Korea Comes Full Circle, Back to Investment Grade
Article from Barron's Online
February 22, 1999
By William Pesek Jr.
What a difference a year makes. Fourteen months ago, South Korea was the scorn of Western-style capitalism. The collapses of Thailand and Indonesia were bad enough. But watching Korea, the world's 11th-largest economy, nosedive was serious business. Before global markets knew what hit them, the Asian financial crisis was spinning out of control.
Today, however, a brighter picture is emerging. Recovery is evident in figures on Korean industrial production and retail spending. Exports jumped an annualized 3.7% in January, while imports surged 15.4%. The won is up sharply. Korean share prices are up over 75% since the third quarter of 1998. Interest rates are drifting lower and credit-quality spreads have narrowed considerably.
But the strongest endorsement of Korea's improving fortunes has come from the international rating agencies. Moody's Investors Service recently joined Standard & Poor's Corp. and Fitch IBCA in restoring Korea to investment-grade status. Now that the former Asian Tiger has moved out of the junk category, Korea is well-positioned to pull in the capital needed to meet the International Monetary Fund's expectation for 2% growth this year, after a 5.5% contraction in 1998.
"Korea has gone full circle," says Andrew Brenner of Fimat USA.
To many, the upgrades are the most important stamp of international approval for the country's recovery efforts. It was the recognition officials in Seoul had sought to convince the world they were serious about fixing their broken economy and fragile banking system. Moody's raised Korea's foreign currency country ceiling for long-term bonds and notes to Baa3, the lowest rung of investment grade, from Ba1, and its rating for bank deposits to Ba2 from Caa1.
Investors' enthusiasm was seen in the significant narrowing of Korean government bond spreads. The gap between yields on Korea's dollar-denominated 8 7/8 % global bonds due 2008 and comparable U.S. Treasuries came to 240 basis points (2.4 percentage points) last week. That's a far cry from the 500-plus basis-point spreads seen last year. The gap was 330 basis points at the start of 1999.
Yields on three-year Korean won corporate bonds, another key barometer of Korean rates, also are ratcheting lower. Corporate yields were as high as 33% in December 1997, at the height of Korea's financial crisis, but now are lower comparable dollar-pay issues as the central bank continues to ease monetary policy.
Dollar-denominated issues look the most attractive, and the best buy among them may be Korean Development Bank, which trades at a higher yield than Korean government debt. ...
...
Of equal importance to bond buyers, Seoul is in better shape to defend its currency should turmoil return to the region. Analysts estimate Korea's foreign currency reserves to be in the $50 billion range. Meanwhile, its external debt isn't particularly high, while direct foreign investment is on the rise. Moreover, the risk of default isn't a big concern for investors.
All's not perfect, however. Korea still has a long way to go restoring financial stability. Unemployment, for example, remains historically high. ...
... after months of darkness, a new dawn seems on the horizon, particularly in Korea. Korea's buildup of foreign currency reserves, progress in restructuring its financial sector, lower interest rates and success in stabilizing exchange rates should give the investment community more confidence. For a country that couldn't pay off its short-term loans a little over a year ago, this is a vast improvement.
At the start of the year, Michael Mussa, the IMF's director of research, predicted that analysts may be surprised by how rapidly Korea will rebound. While many economic recoveries -- viewed in chart form -- resemble the shape of a U, Mussa argued that Korea's turnaround may look more like a V. "I am an advocate of the 'V' view, that once the economy hits bottom, the turnaround can be pretty fast, even though a lot of structural problems are going to remain," he said.
Of course, bond investors aren't known for pro-growth leanings. But rather than runaway inflation, stronger Korean growth will mean more capital and liquidity. Inflation is seen advancing at a 3% rate in 1999, compared with 7.5% last year. Unemployment, meanwhile, may approach 9% this year. Add in the fact that the won is well off its lows, the trends hardly have the makings of a price surge.
As any contrarian knows, it's just when things look bleakest that buying opportunities often arise. While many investors remain unwilling to make big bets, some are already reaping the benefits. "Those who understood the Korean recovery story early on are happy today," says David Rolley, emerging markets strategist at Loomis Sayles & Co., a firm whose fund managers were among the first to place bets on Korea following its receipt of a $60 billion IMF bailout.
What's helped Korea, Rolley notes, is that investors are more willing to discriminate among emerging-market economies instead of lumping them into one big unwanted asset class. Today, prospects for financial stability in Latin America and Eastern Europe are far less tied to Russia's woes. And in Asia, Korea, Thailand, and the Philippines are being assessed separately from less reform-minded economies like Indonesia and Malaysia.
As such, it's premature to declare definitively that Southeast Asia has turned the corner. Indonesia, for example, remains mired in economic and political chaos, while Malaysia continues to control the flow of international capital.
But in Thailand, things also are looking up. The nation that represents groundzero of the Asian contagion is either at or rapidly approaching the bottom of its recession. Industrial production is on the verge of moving into positive territory, while consumer demand is on the rise. Its balance of trade has improved, while the baht is up roughly 50% since early 1998. That hasn't been lost on the market. Thailand's benchmark dollar bond trades at 250 basis points over Treasuries, a sharp improvement from 350 basis points at the start of the year and 525 basis points last October.
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