By Kyle Ferrier
Expecting the Moon-Kim summit to go well, the Financial Times has reported that markets are more upbeat about the South Korean economy. The price of South Korea’s five-year credit default swaps—reflecting market sentiment on geopolitical risk among other things—is down (which is a good thing) and investors are parking more of their money in Korean stocks, particularly construction companies. They are banking on rapprochement leading to a revival of South Korean-led construction projects in the North. It is thus not surprising that shares of Hyundai Engineering and Construction, responsible for projects in North Korea such as the Mount Kumgang Resort, hit a three-year high on Monday.
While there are reasons to be hopeful about the outcome of the summit, investing now in the resumption of Inter-Korean construction projects is premature even in the best case scenario. This is true for three reasons.
The first is that Seoul has stated it would continue to exert maximum pressure against Pyongyang until concrete actions are taken to address its missile and nuclear programs. As numerous precautionary op-eds in the past month have made clear, North Korea and the United States likely have different definitions of “denuclearization,” which could prove to be a major sticking point in negotiations. Should they come to an agreement on U.S. terms, the next steps would likely be the negotiation and then implementation of verifying and dismantling the North’s nuclear program in exchange for the gradual drawdown of sanctions. This long, drawn-out process suggests that it could very well take years before investors start to see any North Korea-related returns on investments made this week. One could be tempted to make the argument that waiting isn’t a problem once you’ve gotten in on the ground floor and the value of your investment skyrockets. However, others have taken this gamble in the North before and most have lost.
The second reason is that foreign direct investment in North Korea doesn’t have a great track record, at least not for the investors. Although smaller investors not linked to politically motivated ventures have been able to get by in North Korea’s Special Economic Zones, larger investors have had a much tougher go of it. Hyundai lost around $900 million when its Mount Kumgang resort was closed in 2008 after a North Korean guard shot and killed a South Korean tourist. After Seoul shut down the Kaesong Industrial Complex in February 2016, a consortium of 174 South Korean companies claimed to have lost a combined $60 million, which South Korea’s Ministry of Unification agreed to cover last November. There is evidence in both cases of Pyongyang taking over the facilities for their own gain after the South Korean companies closed shop and left. Yet, perhaps the biggest cautionary tale is Orascom.
Orascom, an Egyptian telecommunications conglomerate, entered into a joint venture with the North Korean government in 2008 to form Koryolink, which was charged with building the country’s mobile network. Putting up the majority of the capital, Orascom may own 75 percent of the venture but this does not mean it has effective control. The company has been unable to repatriate revenues from the North estimated to be worth between $500 and $600 million because Pyongyang is either unable or unwilling to let them do so because of sanctions. In an attempt to decrease its activity in the country, Orascom even attempted to give up its majority stake in Koryolink by merging with the government-owned cellular provider Byol in 2015. While this failed, Orascom is still looking to pursue the merger, but that is unlikely to go anywhere until sanctions are lifted.
This poor record may not necessarily reflect what is to come, but rather provides the context for the many challenges which still need to be worked through for foreign investors in North Korea. Kim Jong-un’s apparent shift in focus from the nuclear to the economic side of byungjin (the Kim policy of simultaneously pursuing nuclear weaponry while improving the domestic economy) could again open the door to foreign investors. However, even if we discount the possibility of the door closing as it has done to the detriment of outsiders in the past, it is important to note the limited avenues of recourse investors have in North Korea. It is not as if robust rules to protect foreign investment, which have historically been a major point of contention between developed and developing countries, would be readily implemented should sanctions be lifted. The North’s history of capriciously taking advantage of foreign business ventures suggests that potential investors should be clear-eyed about investing there.
The last and perhaps most important reason that investing now in future Inter-Korean construction projects is premature is that placing long-term bets on the North dismisses possibly more immediate risks in the South. Although there are signs that the rate of increase is slowing, South Korea’s household debt problem is perhaps the most important structural issue facing its economy. Household debt is around 95 percent of GDP, making it among the highest in the world. The government has focused on curbing bank loans to slow the accumulation of household debt and rising home prices, but undeterred borrowers have increasingly turned to non-bank lenders to pay for new homes, further raising prices and making outstanding debt more precarious. The construction industry may be doing well now, growing by 3.3 percent in the first quarter of this year, but with the prospect of more Federal Reserve rate hikes this year there is greater risk of debt problems coming to a head well before the groundbreaking of Inter-Korean construction projects.
It is certainly a good sign that markets are less concerned about geopolitical risks on the Korean Peninsula than they were last fall, though investors should be careful to not get too carried away with the prospect of rapprochement just yet. Being among the first in a new, relatively untouched market can be a tempting prospect, but events that would allow this to happen are far off and even then there would still be major challenges. At this point investors should be more concerned with the more immediate realities in the South and not let a fascination with the North cloud their judgement.
Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone.
Photo from U.S. Army Garrison Red Cloud’s photosteam on flickr Creative Commons.