South Korea is a high-tech industrialised country that is still classified as an emerging market by MSCI. And that, it seems, suits South Korea.
By most criteria, South Korea shines as a modern developed economy that boasts a skilled population. The country, a democracy since 1987, OECD member since 1996 and past chair of the G20, is the world’s thirteenth-largest economy, when ranked on purchasing-power parity.
South Korea’s achievement in creating a modern $US1.4 trillion economy, which is ranked 45th in the world by GDP per capita (at $US30,000 ), is impressive considering that in 1980 South Korea was just an $US88 billion economy, or one-fifteenth its size today.
The immediate economic outlook of the country of 50 million people is favourable. South Korea was one of the few OECD members to escape recession after the global financial crisis thanks to the largest stimulus package of any OECD member (6.1 per cent of GDP). The IMF expects strong export and investment spending to underpin annual GDP growth of 4.2 per cent in the coming four years.
‘Chaebols are giant family-controlled businesses that drove South Korea’s industrialisation from the 1960s’
Even many of South Korea’s structural economic challenges now mirror those of other developed nations. The country has an ageing population due to the lowest birth rate by far of any of the 34 OECD members (1.15 child per woman)while having among the highest household debt burdens (above 150 per cent of disposable income). South Korea’s small and medium-sized business sectors are inefficient, the labour market is inflexible and the economy is too reliant on exports.
At an investment level, South Korea meets many developed-market standards. The country is home to one of the world’s most liquid stock markets where investors can find some of the world’s most savvy companies. Samsung, Hyundai and LG are global leaders in many of their core businesses and, accordingly, have extended their reach around the world.
Investors who track FTSE indices recognised South Korea’s achievements in 2008 when their feedback prompted FTSE to promote South Korea to its highest classification of “developed”.
(Index providers ask big investors their opinions before promoting and demoting countries on classifications such as “developed”, “emerging” or “frontier”.)
Yet in June, after its annual review of classifications, MSCI once again kept South Korea as an “emerging” market, which lumps it with countries such as Morocco, Peru and the Philippines. South Korea, at 15 per cent of the MSCI Emerging Markets Index, is the largest country in this benchmark after China and Brazil.
There are two reasons South Korea fails to qualify as developed for MSCI. The first is that the won does not trade much outside of the local time zone because the central Bank of Korea bars settlement in other time zones. The other is that investors need to hold a licence to buy stocks.
As an emerging market, South Korea misses out on billions of dollars in investor flows that it would attract from funds, especially index portfolios, that are benchmarked to the MSCI World Index. It would be relatively simple for Seoul to overcome these obstacles. The answer to why it’s happy to forgo this money appears to lie, to some extent, in the power of the chaebols.
Chaebols are giant family-controlled businesses that drove South Korea’s industrialisation from the 1960s and now dominate the country’s society, economy and politics. These multinationals, which are either one corporation or linked groups of companies, have ended up monopolies or oligopolies across vast swathes of South Korea’s economy.
Importantly, chaebols such as Samsung, Hyundai and LG are major exporters and here’s where the developed/emerging-market classification comes in. The chaebols don’t want South Korea to be flooded with capital because they want to keep the won competitive, especially at a time when household debts are so steep that consumer spending at home is slow – Hyundai Motor’s domestic sales, for instance, only rose 4.4 per cent in the first five months of 2011 while foreign sales surged 11.6 per cent.
Exporters want to keep the won as low as possible against the US dollar because South Korea’s exports are traded in US dollars and the country’s biggest trading partner, China, links its yuan to the US dollar. They would already be unhappy that the won is at three-year highs against the US as higher interest rates in Korea have attracted capital – Korea has boosted its benchmark rate five times since July last year to control inflation. The central Bank of Korea doesn’t seem to want the hassle of coping with the extra investment flows that would come with any MSCI status promotion.
The Financial Times opined that last year that Seoul reimposed a withholding tax on government bonds to keep the country out of Citigroup’s World Government Bond Index because it knew belonging to this global bond benchmark would attract foreign investment flows and put upward pressure on the won.
A Goldman Sachs study shows that in 2010 Korea, relative to the size of its economy, interfered in currency markets to a greater extent than China, when judged by the increase in foreign reserves as a percentage of the monetary base.
