Court Intrusion Incident Severely Damages External Credibility? High Risk of Credit Rating Downgrade [Why&Next]

Concerns about damage to external credibility are being raised again following the incident where supporters of President Yoon Suk-yeol stormed the Seoul Western District Court. Since the onset of the impeachment crisis triggered by martial law, repeated incidents demonstrating political uncertainty?such as calls for President Yoon's arrest, extreme confrontations, divisions, and violence?are having a negative impact on the overall economy and increasing the risk of a downgrade in the country's credit rating. Through key evaluation indicators used by the world's three major credit rating agencies to determine national credit ratings, we examined the economic crisis theory that political turmoil could escalate into a national default crisis and the possibility of a credit rating downgrade.

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Foreign Exchange Reserves and Net External Assets Provide a Strong Buffer Against External Shocks

The key quantitative indicators used by the world's three major credit rating agencies in analyzing and determining national credit ratings are foreign exchange reserves and national debt. Especially for an export-driven economy like South Korea, foreign exchange and fiscal soundness are the two pillars supporting national credibility. The foreign exchange reserves, which can be used in emergencies, are evaluated to be at a stable level. According to the Bank of Korea's foreign exchange reserves statistics, South Korea's foreign exchange reserves stood at $415.6 billion as of the end of December last year. Although this is $47.6 billion less than the peak at the end of 2021 ($463.2 billion), which was reached while defending against exchange rate increases due to the interest rate inversion between Korea and the U.S. after the pandemic, it still exceeds $400 billion.

Despite shocks caused by political uncertainty, this level is sufficient to defend against foreign currency outflows. In a report released after the martial law incident, Fitch rated South Korea's foreign exchange reserves as sufficient, noting that "South Korea's foreign exchange reserves amount to 6.5 times the current account payments." A financial investment industry official diagnosed, "During the past foreign exchange crisis, high foreign currency debt led to a financial crisis due to a sharp rise in the won-dollar exchange rate, but currently, the world's ninth-largest foreign exchange reserves are at a stable level capable of defending against exchange rate increases."

Similarly, the continued surplus trend of net external financial assets, which also helps defend the exchange rate, distinguishes the current situation from past crises. South Korea's net external financial assets reached $977.8 billion as of the end of the third quarter last year. This means that South Korea is a net external asset-holding country with about $1 trillion more invested abroad by domestic investors than foreign investors have invested domestically in stocks, bonds, real estate, and other assets. South Korea's net external financial assets turned positive for the first time in history in 2014 after being negative during the 1997 foreign exchange crisis (-$63.5 billion) and the 2008 financial crisis (-$70.3 billion), and the amount has steadily increased since then. Excluding foreign exchange reserves, the private sector's net external financial assets also turned positive in 2018 and have been on an upward trend since. The ratio of short-term external debt with maturities under one year was 37.8% as of the end of the third quarter last year, indicating a debt structure centered on long-term debt. This ratio was twice as high during the 2008 global financial crisis (72.4%) and soared to 211.4% during the 1997 foreign exchange crisis.

National Debt Tightened but Twice as High Compared to Past Crises

The problem lies in the national debt growing faster than the gross domestic product (GDP). The ratio of national debt to GDP was 46.2% as of the end of December last year. This is at the median level of countries with the same credit rating (AA by Fitch), but it has nearly doubled compared to the 25.7% during the 2008 global financial crisis. The government is tightening the reins by maintaining the national debt-to-GDP ratio below 50% (based on the 2024?2033 medium-term fiscal outlook), but due to rapid aging and other socio-structural changes, it is predicted to surge close to 60% (57.7%) by 2033.

Additionally, increasing fiscal spending pressure to resolve the martial law and impeachment political crisis poses a risk factor. The market views that if an additional supplementary budget is enacted at the level of 1% of GDP, around 25 to 30 trillion won, national debt will increase further, weakening fiscal capacity. Fitch has pointed out, "If government debt increases due to high fiscal deficits, it could exert downward pressure on the credit rating in the medium to long term."

Experts see that, compared to past crises, the increased foreign exchange reserves, significantly expanded net external financial assets, and low short-term external debt ratio act as a solid safety buffer to prevent crises. However, the rapidly increasing national debt could become a risk factor in the medium to long term. The deterioration of the export environment following the launch of Trump's second term, which reduces the current account surplus margin, is also cited as a concern. According to the Ministry of Economy and Finance, the government forecasts this year's current account surplus to be $80 billion, an 11% decrease from the previous year ($90 billion).

If political uncertainty prolongs beyond the second half of this year, the three major credit rating agencies are widely expected to strongly consider the possibility of a credit rating downgrade. Political instability amplifies economic repercussions and policy uncertainty, accelerating the growth of government debt relative to GDP, which could undermine the foreign exchange and fiscal soundness that form the foundation of the national credit rating. Professor Lee Yoon-soo of Sogang University's Department of Economics said, "Concerns about deteriorating fiscal soundness due to increased spending from aging have already been raised, and with the addition of martial law and impeachment issues, economic agents' sentiment is shrinking, deepening the downward cycle of the economy. While these series of incidents may not immediately lead to a rating downgrade, if prolonged, they will increase the possibility of a downgrade."