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Korean Détente
Last week, the U.S. announced that it had removed North Korea from a list of state sponsors of terrorism. The removal was welcomed by North Korea, which had agreed to allow United Nations inspectors back into its nuclear facilities to resume the process of disabling its nuclear program. The country had previously barred inspectors in recent weeks. While this progress has gone largely unnoticed by the market amid a continuing global financial crisis, we believe North Korea’s removal from the terrorist blacklist should help ease some concerns over the South Korean economy, which has seen its currency fall sharply this year. The South Korean won has depreciated approximately 29% against the U.S. dollar year-to-date through September 30, making it the worst performing currency in the region. For many, the collapse of the won is a sore reminder of the Asian financial crisis of about a decade ago. It highlights some of the weaknesses of regional capital markets—bond markets are underdeveloped and there is consequently little long-term funding for corporations as well as an over-reliance on short-term debt. In addition, Korean bank loans are about 30% greater than their deposit base, which means that the banking system has been more reliant on U.S. dollar-denominated funding. Foreign exchange reserves are able to cover the system’s near-term funding needs, but with little room to spare. However, Korea has on its doorstep two large pools of U.S. dollars—from China and Japan. In fact, regional leaders today pledged to set up an $80 billion foreign-exchange reserve pool by the middle of next year—a welcome first step in the fight to shore up confidence in Korea and across the region. However, we think that the size of the commitment could be increased and the pace of its implementation sped up to have maximum effect. For the most part, Korea’s banking system is stretched further than those of other Asian nations. Nevertheless, all confidence-building measures are welcome. The South Korean government has also announced a US$130 billion financial aid package this week—guaranteeing US$100 billion of external debt and providing US$30 billion to banks. Despite the recent credit woes and the difficulties facing the Korean financial system, we believe that Korea’s manufacturing sector, the backbone of the Korean economy, remains relatively healthy compared to the financial sector. A weak won also helps some exports stay more competitive amid the global slowdown. This may help the Korean economy weather short-term pain. These events should be positive for the South Korean economy in the long term, however, we must recall that North Korea has broken agreements in the past. If the global credit crisis persists and there is an ongoing slowdown in global demand for consumer products, South Korea and the region will continue to be adversely impacted.
Single country and sector funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific sector or geographic region. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. |
