A clearer picture in Seoul
South Koreans went to the polls last week and elected a special forces soldier turned human rights lawyer as president. Moon Jae-in will need both skillsets in dealing with a belligerent North Korea, distrustful China and saberrattling US. Yet an even tougher task may prove delivering on his promises to shake up collusive ties between big business and the government, and so unleash animal spirits. I would argue, however, that for once the combination of geopolitical imperatives and domestic economic realities could produce a situation that favours investors.
First the geopolitics. Simply by being there, Moon should be able to lessen tensions. Since his predecessor’s ouster in March, other political actors have been able to capitalise on the vacuum for their own gain.
Moon is likely to offer a refreshed version of the “sunshine” policy, which may lessen tensions with Pyongyang and Beijing. As for Washington, he is likely to allow deployment of the THAAD anti-missile system, while at the same time cranking up defense spending — US contractors should do well — thereby defusing tensions over South Korea’s big trade deficit with the US.
Moon campaigned to upend collusive ties between “Chaebol” groups and top officials and push institutional reform that spreads economic gains. These ambitions will be hard to achieve quickly, which is why the government is likely to look for shorter term measures to boost economic growth.
There are two broad paths to reshape Korea Inc, namely, (i) bottom-up reform based on improved governance and anti-trust measures to tackle dominance and collusive behaviour, and (ii) top-down measures focused on constitutional reform. The latter would limit Korea’s “imperial presidency” by, for example, stopping pardons being granted to convicted Chaebol bosses — a practice that provides a “put option” to bad business leaders.
Moon has indicated a desire to push constitutional reform as his main agent of change, however, that will require a 60% parliamentary majority. His Minjoo Party is the largest in the National Assembly, but only has about 35% of the seats. The next parliamentary election is slated for 2020 and Moon seems to be arguing that this election will be framed around core issues of constitutional reform.
Which brings us to the here and now. Moon has promised to boost the growth in fiscal spending to 7% a year through 2022.
He plans to fund this expansion without incurring a deficit blow-out by raising the corporate profits tax level from its current effective 19%. A big chunk of this extra government spending is set to go on military hardware. For example, a planned “Kill Chain” system — allowing a pre-emptive missile strike against the leadership in Pyongyang and its nuclear capability — has been pushed forward. Such spending will likely temper demands in Washington for a US-South Korea free trade agreement to be renegotiated.
It’s a fools errand to predict Pyongyang’s actions, but there is reason to think this election will lessen the geopolitical risk premium attached to South Korea. On the other side of the ledger, hopes for structural reform should be discounted far into the future.
Given that Moon will likely push incremental measures that nudge corporate governance in the right direction, the net outcome should be supportive to Korean asset values.
Moreover, Korea should benefit from an improved global growth outlook as shown by exports rising 15% this year, their fastest expansion since 2011.
Benign inflation will allow the Bank of Korea to maintain an easy monetary policy stance which, combined with undemanding valuations, means that the current rally in South Korean equities (up more than 20% in currency adjusted terms this year) has room to run.