Dagong Global Credit Rating Co., Ltd.
November 22, 2017
Dagong Global Credit Rating Co., Ltd. (“Dagong”) has decided today to maintain both the local and foreign currency sovereign credit ratings for the Republic of Korea (“South Korea”) at AA-, each with a stable outlook. In spite of growing geopolitical risks, South Korea’s domestic political environment is witnessing a return to stability, as wealth creation ability improves with the ongoing implementation of reforms and the government sees a sounder financial base. That, together with relatively low debt loads, persistent current account surpluses and sufficient foreign exchange reserves, guarantees the government’s local and foreign currency solvency.
The main reasons for maintaining the sovereign credit ratings of South Korea are highlighted as follows:
1. Geopolitical risks are increasing, yet the domestic political situation eyes a return to stability, which is conducive to policy implementation. There are mounting tensions on the Korean Peninsula, as a result of North Korea’s fifth and sixth nuclear tests and missile launches, as well as joint military exercises conducted by South Korea and the US. Consequentially, the Korean Peninsula is locked in a stalemate due to the interplay of multiple political powers, which adds uncertainty to the debt repayment environment of South Korea. However, the country’s political situation at home has released some pressure following the recent change of regime. The Minjoo Party of Korea (the liberal party) has won the parliamentary election and presidential election consecutively with broader public support than the conservative opposition at present, which helps carry out economic stimulus policies to create job opportunities, reduce household debt and promote social welfare.
2. The financial system remains stable as risks occur in the private sector. South Korea’s financial system boasts great capabilities of credit supply while banking soundness is continuously consolidated. Benefiting from the asset reorganization of large enterprises in the shipbuilding industry and so on, the debt pressure facing non-financial firms is partially eased. However, household debt is mounting, equivalent to 153.3% of disposal income in Q1 2017, which will pose a potential threat to banking asset quality over the medium term - something which cannot be overlooked.
3. Growing domestic demand will give rise to a stable and improved economy in the short term, with comparatively enormous growth potential in the medium and long term. In the short term, private consumption will recover gradually owing to declining youth unemployment and eased household debt pressure. The government’s strengthening of market regulation over the real estate industry will undercut the performance expectation of the construction industry, yet investment in equipment including semi-conductors will achieve rapid growth. Major trading partners seeing slower economic growth, the devaluation of the Japanese Yen, and the Terminal High Altitude Area Defense (THAAD) effect may place export under pressure. That, combined with an increase in import on behalf of growing domestic demand, will lead net export to make a negative contribution. Therefore, the country’s growth rate is estimated to slightly rise to 2.9% in 2017 and 3.0% in 2018. In the medium and long term, the government led by Moon Jae-in strives to build an innovative economy, reform the social wealth distribution structure, and improve labor market mismatch, which renders non-trading sector-like services as well as small and medium enterprises filled with vitality. South Korea’s economic growth rate in 2019-2022 is estimated to average around 3.4%.
4. Although fiscal surplus is tending downwards slightly, the government’s repayment sources will maintain stable. In the short term, the government’s raising of large corporate tax rates, enhancing efficiency in finance spending, as well as local fiscal freedom all help generate additional fiscal revenues. However, the government will provide greater financial support to social welfare, medicare, SMEs’ development, and defense. As a result, South Korean general government’s fiscal surplus is projected to shrink to 0.8% in 2017 and 1.0% in 2018 while the fiscal surplus excluding social security funds will stand at 1.7% and 1.6% of GDP. However, thanks to the country’s low taxation level, a mid-term tax reform and a stable and improved economic outlook both enable fiscal revenues to reduce the increasing fixed expenditure pressure resulting from population aging. That, coupled with the government’s sufficient financial assets, renders stable repayment resources.
5. The government solvency in local and foreign currency will remain stable. Government debt as a percentage of GDP is expected to increase to 38.6% in 2017 and 39.5% in 2018. The government’s debt burden is reasonable and has a rational structure; state-owned enterprises vigorously cracking down on statements of assets and liabilities reduces contingent liability risks facing the government, thus bolstering solvency in local currency. Meanwhile, the total external debt ratio of South Korea is below 30%, and international reserves cover 3.5 times the short-term external debt. The current account will sustain a moderate surplus in the short run, though facing some pressure of possible narrowing. Furthermore, the country’s moderate external debt and sufficient foreign exchange reserves, as well as a continuously consolidated net creditor position, can retain strong solvency in foreign currency.
In the short term, South Korea’s increased geopolitical risks and heavy debts of the private sector will not significantly undercut government solvency. Delivering modest economic growth and tax revenues showing growth potential can reduce the government’s spending pressure. Additionally, a certain scale of financial assets, strong financing capability, as well as sufficient foreign exchange reserves can ensure government solvency. In this regard, Dagong has decided to maintain a stable outlook for the local and foreign currency sovereign credit ratings of South Korea for the next one to two years.