South Korea has made noises to re-assure the financial markets that its economy can absorb the shocks of yesterday’s (November 23) exchange of fire with North Korea and would make moves to stabilise markets if further military action from North Korea occurred.
Yesterday afternoon North Korea fired shells at the South Korean island of Yeonpyeong, killing two marines and injuring several others including civilians. South Korea returned fire and has made clear that any further provocation will provoke a severe response.
South Korea’s vice-Finance Minister Yim Jong-yong said at the start of an emergency meeting of senior finance officials that the country would be able to withstand a serious shock.
"With its solid recovery pace, high foreign reserves, strong current account balance and high investors' trust, our economy has sufficient capacity to absorb any outside shock," he said.
The South Korean markets reacted strongly to the shelling of Yeonpyeong. The Korean won lost 3.6% in the non-deliverable forward market immediately after the attack while credit default swap spreads on South Korea widened by 15 basis points (bp). Yields on the three-year sovereign bond moved out 10bp as indicated by the futures market.
Since then the markets have retraced their steps, indicating a cooling of anxiety.
Three and five-year government bond spreads both narrowed 4bp from yesterday’s wides while five-year sovereign credit default swaps tightened some degree to be only 3bp wider than yesterday morning.
However the Kospi, Korea’s equity index benchmark, is down 1.9%, while the Korean won dropped 2.1% against the US dollar.
Yim's sentiment was shared by economists in the region. Erik Lueth, senior economist at Royal Bank of Scotland in Hong Kong said, “Korea can certainly deal with potential fallout on financial markets—which I don’t expect to be major—it has ample foreign exchange reserves, its banking sector is sound, and its policy response to the Lehman [Brothers] crisis was exemplary.”
The dominant market expectation is that the flurry of military violence will not spiral out of control. Lueth raised the point that China, presumably well informed of the matters in North Korea, has spent a lot of 2010 buying South Korean debt, doubling its stock to US$5billion since the end of 2009.
“Hence one of the main and most powerful stakeholders is not too concerned about instability on the Korean peninsula,” he said.