South Korea finds itself grappling with financial turbulence and political uncertainty following an unprecedented martial law declaration by President Yoon Suk Yeol. The announcement, later lifted under parliamentary pressure, sent shockwaves through financial markets, pushing the won to multi-year lows and raising questions about the nation’s stability.

The South Korean government and central bank acted swiftly to mitigate economic fallout, pledging “unlimited” liquidity injections and implementing a range of emergency measures. Despite these efforts, concerns over the long-term implications for South Korea’s economy and global investment sentiment remain high.

Government and Central Bank Interventions

On Wednesday, the Ministry of Economy and Finance, alongside the Bank of Korea (BOK), unveiled a robust response plan aimed at restoring confidence in South Korean markets. The measures include injecting liquidity into stocks, bonds, short-term money markets, and the forex market until conditions normalize.

The BOK announced it would begin special repurchase operations to ensure financial institutions can maintain smooth operations. Additionally, the central bank loosened its collateral acceptance policies, allowing state-run enterprise bank debentures to qualify, a significant move aimed at increasing liquidity in the strained credit market.

In a coordinated effort, the Financial Services Commission pledged a stock market stabilization fund of up to 10 trillion won ($7.07 billion), a tool previously used during crises to shore up investor confidence.

Impact on Financial Markets

The initial reaction to the martial law declaration was stark. The South Korean won plummeted to a two-year low of 1,442 per U.S. dollar, while the benchmark KOSPI index dropped 2%. Major players like Samsung Electronics and LG Energy Solution saw their stock values dip by 1.31% and 2.64%, respectively.

Foreign-listed South Korean assets also took a hit. Exchange-traded funds like the iShares MSCI South Korea ETF and the Franklin FTSE South Korea ETF each lost about 1%, reflecting international apprehension.

As of Wednesday, the government’s interventions appear to have stabilized the situation somewhat, with the won recovering 0.8% and the stock market trimming earlier losses.

Political and Economic Context

President Yoon’s martial law declaration stemmed from escalating tensions with the opposition-controlled parliament, which has been locked in a budgetary standoff. The Democratic Party recently reduced the administration’s proposed 677.4 trillion won ($470.7 billion) budget by 4.1 trillion won, creating a deadlock that has prevented a final vote.

Observers view the move as a strategic miscalculation by Yoon, whose minority government is already vulnerable. Parliament’s unanimous vote to lift the martial law highlighted the president’s political isolation and raised doubts about his ability to navigate future crises.

The timing of the turmoil is particularly problematic for South Korea, which is already grappling with slowing export growth and a fragile global economic environment. Analysts warn that reduced fiscal spending could exacerbate these challenges, particularly if budget negotiations remain stalled.

Global Implications and the ‘Korean Discount’

The incident has reignited discussions about the “Korean Discount,” a phenomenon in which South Korean companies are valued lower than their global peers due to perceived risks, including political instability and corporate governance issues.

Daniel Tan, a portfolio manager at Grasshopper Asset Management, noted that the turmoil could deepen the discount. “Investors are likely to demand a higher risk premium for Korean equities and the won, particularly given the volatile political landscape,” he said.

The KOSPI index currently trades at 0.8 times forward book value, significantly lower than the MSCI World Index’s multiple of nearly 3. This disparity underscores broader challenges in attracting foreign investment, even as South Korea seeks to globalize its markets.

Expert Perspectives on Financial Stability

Economists and market analysts have largely applauded the government’s quick response to the financial crisis, though opinions are mixed on its effectiveness in the long term.

Citi economist Kim Jin-wook expressed cautious optimism, suggesting that “the negative impact to the economy and financial markets could be short-lived, provided proactive policies continue to be implemented effectively.”

However, other experts warn that the underlying political and structural issues need to be addressed to ensure sustained stability. The opposition-controlled parliament’s ability to block key government initiatives poses a significant risk to policy continuity, they argue.

Comparisons to Past Crises

South Korea’s financial history includes several major crises, most notably the 1997 Asian Financial Crisis, which forced the country to seek a bailout from the International Monetary Fund. While the current situation is far less severe, parallels have been drawn regarding the need for swift and coordinated action to restore market confidence.

In 2020, during the COVID-19 pandemic, the South Korean government successfully implemented stabilization measures to prevent a financial collapse. The lessons learned from that period are now being applied, albeit under very different circumstances.

Broader Political Ramifications

The martial law controversy is likely to have lasting political repercussions. Public protests demanding Yoon’s resignation have gained momentum, reflecting widespread dissatisfaction with his leadership.

The incident also highlights the fragility of South Korea’s democratic institutions, with critics arguing that the martial law declaration was an overreach that undermines public trust. Political analysts suggest that Yoon may face impeachment efforts if his administration fails to regain credibility.

Looking Ahead

South Korea’s ability to navigate the current crisis will depend on several factors, including its capacity to stabilize markets, resolve budget disputes, and restore public confidence. International investors will also be watching closely, as South Korea’s status as a key global economy hinges on its ability to maintain stability.

In the longer term, addressing structural issues like the Korean Discount and improving corporate governance will be essential for enhancing the country’s attractiveness to global investors.

Conclusion

The events of December 4, 2024, mark a pivotal moment for South Korea. While the government’s swift economic interventions have averted immediate disaster, the political and financial challenges ahead are formidable.

As President Yoon’s administration seeks to recover from this crisis, the lessons learned will not only shape South Korea’s future but also serve as a case study for managing complex intersections of politics and economics in a globally interconnected world.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

5th December, 2024