When Moody’s Investors Service elevated Korea to the “double-A” category two weeks ago by raising its sovereign credit rating by one notch to “Aa3” from “A1,” some analysts were not sure whether Korea really deserved it.
As if to assure them that Korea fully deserved it, Fitch Ratings also made Korea a double-A country last week by upgrading its credit level to “AA-” from “A+.” Fitch’s “AA-” is equivalent to Moody’s “Aa3.”
The successive upgrades can be seen as a strong vote of confidence in the Korean economy. The two agencies moved Korea up when many countries have been downgraded since last year.
Korea stands out as it is the only country to be assigned a higher grade this year among countries with a single-A or higher credit rating.
Fitch’s decision is especially notable as it puts Korea one level higher than Japan, a first for the nation. The agency downgraded Japan’s creditworthiness by two steps from “AA” to “A+” in May, citing its massive public debt.
The primary driver of the two agencies’ actions was Korea’s sound fiscal health. Korea’s government debt-to-GDP ratio remains in the 30 percent range, enviably low compared with most debt-ridden countries.
The government deserves some credit for the healthy balance sheet as it has maintained fiscal discipline despite the current economic slowdown. It has also resisted the temptation to increase spending in an election year.
Another important element was a significant reduction in Korea’s external vulnerabilities. The nation’s foreign exchange reserves continue to increase on the back of sustained current account surpluses.
The banking sector also managed to reduce their reliance on short-term external funding, which has long been a source of vulnerability. The financial regulator can claim some credit for this.
Korea’s resilience to external shocks also played a role. Despite global economic turbulence, the Korean economy has continued to grow, albeit in a slower pace than before. A sustained economic growth contributed to stabilizing the labor market.
The rating adjustment will benefit Korea in many ways. In the first place, it will cut the nation’s interest payments on foreign debt by $400 million a year. It will also increase inflows of foreign funds into domestic capital markets. The improved creditworthiness will burnish Korea’s image, making Korean products more attractive to foreign consumers.
Yet the government should not be complacent as the rating upgrade does not mean the Korean economy is out of the woods. The economy still faces a host of problems amid continued global economic uncertainty and volatility.
Recently, the nation’s economy has been losing steam rapidly. Exports fell 6.2 percent in August compared with a year ago, following an 8.8 percent drop in July. For the first eight months of the year, exports decreased 1.5 percent.
The lackluster export performance has led domestic and foreign research institutes to downgrade Korea’s growth estimates for this year to the 2 percent range, way below its potential growth rate of around 4 percent.
The government therefore needs to stimulate economic growth to prevent the nation’s growth potential from being further weakened. It should revitalize exports, the main engine of growth, by helping corporations explore new markets.
At the same time, it needs to boldly deregulate the service sector to improve productivity, create more decent jobs and boost domestic demand.
The government should also address problems identified by the rating agencies. For instance, Fitch warned against the rising indebtedness of state-owned enterprises. Total liabilities of the nation’s 28 large SOEs shot up to 26.6 percent of GDP in 2011, up from 16.2 percent in 2007. Efforts should be made to curb SOE debt growth.
Another intractable problem threatening the economy is large household debt, which is suppressing domestic demand. To defuse the debt bomb, the government should press financial institutions to help the “house poor” ― people having difficulties paying their mortgages.
Banks will ultimately help themselves by stabilizing the housing market as mortgages account for a large proportion of their loans to households.
Going forward, the central challenge for the government will be meeting an explosive growth in demand for welfare services without hurting fiscal soundness. The key to unlocking the conundrum lies in creating a virtuous circle of economic expansion, job creation and income growth.
