South Korea’s political shock will reverberate for markets

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A lot can happen in six hours. A declaration of martial law — the first since the 1987 introduction of democracy in South Korea — came out of the blue on late Tuesday night. Protests and fierce opposition from the country’s lawmakers in the hours immediately following pushed South Korean President Yoon Suk Yeol to lift his order quickly. But the effects on the markets should be much longer lived than the few hours of chaos that the country just experienced.

Yoon declared martial law amid a dispute with opposition parties, who he accused of harbouring North Korean sympathies and plotting anti-state activities. His martial law order was rejected unanimously by members of South Korea’s national assembly. Most notably, critics of the move included the leader of the president’s own party.

Following Yoon’s order, the market reaction was as dramatic as the public shock around the country. Sovereign credit default swap premiums rose, South Korean stocks listed in the US plunged and the Korean won weakened sharply against the US dollar, to its lowest level in two years. Whether or not the local stock market would even open on Wednesday looked uncertain, with regulators locked in emergency discussions until two hours before market open.

After the order was lifted, some damage has been reversed. Credit default swap premiums have returned to previous levels. The benchmark Kospi index fell just 1.4 per cent and the finance ministry’s pledge of “unlimited” liquidity support to markets certainly helped soothe panicked investors.

Yet, there are still signs that these are not normal times. The won remains near a two-year low, which will have a significant impact on the local banking sector. A weaker won typically means a decline in the common equity tier one capital ratio at local lenders — especially those with large amounts of foreign currency assets — as risk-weighted assets rise. Shares of the country’s biggest lenders, including Shinhan, Hana and KB financial groups, fell 6 per cent on Wednesday. Meanwhile, foreign investors net sold local shares worth $300mn on the main bourse reflecting heightened concerns over political risk. 

One lasting source of investor fears will be the stunning abruptness of the martial law order — with the question being whether it could happen again, at any time. With South Korean opposition parties having submitted Yoon’s impeachment bill just hours ago, a long drawn-out political struggle is just getting started. Until a resolution is reached, local stocks will have to price in a higher political risk premium to keep investors onboard.

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