Fitch Affirms Korea at 'AA-'; Outlook Stable - Reuters News

Fitch Ratings has affirmed Korea's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AA-'. The issue ratings on Korea's senior unsecured foreign- and local-currency bonds are also affirmed at 'AA-'. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at 'AA+' and the Short-Term Foreign- and Local-Currency IDRs at 'F1+'.

KEY RATING DRIVERS

Fitch's affirmation of Korea's sovereign ratings with a Stable Outlook balances a strong macroeconomic performance and robust external finances, with geopolitical risk related to the tense relationship with North Korea and longer-run challenges of rapid population ageing and low productivity.

Korea's economy has continued to perform strongly compared with many of its peers. The export earnings of its small, open economy fell drastically in recent years, but domestic demand was supported by fiscal and monetary easing. Fitch forecasts GDP growth to be broadly stable in the coming years: at 2.8% in 2016, 2.9% in 2017 and 2.8% in 2018. This growth path is slightly below the 2011-2015 average of 3%, partly reflecting the gradual weakening of GDP growth in China.

Robust external finances continue to support the credit profile. This includes persistent current-account surpluses since 1998, foreign exchange reserves at 8.6 months of current-account receipts (versus a median of 4.6 months for sovereigns rated in the 'AA' category) and a net external creditor position, even though net external assets of 27.4% of GDP are lower than the 'AA' median of 45.5%. The strong external balances make Korea less vulnerable than many other countries in the Asia-Pacific region to potential general financial market turmoil. However, Korea is more exposed than many other countries to a severe slowdown scenario in China, its largest trading partner.

The ongong corporate restructuring in a number of sectors, including shipbuilding and shipping, is likely to weigh somewhat on GDP growth in the short run, but will support more productive allocation of resources in the longer run. The Korean economy is challenged in the longer run by a rapidly ageing population, as evidenced by the lowest fertility rate (1.24% for 2015) among some 40 countries tracked by the OECD, which had an average of 1.68%. Stronger domestic demand-led GDP growth in the long run without increased leverage in the economy does not seem viable unless the impetus comes from a significant rise in productivity growth. Low productivity is prevalent, in particular in the services sector and among SMEs.

Geopolitical risk resulting from the longstanding conflict on the Korean peninsula continues to weigh on the rating. The build-up of tensions in 2016, following the fourth and fifth nuclear tests performed by the North Korean regime in January and September respectively, is illustrated by the closure of the jointly-run Kaesong Industrial Complex in the North. Uncertainties are exacerbated by the opacity of the North Korean regime's policies. Risks to the sovereign balance sheet relate to both the risk of conflict and a long-term scenario of reunification. However, reunification would also provide opportunities in terms of political stability and relatively cheap labour during a transition period of integration for manufacturing export-led growth.

Korea's government debt of 38.9% of GDP in 2016, as forecast by Fitch, is broadly in line with the 'AA' median of 39.8%. To deal with pressures arising in the long run as a result of the unfavourable demographics, the authorities are proactively working on new legislation with the aim of increasing fiscal accountability and setting out clear fiscal policy rules. Fitch expects the consolidated fiscal surplus (including social security) of 0.2% in 2016 to increase marginally to 0.3% in 2017 and 0.4% in 2018.

Household debt is high (93% of the rolling four-quarter GDP in 2Q16) and rising fast (8pp of GDP in just two years). This dampens households' propensity to consume and increases Korea's vulnerability to shocks, although household assets are also relatively high, which mitigates the risk to financial stability and the economy. The authorities' measures to stimulate conversion of mortgage debt into longer maturities and at fixed rates seem effective: 77% of total new loans are now amortising and 72% have fixed rates.

Korea's expected per capita income at USD27,687 in 2016 is one of the lowest in the 'AA' category (the median is USD40,222). However, Korea is more developed than the income level would suggest. The country is ranked fourth out of 189 countries for the World Bank's Ease of Doing Business indicator, but scores below the 'AA' median for its Governance indicator (73rd percentile versus 81st percentile).

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Korea a score equivalent to a rating of 'AA' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:

• Structural features: -1 notch, to reflect substantial geopolitical risk related to the tense relationship with North Korea and a Fitch Banking System Indicator (BSI) score of 'bbb', which is well below the Sovereign Long-Term Foreign-Currency IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that, individually or collectively, could trigger positive rating action are:

• Implementation of a convincing strategy to improve overall debt dynamics for the general government and state-linked enterprises.
• Evidence that the economy can grow at a relatively high rate over time without deterioration in the aggregate household balance sheet, for instance resulting from successful reform implementation that would spur productivity growth.

The main factors that, individually or collectively, could trigger negative rating action are:

• An unexpected large rise in the public-sector debt burden caused by a deviation from the current prudent fiscal-policy framework or crystallisation of financial sector or other contingent liabilities.
• Evidence that GDP growth will be structurally lower than expected, potentially reflecting medium- to long-term challenges for Korea's economic model.

KEY ASSUMPTIONS

• No significant change in the relationship between North and South Korea, such as a full-scale military conflict, or the sudden collapse of the regime in the North leading to instability on the Korean peninsula.
• The global economy performs broadly in line with Fitch's Global Economic Outlook, with a slight rise in global real GDP growth to 2.8% in 2017 and 2.9% in 2018, from 2.6% in 2016 and a gradual slowdown of growth in China to 5.8% by 2018.