associate Economist Dave Chia said in a recent interview. Chia added its July decision to lower its 2023 growth forecast for South Korea to 2 percent from 2.2 percent is a reflection of external headwinds for foreign trade.

Exact definitions of economic recession vary, but all include a sustained period of decline in all areas of economic activity.

"Export growth will moderate through early 2023 from 2021's record pace. High energy prices and manufacturing woes in China remain as key risks to growth. However, the higher cost of living, coupled with tightening monetary policy, will weigh on consumption," according to Chia. China is South Korea's largest trading partner and Seoul's heavy export reliance with Beijing has backfired as the core source of weakness in recent months.

"As the Fed attempts to rein in inflation, fears of a near-term U.S. recession are increasing. Nonetheless, there is still some room for optimism because U.S consumer spending is picking up, and the labor market is holding up well. Europe has relatively higher odds of entering a recession as it struggles with inflation and energy shortages. This is unlikely to trigger a global recession, but could cause an economic slowdown," Chia added. A decline in service activity and higher input costs are considered as factors that could burden the Chinese economy at least through early 2023.

Chia said the recent agreement between the Bank of Korea (BOK) and the National Pension Service of Korea (NPS) for a currency swap could have some positive impact in terms of slowing the won's further slide. However, he added the swap itself won't be an eventual solution because the recent weakness of the won has been exacerbated by widening interest rate differences between South Korea and the U.S.

"Even though the BOK started to tighten monetary policy much earlier than the Fed, large rate hikes in the U.S. of late have triggered capital outflows from South Korea. The recent agreement with the NPS for a currency swap could mitigate some weakness in the near term, but it is not a long-term solution to the won's weakness," he said.

A man wearing a face mask is reflected on an electronic foreign currency exchange rates board in downtown Seoul, Oct. 7, 2022. AP-Yonhap

Despite the recent steep decline in South Korea's foreign currency holdings, the country has enough foreign reserves to defend the won, according to Chia. As of Oct. 6 this year, South Korea has $416.77 billion in foreign reserves, data provided by BOK showed.

After the 1997 Asian financial crisis, South Korean authorities have spent many years stockpiling foreign exchange reserves as a way to defend the won in times of massive depreciation. In September, the central bank unloaded some $19.6 billion for market intervention, marking the fastest pace of month-on-month decline since October 2008, when the amount of the reserves slid by the largest ever $27.42 billion amid the global financial crisis.

Regarding the necessity of the BOK reopening a currency swap line with the Fed to stabilize the foreign exchange markets, Chia declined to elaborate. The BOK and the Fed signed a $60 billion currency swap pact back in March 2020. However, the deal had expired last year. The BOK recently confirmed that it was in discussions with U.S. authorities to reopen a currency swap.

With regard to the estimated effects of the BOK's October rate hike decision on the foreign currency market, Chia said, "Easing South Korean inflation and narrowing interest rate differentials with major economies would help. This could be achieved by the BOK tightening monetary policy to ensure that the interest rate gap with the U.S doesn't widen significantly."

The economist added that if commodity prices come down, supply-side inflation will ease and central banks around the world will have less need to tighten interest rates. "This would be good for South Korea's terms of trade and won stability," he said. The depreciation of the won is cited as an underlying factor in accelerating inflation in the country.

N.Korea's provocations burden S.Korea's sovereign rating

Another focus of investors is how rising tensions between the two Koreas will affect the South's equity markets and credit profile.

A TV screen shows an image of North Korean leader Kim Jong-un during a news program at Seoul Station in Seoul, South Korea, Oct. 10, 2022. North Korea said Monday its recent barrage of missile launches were tests of its tactical nuclear weapons. AP-Yonhap

North Korea demonstrated its full readiness to fire tactical nuclear warheads at potential targets in South Korea. Despite President Yoon Suk-yeol's verbal warnings that North Korea has nothing to gain from nuclear weapons, U.S. intelligence officials and security experts said the North will conduct another nuclear test by the end of this year in an attempt to establish a position of national strength. Pyongyang has tested ballistic missiles seven times since September 25, the latest of 25 ballistic and cruise missile launches this year, according to intelligence officials.

Because investor sentiment remains so fragile, even the persisting North Korean nuclear issue could justify investors' appetites to weigh further on downward pressure in the markets.

"The ongoing risk of military confrontation with North Korea poses unusually pronounced exposure to event risk for a sovereign in the Aa-rated category. Moreover, a material and irreversible reduction in geopolitical risk, and in particular a lowering of the threat of warfare on the Korean Peninsula, would also support a higher rating," Moody's Investors Service Vice President Anushka Shah told The Korea Times, separately.

Shah, also the rating agency's senior credit analyst, referred taking significant and tangible steps toward denuclearization and a permanent peace settlement between the Koreas, as well as toward an ending of North Korea's economic and diplomatic isolation as the possible factors for South Korea's higher sovereign rating.

Besides geopolitical risks, the executive said the top credit challenges faced by Asia's fourth-largest economy are related to the long-term economic and fiscal costs brought on by a rapidly aging population.

"Economic and structural reforms that were increasingly likely to durably increase potential GDP growth and mitigate the adverse impact of an aging population could lead to an upgrade in the sovereign rating. Longer-term credit constraints for the sovereign are predominantly centered on the government's ability to implement structural reforms to maintain its strong economic performance and prevent material further erosion in its fiscal position, against the background of a rapidly aging society," according to the executive.

She assessed that South Korea's credit metrics are likely to be as resilient as similarly rated sovereigns. "[South] Korea's credit profile is underpinned by its policy effectiveness and economic strength, although rising government debt since the start of the pandemic has tested a track record of fiscal discipline."