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Conflict risk is cracking South Korea’s appeal

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A stronger yen-won exchange rate underlines Japan’s perception of safety with Seoul now plunged into a crisis, awaiting elections and wary of tensions escalating on the Korean Peninsula.

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South Korea has been long considered a safer bet than Japan, with its stronger growth profile, political stability and more favourable fiscal situation.

Rated a stable AA credit by Standard & Poor’s, an equivalent Aa2 by Moody’s, and AA- by Fitch, South Korea ranks 20th in Euromoney’s global risk rankings, just above the United Kingdom and within the second of five categories, indicative of a low level of risk.

However, the North Korean situation is beginning to alarm country risk experts with its potential for such a huge loss of life, and the economic and financial turmoil that would bring.

One contributor who asked not to be named said there is now a big risk of the situation spiralling out of control, especially if Donald Trump senses there is no benefit from pursuing political dialogue.

No wonder the won has been depreciating against a stronger yen lately following a surge in April:

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Until now the economic news has been largely positive for South Korea with the economy expanding on a real terms basis by 0.9% quarter on quarter in January-March (2.7% year on year), bolstered by construction and exports.

GDP growth is forecast to come in at 2.7% in 2017, according to the IMF, compared to 1.2% in Japan, and it should be borne in mind that Japan would also be at risk of conflict should hostilities ever break out, undermining its own investor prospects.

But the country risk scores are starting to converge as experts take a dimmer view of Korean prospects.

It’s a very small yet perceptible drop in country risk score for South Korea, causing it to fall one place in the global rankings.

Japan’s budget deficit is larger, but is narrowing. By contrast, South Korea’s is increasing and hostilities would make matters worse by raising military spending and worsening investment spending.

Regional specialists at BBVA, a bank taking part in Euromoney’s survey, state, “If a war really did break out in the Korean Peninsula, China would suffer greatly.

“Even in a benign scenario where no nuclear weapons were used or leaked, China might still need to take in millions of refugees from North Korea.

“Moreover, China’s trade with South Korea and Japan would also be adversely affected if the war extended beyond North Korea’s borders.”

Even the threat of warfare is enough to damage South Korea’s reputation, not least when also considering the simmering South Sea China tensions concerning Beijing’s ‘nine-dash’ territorial claims.

Plus, South Korea has a household debt burden which is higher than the OECD average, snowballing since the global financial crisis to 170% of disposable income.

Presidential hopeful Moon Jae-In, who is favourite to win the election next week following the impeachment of Park Geun-hye, has vowed to tackle the problem.

Yet with debt spiralling and measures required to constrain it, there are fears the country could be heading for another financial crisis.

On North Korea, too, Moon’s softer approach than Park’s may not amount to much.

Moon favours sanctions, and wants to reopen the Kaeson Industrial complex, a joint initiative providing mutual economic gains.

He also rejects the Terminal High-Altitude Area Defence System (Thaad), reflecting public discontent with US interference.

But it will be difficult for him to return to the Sunshine Policy combining dialogue without pressure favoured by former leader Kim Dae-jung without his counterpart in Pyongyang dismantling the nuclear weapons programme.

Korean investors seem set for a bumpy ride.