Seoul braces for a slowdown; S Korea is trying to find best balance between intervention and market forces at times of stress

July 9, 2013 5:46 pm

Inside Business: Seoul braces for a slowdown

By Henny Sender

S Korea is trying to find best balance between intervention and market forces at times of stress

Asia is bracing for harder times once again. “The oxygen is getting thinner,” noted Frederic Neumann, HSBC’s Asian regional economist, as he slashed growth projections for the region in a report this week. One early straw in the wind was the decision by South Korea’s new government of Park Geun-hye some weeks ago to quietly cancel the planned privatisation of Korea Development Bank, one of Seoul’s principal policy arms. The decision is understandable. As a relatively open economy that lacks the continental dimensions of its neighbour, South Korea is among the countries that are potentially most exposed to the harder economic times. About a quarter of its exports go to China. So when economic growth in its neighbour slows, South Korea also slows.In addition, Japan may have three arrows but so far the only one it has really deployed is depreciation of its currency which assails – and deliberately so – the fortunes of South Korean exporters.

Whole swaths of the South Korean economy, including shipping, shipbuilding, construction and real estate lie in distress, while sectors including chemicals and steel have come under pressure. A series of bankruptcies in recent months means that the corporate bond market is not functioning smoothly and the stock market is down. South Korea doesn’t look to be in great shape. Many hedge funds in Asia now have their biggest shorts on the won and South Korean Treasuries. That is partly because South Korean companies have high debt levels and their cash flows are likely to weaken. This is partly because when foreign investors want to get out of Asia, as many do these days, South Korea is the easiest and most liquid market to exit.

Local private equity groups consider KDB their single biggest rival for deals – especially rescue finance – since distressed companies can get support from such policy banks rather than turning to the market for capital on far less favourable terms. In other words, to many investors, South Korea is resisting market forces as it always has done.

But what is going on in the country is a little more nuanced than that. South Korea is trying to work out the best balance between government intervention and market forces at times of economic stress. Indeed, in the five years since 2008, there has been a worldwide swing in many countries away from the self-correcting function of markets. The decision to cancel the privatisation of KDB is one manifestation of that.

There are other signs of a move away from letting market forces rule absolutely. For example, big banks have invested together to form an asset management company called UAMCO to buy their non-performing loans. On the surface, that looks like more related party transactions. But there is a formal process involved these days, in contrast to past practice. And if that asset management company is more successful than other bidders in winning such portfolios, it is partly because it has a lower cost of capital and a lower threshold for returns.

Moreover, it is possible for distressed players to buy loans from the asset management company. One hedge fund manager, for example, has been buying from this asset management group some of the 500 distressed real estate projects across the country where banks extended loans that are now in trouble.

South Korea has also shored up its defences in other ways, such as by increasing its current account surplus and trying to keep its debts in local currency. South Korea is also fortunate in that the Bank of Korea can cut rates because it wants to keep downward pressure on its currency and its companies and households are still highly levered. The true test for South Korea will be whether, once the bad times pass, the country can reverse course and let market forces reassert themselves, such as by putting privatisation back on the agenda.

For the moment, South Korea is in somewhat better shape than many of its regional neighbours who are still in denial about how bad things might get as capital flows reverse and their cost of capital rises. Especially at risk are the local Asian companies that borrowed in dollars since dollar interest rates were so cheap, and didn’t bother to hedge the loans.

Pity Thailand’s CP Group, for example, which borrowed about $11bn this year, mostly to finance two mergers. Memories are short in Thailand, which was the first Asian country to go through the Asian financial crisis. In South Korea, apparently, the scars are deeper.