REPUBLIC OF KOREA - 2018

MARC has affirmed the Republic of Korea’s (South Korea) foreign currency sovereign rating of AAA with a stable outlook based on MARC’s national rating scale. The AAA rating reflects South Korea’s economic resilience, sound fiscal position and strong external position. Its strengths are, however, moderated by its rapidly ageing population and geopolitical risk stemming from North Korea. The stable outlook is based on expectations of continued pragmatic and effective policy-making, and that there is no sudden erosion of its considerable fiscal and external buffers. We are, nevertheless, cautious on the outlook because of the ongoing US-China trade spat and geopolitical risk stemming from the unpredictability of the North Korean regime.

The South Korean economy remains resilient to global shocks, thanks to strong macroeconomic fundamentals. Gross domestic product (GDP) growth in 2018 is likely to come in at slightly below the 3% level even with higher fiscal spending because of elevated global trade tensions. The government’s “income-led growth” strategy, which will be driven by increased public employment, a sharp rise in the minimum wage and higher social spending, should support domestic demand. Going forward, economic potential should improve as the government implements supply side policies to boost innovation.

A strong record of fiscal prudence has led to a sound fiscal position, the soundest among its peers in the Organisation for Economic Co-operation and Development (OECD). South Korea’s fiscal balance is expected to fall into a deficit of 1.7% of GDP in 2018 given the new administration’s expansionary fiscal policy and welfare spending. The government, a net creditor, has reserves equivalent to about 30% of GDP. As of end-3Q2017, government debt stood at a relatively low 36.7% of GDP.

Thanks to persistent current account (CA) surpluses, South Korea has built up a strong external position. Its external buffers are significant. As of end-July 2018, it has foreign exchange reserves amounting to USD402.4 billion. In addition, it is a net international creditor with a net international investment position equivalent to 16.2% of GDP (2017). It is not surprising then that capital flows have proven relatively resilient despite US monetary tightening and geopolitical tensions.

A rapidly ageing population continues to weigh on South Korea’s sovereign credit rating. Over the 1997-2017 period, the proportion of those aged 65 years or over more than doubled from 6.4% to 13.9%. With fewer working-age adults now supporting each resident aged 65 years and above, the expected impact on economic growth, productivity, and fiscal cost is a credit concern. Meanwhile, inadequate social protection, which is creating poverty among the elderly, has affected consumption spending with implications for GDP growth.

With the Korean peninsula remaining in a technical state of war and the US and North Korea at times engaging in “belligerent rhetoric,” geopolitical tensions have never been far away. Against this backdrop, there is always the possibility of an unexpected event triggering a military confrontation. Even if that does not happen, the tensions have the potential to negatively affect consumer and business sentiment. Meanwhile, the Korean summit may not necessarily lead to anything substantial given that the north has not agreed to a substantive process to hammer out its agreement to denuclearise.

Major Rating Factors

Strengths

• Resilient high-income economy;
• Sound fiscal position; and
• Strong external position.

Challenges/Risks

• Ageing population; and
• Geopolitical risk.