Fitch Lowered South Korean’s Ratings Because of Trump – Kim Summit Result

Diep Nguyen

17:06 07/03/2019

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Fitch maintains a one-notch reduction relative to the outcome of our Sovereign Rating Model on South Korea's rating, which we affirmed at 'AA-' in January, to reflect these risks.

Fitch Lowered South Korean’s Ratings Because of Trump – Kim Summit Result
The lack of an agreement during last week's summit in Hanoi between US President Donald Trump and North Korean Chairman Kim Jung Un confirms that the diplomatic process on the Korean peninsula will be protracted and highly uncertain, says Fitch Ratings in the latest report.
The easing of tensions over the past year is positive for South Korea from a credit perspective, but is yet to result in structural decline in geopolitical risk. Fitch maintains a one-notch reduction relative to the outcome of our Sovereign Rating Model on South Korea's rating, which we affirmed at 'AA-' in January, to reflect these risks. 
The latest talks appear to have faltered over the scope of sanctions relief sought by North Korea in return for closing its Yongbyon nuclear site, and lack of agreement over the definition and sequence of denuclearisation of the Korean peninsula.
Differences over the scope of denuclearisation remain a key sticking point in reaching an agreement significant enough to form the basis of an eventual normalisation of relations. North Korea seems to maintain that denuclearisation should entail the removal of the US nuclear umbrella from South Korea.
A full assessment of the implications of the summit may take time, as the two sides appear willing to continue a dialogue. Fitch expects negotiations to continue at a working-level, but there remains a risk of a further breakdown. Fitch has previously flagged the possibility that a breakdown in the diplomatic process, were it ultimately to happen, could be a trigger for conflict, but that does not appear to be an immediate risk. 
Fitch believes that the negotiations still have the potential to reduce tensions between North and South Korea on a more permanent basis. Nevertheless, North Korea has failed to follow up on promises in the past, including on denuclearisation. Media reports this week suggest that North Korea has recently resumed construction of a long-range missile factory, possibly before the Hanoi summit, underlining the uncertainty over the regime's intentions.
The lack of an agreement in Hanoi was a setback for South Korean President Moon Jae-In's efforts to deepen ties between South and North Korea. UN sanctions are likely to remain in place for the foreseeable future, and will limit South Korea's ability to foster increased economic integration with the North. Stronger economic cooperation is likely to be a key factor underpinning any eventual structural decline in tensions on the peninsula. 
It remains to be seen whether there will be any domestic political spill-overs in South Korea that could complicate the implementation of President Moon's economic agenda. President Moon's approval ratings have fallen significantly amid recent economic challenges, and he is likely to remain eager to support his popularity through progress toward a further easing of tensions with North Korea. 
Business and consumer confidence indicators in South Korea have shown little correlation with the significant swings in tensions with North Korea in the past few years. The economy has, however, slowed amid weaker external demand and US-China trade tensions, with GDP growth falling to 2.7% in 2018 - the slowest pace since 2012.
The unemployment rate rose to 4.4% in January 2019 from 3.7% at end-2017. Fitch expects GDP growth to moderate further to 2.5% in 2019, as government stimulus measures will only partially offset soft exports and private investment.

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