South Korean black swan may be about to spread its wings
Seoul's biggest worry is that Trump administration reopens trade deal
YOICHI TAKITA, Nikkei senior staff writer
TOKYO -- It has been a turbulent month on the Korean Peninsula. First the North tests another missile, then Kim Jong Nam is murdered in a Malaysian airport, and now the de facto head of Samsung Electronics has been arrested on bribery allegations. Investors should brace for the possibility of an unexpected shock to financial markets from Seoul.
Market watchers are looking ahead anxiously to April, when the U.S. Treasury Department will release its next semiannual report on the foreign exchange policies of major trading partners. The fear in Seoul is that Washington may brand South Korea a currency manipulator.
A recent Financial Times article argues Donald Trump may have picked the wrong Asian partners to go after as manipulators. South Korea and Taiwan, rather than China and Japan, are more obvious targets for such criticism, Robin Harding writes in Tokyo.
Japan and China run current-account surpluses equal to around 3% of their respective gross domestic products; South Korea's surplus stands at more than 8%. Moreover, Seoul does not announce its foreign exchange interventions.
South Korea's government is eager to quash such speculation. But one think tank reckons the country may become the first to be designated a manipulator by the U.S., as a sort of scapegoat for bigger-fish China.
The FT article appears to have touched a raw nerve in South Korea, for spokespersons for the Ministry of Strategy and Finance and the central bank wrote a letter to the newspaper denying that the country manipulates its exchange rate.
They contend that assessments by the International Monetary Fund and the U.S. Treasury affirm this fact. As for South Korea's current-account surplus, "extensive research" suggests the causes lie mostly with demographic changes and a fall in the price of crude oil, the spokespersons write.
How do these arguments stand up to scrutiny? On the first point, the October 2016 forex policy report states that "Treasury has urged Korea to limit its foreign exchange intervention to only circumstances of disorderly market conditions." Rather than an understanding for Seoul's position, this suggests mounting frustration on the U.S. side.
The report also notes that South Korea does not disclose its interventions, "unlike many other major emerging markets and industrialized economies."
"Treasury continues to encourage the Korean authorities to increase the transparency of their foreign exchange operations," the department also writes. All this urging and encouraging seems to be falling on deaf ears.
While it is true that an aging society and the oil price influence South Korea's current-account surplus, the problem is its sheer size. At 8.3% of GDP in the first half of 2016, South Korea had the second-largest surplus in the Group of 20, trailing only Germany. The Treasury report cites an IMF assessment that the won's real effective exchange rate is 4-12% undervalued.
Kid gloves or gloves off?
Needless to say, the Korean Peninsula is a crisis waiting to happen, as shown by the fact that U.S. Defense Secretary James Mattis' first trip abroad in office was to Seoul. North Korea's nuclear and missile development continues apace. The U.S. surely wants to avoid unrest in its southern ally, if only to ensure deployment of a ground-based missile defense system there.
But such strategic concerns may not alleviate U.S. pressure on Seoul when it comes to trade and currency matters. Trump says the benefits of their bilateral free trade agreement are skewed to the Korean side. It is true that the U.S. trade deficit with South Korea has widened dramatically since the agreement took effect in 2012.
Seoul worries that the deal may become next on the Trump administration's list of renegotiation priorities, after the North American Free Trade Agreement. The fear of being labeled a currency manipulator is a manifestation of this state of anxiety. If President Park Geun-hye's impeachment is confirmed and a left-wing administration succeeds her center-right government, that fear could become a reality.