[Herald Interview] 'Reunification could damage S. Korea’s sovereign rating'

North Korea is the only potential trigger for a downgrade of South Korea’s current sovereign rating of AA -- the third-highest level on the S&P Global Ratings table, an expert from the credit appraiser said.

If reunification of the Korean Peninsula is to happen -- though it is a very “unlikely scenario” -- South Korea’s sovereign rating could take a hit, according to Kim Eng Tan, senior director for the sovereign ratings team in Asia-Pacific.

"(Reunification) is a contingent liability, and if it happens, the South Korean government would have to spend very heavily on rebuilding infrastructure and social infrastructure in the North,” Tan said in an interview with The Korea Herald in Seoul last week.

Although reunification could eliminate the security risk associated with the Korean Peninsula in the long term, it would bring down South Korea’s creditworthiness in the short term as fiscal spending will have to grow to support the North, he explained.

Two additional ways South Korea’s sovereign rating has been penalized in association with North Korea are in assessments of its institutional framework and its investment climate.

“The institutional framework here is very strong, but due to the security risks emanating from North Korea, the institutional environment is weaker than some other countries with an equally strong system,” Tan said.

He further explained the on-and-off provocations from the North create a negative sentiment on the overall investment climate for South Korea, resulting in a so-called “Korea discount.”

But ironically, if the attacks were to continue, the rating could be boosted, as it shows that the South Korean economy remains stable regardless of the provocations from the North, Tan suggested.

“If provocations like this continue to have very little impact on economic or financial sentiments, then we may remove the adjustment. In that case, the rating may go up,” he said.

Aside from North Korea, South Korea's only concern would be surging government debt, though the ratings expert does not view this to be a grave threat. While the national debt-to-gross domestic product ratio reached 49.6 percent in 2022, this liability has yet to reach a concerning level for South’s credit assessment, Tan said.

“We believe that the government has quite a lot of financial assets locked up in social security funds, especially under the National Pension Service,” he said, referring to the world's third-largest pension fund with 984.2 trillion won ($747.9 billion) in its coffers.

“If we were to compute (taking in these liquid assets), then the net debt level for South Korea is just about 10 percent of the gross domestic product, which is quite a low level,” he said, adding the threshold level to weaken the rating support is at about 30 percent.

With the turbulent economy, the global ratings environment has seen unprecedented changes in the past months. Top credit rating agencies have put the US and China on downgrade warnings out of concern for surging government debts.

In November, Moody's affirmed the top AAA rating for the US while changing the outlook to negative, while Fitch brought down its rating by a single notch from AAA to AA+ in August.

Moody's further adjusted its outlook on China, lowering it to negative earlier this month while maintaining its A1 rating, several notches below the top level.

Though the downgrade warnings pose a risk for South Korea, which is heavily dependent on the world's two largest economies, the rating firm views they will not have a direct impact on the credit assessment of South Korea, as the country's domestic economy is large enough.

The growing tension between the US and China, however, may have an indirect impact on the rating, as the growth of the local economy is limited by the US trying to control technological flows to China, Tan projected.

“To the extent that big companies in South Korea cannot export some of their goods or grow their market share in China or even their investments, there may be some impact on economic growth going forward,” he said.