By Kyle Ferrier
After North Korea’s second “satellite launch” in February this year I looked at how North Korean provocations have impacted the South Korean economy over time through the KOSPI index and the won/dollar exchange rate. The findings suggested financial markets in Seoul have not necessarily become accustomed to provocations, as judged by a limited economic reaction, if a given event is viewed to be outside the context of normal geopolitical developments. The deeper the drop and the longer the recovery a provocation causes, the more investors perceive the circumstances to engender geopolitical risk and thus uncertainty in the marketplace. A number of media outlets linked the drop in the KOSPI and the value of the won at the end of trading on September 9 to North Korea’s nuclear test earlier that day, but to what extent is this actual causality or a coincidence?
While North Korea’s fifth nuclear test is troubling for a number of reasons, perhaps most of all for how soon it took place after the previous test as compared to past intervals, it does not necessarily translate into a market reaction. Though the 1.25% fall in the KOSPI on September 9 coincides with the nuclear test, intraday trading reveals the economic impact of the test itself to be fairly minimal.
News first broke of an earthquake in North Korea, the precursor to a confirmation of a nuclear test, at 9:45am KST, yet from 9:45am to close the KOSPI only lost 0.07%. It is much more difficult to discount the influence the test had on volatility, particularly a spike just after 10am, but the trading range after 9:45am is too narrow to assert it had much of an impact. The vast majority of the day’s fall occurred during pre-market trading, 0.75%, and from open to 9:44am, 0.42%. This opening followed a slump in the U.S. on Thursday, where the S&P lost 0.22% and the Dow was down 0.25%, with the European Central Bank’s (ECB) decision to not extend its current monetary easing program contributing to the drag later in the day.
Moving beyond Friday, separating the reverberations from the event, such as news that another test may be imminent, as opposed to the event itself is also more difficult to definitively do. If we were to assume investors panicked about North Korea over the weekend, holding all other things equal, KOSPI’s 2.3% drop on September 12 would be the biggest reaction to a test since the first one was conducted in 2006. Yet, the geopolitical circumstances of each are so divergent that such a strong response to recent developments seems extremely unlikely, making statements from the Fed and ECB—impacting markets across the globe—and Samsung’s woes much more likely to be responsible for the downturn.
In the currency market, the depreciation of the won since September 9 has also been driven much more by economic factors than Kim Jong-un. Going into the weekend on Friday evening, the won was trading at 1105.05 against the dollar, 0.87% lower than 24 hours before. However, the downtrend in the value of the won started on Thursday after the won traded at its highest point since May of last year on Wednesday, and has continued through this week.
The same economic events influencing the KOSPI are acting on the won, quite possibly to a greater extent. The Bank of Korea’s decision to maintain its key interest rate at 1.25% and the prospects for a Fed rate divergence is an overriding concern, leading one analyst quoted by Reuters to claim, “there are many issues going on in the South Korean market, but it is largely up to the Fed.” Due to its size, Samsung Electronics’ problems with the launch of the Galaxy Note 7 have also hurt the value of the won. As an economist at Shinan Investment Corp. noted, the won was boosted in recent months by foreign investors purchasing stock in tech companies like Samsung Electronics, with the new smartphone problems resulting in much less overseas interest. To put this in context, a sizeable portion of the near 7% drop in Samsung Electronics shares on September 12, which is around 17.6 trillion won of the tech giant’s market cap, was foreign investors selling their shares and their won, leaving Seoul.
Much like with the examination of the test’s impact on the KOSPI, there are limitations to completely isolating out the geopolitical event’s effect on the won. Even so, the possible scope for North Korea to have influenced the won in this instance is clearly quite restricted due to the magnitude of the relevant economic factors. Furthermore, given South Korea’s export struggles, this small potential downward pressure may not be wholly intolerable.
Conflating the negative market effects of North Korean provocations with other economic considerations is not only too simplistic, it can skew perceptions of how influential Kim Jong-un’s actions really are. While monitoring geopolitical risk from North Korea is still very important—surprisingly Japanese stocks may have reacted the most to the test—the financial markets in Seoul are so concerned with risk originating in the market that it would take an event which they believe could directly precipitate armed conflict to produce a reversal in priority for these two risk types. We have arguably witnessed this type of reaction in the past and we may very well witness it again if Pyongyang decides to test again in the coming days or weeks, but it is not what we have seen in response to the fifth test.
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 Bailey Cheng’s photostream on flickr Creative Commons.