Moody's: Damage to Korea's credit profile from any conflict would depend on length and intensity

Moody's Investors Service says that any military conflict on the Korean peninsula would damage the South Korean economy, the functioning of its government and its finances, and its payments system, while the severity of the credit impact would depend on the length and intensity of hostilities.

In its analysis, Moody's has considered two broad scenarios: 1) a relatively short-lived conflict lasting a few weeks that imposes material economic damage, but which Moody's assumes would not fundamentally and durably weaken Korea's economy, government finances or institutions; and 2) a longer conflict that is broader in its economic and possibly geopolitical impact, and which would materially weaken several aspects of the sovereign's credit profile.

Moody's conclusions are contained in its just-released report on the Korean government (Aa2 stable), "Extent of negative credit impact of military escalation would depend on containment of conflict".

In August 2017, Moody's raised the assessment of Korea's geopolitical risk to "Moderate (+)" from "Moderate (-)," reflecting an increase in the probability of military confrontation with North Korea (unrated).

While Moody's believes that the potential for outright military conflict involving South Korea, the US (Aaa stable) and possibly others in Asia remains low, it has risen from very low levels. Recent developments are consistent with that view.

The just published report says that a conflict would damage Korea's credit profile through its impact on its economic strength, fiscal strength, institutional strength, and external vulnerability, the four rating factors in Moody's government bond rating methodology.

In the case of a short, contained military conflict, the credit implications would be limited. While such a development would hit financial markets and likely lead to capital outflows, Korea has significant external liquidity buffers.

Korea's economic infrastructure would also incur damage, growth would slow, and inflationary pressures would rise, at least temporarily.

In such a case, the government would likely make use of its fiscal space to support the economy, but the overall financial profile would most likely remain very strong. The impact of such a conflict might also be absorbed without material damage to Korea's credit profile, though Moody's might well choose to reflect the downward bias of risk by assigning a negative outlook to its rating.

However, while a limited conflict is conceivable, there is a high likelihood that, once a conflict starts, it would draw in a wider range of countries and last longer than a few weeks. In the case of a longer conflict, the economic and fiscal costs would be significantly higher and Korea's policy-making and -implementing institutions would come under far greater pressure.

In such a scenario, the sovereign rating would likely move down, potentially by several notches.

In any case, time would be needed to assess the likely impact once a conflict broke out. Moody's has a number of tools at its disposal to reflect the uncertainty during that period, including the option of placing the rating on review for downgrade while the uncertainty persists.