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Moody's upgrades Korea to Aa3; outlook stable

Posted on August 27, 2012 at 12:20 AM

Singapore, August 27, 2012 -- Moody's Investors Service has today upgraded the Republic of Korea's government bond rating to Aa3 from A1. The rating outlook is stable.

Firstly, Korea's strong fiscal fundamentals enable a relatively large degree of policy space to cope with contingent domestic risks and external shocks. Its government finance metrics are very well placed among all Aa-rated peers.


The government's balance sheet has been relatively unscathed by the global financial crisis and, so far, by the eurozone crisis. The general government budget went into a modest deficit in 2009 as a result of the global financial crisis, but swiftly bounced back into surplus in 2010, and has remained in the black since then. Government debt has been contained at a moderate level in relation to GDP.


The above factors are reflected in Korea's very low gross financing requirement, which at 0.9% of GDP in 2012, according to the International Monetary Fund, is among the lowest for an industrialized economy. Over the medium term, Moody's sees the government's debt trajectory gradually declining.


Moreover, the outlook for government finances is favorable. The large size of Korea's domestic capital market, low inflation, a low risk premium on government securities, and a relatively favorable long-term outlook for economic growth mean that fundamental pressures on the government's debt-carrying capacity are notably absent.


Secondly, the Korean economy has demonstrated resilience to external shocks. It avoided a recession because of the global financial crisis in 2009, and rebounded strongly in 2010. Korea's trend growth has become closely aligned with that of global growth in the past decade, and is therefore stronger than that of the advanced industrial countries.


Korea's economic growth rate this year is slowing with the downturn in global growth, but the competitiveness of its export sector will help lead a rebound as the global economy recovers. Despite these headwinds, the country's labor market has remained relatively healthy—the unemployment rate was 3.1% in July. Over the long run, continued gains in labor productivity and restraint in unit labor costs will be essential in maintaining the economy's competitiveness and its potential growth rate, which is close to 4%.


Thirdly, macro-prudential regulatory measures and improved risk management have proved effective in reducing banking sector vulnerabilities. The risks associated with a heavy reliance on off-shore wholesale market funding became evident during the global financial crisis. Since then, banks' have appreciably reduced their reliance on short-term external funding as a share of total external liabilities; loan-to-deposit ratios for the regulated banks; as well as for the policy banks; have declined to a more prudent level.


Related to this issue is the presence of system-wide self-insurance against deleveraging and risk aversion in the global financial markets. Official foreign exchange reserves have risen and have remained above $300 billion since April 2011; standing near a record level of $314 billion as of July 2012. In contrast, during the global financial crisis, they had plummeted to $201 billion.


Fourthly, the rating action is supported by a developing outlook which suggests that the geopolitical status quo will not be adversely disrupted by the ongoing leadership transition in Pyongyang. However, a possible step-up in Pyongyang's economic engagement with Beijing, as seen in the announcement of three new industrial zones along the China-North Korea border, suggests that the risk of an collapse of the autarkic communist state during the leadership transition phase is diminishing. Furthermore, the risks relating to renewed military conflict on the Korean peninsula are contained by the long-standing deterrence provided by Seoul's robust alliance with Washington.


North Korea-related event risks factored into our Sovereign Bond methodology do not constrain the Republic of Korea's rating at the Aa3 level.



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