The Korean economy has presented a series of encouraging economic indicators lately, and the rosy outlook for the nation was further bolstered last Monday when internationally renowned credits rating firm Moody’s upgraded Korea’s sovereign credit rating outlook from “stable” to “positive.” It is likely that Korea will soon enjoy the status of “AA (double A),” while other nations continue to see their credit ratings slip. Why did Moody’s decide to positively adjust Korea’s credit rating and what does it imply? Dr. Kim Chang-bae of the Korea Economic Research Institute is here today to answer those questions. First, he tells us about the significance of Moody’s ratings adjustment for Korea.
Moody’s actions have two meanings for Korea. First, it is an indication of the world’s trust in Korea’s economic status and performances. Since 2011, Moody’s has raised the rating or rating outlook of only three countries with a rating of A or better – Korea, Botswana, and Chile. The exclusivity of Moody’s decision illustrates the latest rating upgrade has significant implications. Second, Moody’s upgrade from “stable” to “positive” puts Korea on the threshold of “AA” rating after many years in the “A (single A)” category. The highest level of credit rating achieved by Korea was “A” or “A1,” but now the nation is poised to go to the next level.
A credit rating outlook is a projection of changes in credit rating within a year or a year and a half. A “positive” outlook indicates a possibility of an upward adjustment, while a “negative” one many result in a drop in ratings. Currently, Korea’s credit rating stands at “A1,” and the recent Moody’s decision increases Korea’s chances of reaching “Aa3 (double A three)” within a year. If Korea does get a rating of “Aa3,” that would be the highest grade given to Korea by Moody’s, which had downgraded Korea’s rating to Ba1 during the 1997 Asian financial crisis. What led Moody’s to give the Korean economy a positive assessment in 2012?
There are four factors behind Moody’s decision on Korea. First, Moody’s had factored in Korea’s fiscal soundness. Ever since the financial crisis, credit ratings firms have looked at a country’s fiscal conditions first when upgrading the rating. The second factor is Korea’s external soundness. Considering Korea’s growth potential or inflation rate, Moody’s must have thought that the Korean government is capable of paying back its foreign debts. Thirdly, Korean banks were deemed less vulnerable to external factors by cutting down on their short-term foreign debts. Lastly, despite the power shift in North Korea following the death of its leader, the geopolitical risks associated with North Korea remain under control, which certainly helps South Korea’s economic prospect.
Among the four factors that have driven Moody’s decision, the most noteworthy one is fiscal soundness. According to the Bank of Korea, financial debts of the Korean government and public corporations increased to 80.2 trillion won, roughly 70.9 billion U.S. dollars, over the last four years. Korea’s national debt stands at 32% of its gross domestic product, way lower than the average of the Organization for Economic Cooperation and Development nations at 100%. As a matter of fact, foreign investors made 2.3 billion dollars’ worth of direct investments in Korea in the first quarter of this year, the largest amount since the 2008 global financial meltdown, attesting to the international community’s favorable assessment of Korea’s economic capacity and potential. How farther can these positive evaluations take the Korean economy?
Last November, another international credit ratings firm, Fitch, raised Korea’s credit rating from stable to positive. Just four months later, Moody’s followed suit. That means two out of three major credit ratings firms have signaled their intent to raise Korea’s sovereign rating, nudging Standard and Poor’s, the harshest grader of the three, to make a similar move in the near future. An upgrade of rating outlook, not even the rating itself, could bring a number of benefits to Korea. One of the direct benefits is that Korean financial institutions or companies can borrow money more easily. And with the international community’s trust in Korea rising, foreign investors would find Korea an attractive place to invest. As a result, local interest rates would fall, leading to lower investment costs for local companies, as well as fewer defaults and more payments of household debts.
Last August, the national credit rating of the United States fell from AAA to AA+ for the first time in the 70-year history of national sovereign ratings system. Whenever the three major credit ratings firms make important decisions, such as downgrading the ratings of European nations, the stock markets and investors around the globe are thrown into confusion and turmoil. Meanwhile, Korea’s export continued to surge and the foreign currency reserve stood at a record 315.8 billion dollars as of late February, all positive economic indicators for the nation, which results in easier funding and lower interest rates. But it is too soon to relax. Before Moody’s actually upgrades Korea’s rating a year from now, Korea must turn these positive indicators and assessments into real benefits that will improve the lives of ordinary Koreans.
Barring any unforeseen events, Korea’s actual sovereign rating would be upgraded in a year or in six months at the earliest. An AA rating would be the highest rating given to Korea. Our fellow members in the AA category include Saudi Arabia, China, Taiwan, Japan, Belgium, and Chile. The gap between the economic indicators and the real economy is not a problem confined to Korea, but one that’s affecting other major economies. I believe this problem stems from weakened correlations between growth and employment. What I mean is that, unlike in the past, growth does not equate with more jobs, which results in stagnant household incomes. This is why Korea’s encouraging economic data have hardly improved the finances of ordinary households. This is the reason why Korea must create more jobs to improve the real economy.
It is good news that Korea’s credit rating outlook has been upgraded despite many internal and external uncertainties. But the economic stats and indicators must be translated into real income and jobs for Korean citizens. And Korea still remains vulnerable to global economic conditions, soaring oil prices, and modest local spending caused by high household debts. Rather than growing complacent at the prospect of a higher sovereign rating, Korea should continue reinforcing its economic fundamentals and bring real growth benefits to ordinary Koreans.