Moody's: Korea's credit profile supported by very strong fundamentals; geopolitical risks are key credit constraint

Moody's Investors Service says that Korea's (Aa2 stable) credit profile is supported by very high economic strength, given a diversified and competitive economy, with robust growth potential -- around 3% over the next five years -- and high income levels.

Moreover, the government's fiscal fundamentals are also very strong, due to a prudent fiscal stance that maintains government debt at moderate levels -- 38.3% of GDP in 2016 -- and supports debt affordability.

In addition, Korea's very strong institutional framework bolsters its resilience to potential economic and financial stability risks.

The administration's ability to implement structural reforms against the background of a rapidly ageing society poses a longer-term challenge.

Separately, elevated geopolitical risks, given tensions with North Korea (unrated), are the key credit constraint. Uncertainty about the possibility of a conflict has risen in recent months. Any potential military conflict would damage the economy and weaken public finances, and may affect the functioning of the government and the country's payment system.

The severity of the credit impact would depend on the duration and intensity of any conflict.

Moody's conclusions are contained in its just-released annual credit analysis, "Government of Korea -- Aa2 stable". The analysis elaborates on Korea's credit profile in terms of economic strength, Very High; institutional strength, Very High (+); fiscal strength, Very High, and susceptibility to event risk, Moderate (+), which are the four main analytic factors in Moody's Sovereign Bond Rating methodology.

Moody's expects real GDP growth of 3% and 2.8% in 2017 and 2018, respectively. The measures outlined in the government's roadmap, which focuses on income-led and innovation-based growth, are likely to contribute to some extent to maintaining potential growth above many similarly rated advanced economies.

Korea's households have increased their borrowing over the past decade, with total household debt reaching 83% of GDP as of June 2017. Comparing households' liabilities to disposable income, Korea's household debt-to-disposable income ratio rose to about 167% as of the end of 2016. While not posing an immediate financial stability risk, Moody's views elevated household debt levels as potentially significantly dampening growth if households have to deleverage.

In response to the rapid build-up in household debt, the Korean government has taken and continues to introduce measures to counter potential financial stability risks. In Moody's view, this mitigates but does not eliminate the risks to growth posed by high household debt.

In addition to the risk of a military conflict, and possibly not unrelated, geopolitical event risk also lies in the potential for a regime collapse in North Korea. Depending on how it would unfold, such an event could lead to acute financial strains for Korea's government for an extended period, while potential economic benefits would likely take time to materialize.

The stable rating outlook reflects Moody's view that Korea's credit strengths and challenges are balanced. Korea's credit fundamentals will remain strong over the coming three to five years under the rating agency's baseline scenario and also resilient to adverse shocks.