Koristan: Asia’s Riskiest Place
Question: Which country would you feel safer investing in, South Korea or Pakistan? Most people would probably say Korea, but judging by the performance of their currencies this year, the answer is not so clear cut. Every night lately, just before drifting off to sleep, I’ve found myself wondering where the Korean won would be trading when I arrive at work the next day. Although I’ve been bearish on the currency since earlier this year, predicting a drop to KRW1,200/US$, even I have been a little surprised by how steep recent losses have been – which made today’s bounce a pleasant change. The question is whether we are now seeing a turnaround for the won. I think the jury is still out.
Exchange Rates, KRW/US$ and PKR/US$
Indeed, it is incredible that the Korean won has fallen even further than the Pakistani rupee this year – by 32% versus 22%. That’s quite something, when you consider that Pakistan is one of the most troubled countries in the world right now. Aside from more than a year of political turbulence, which included a high-profile assassination, coalition government wobbles, and deadly bomb attacks in the capital, Pakistan has experienced widening fiscal, trade and current account deficits, 25%+ rates of inflation, and the spectre of default. While South Korea is likely to record its first annual trade and current account deficits since the 1997-98 crisis, it runs a fiscal surplus and has US$240bn of forex reserves. Although this has been shrinking as the government has spent tens of billions in propping up the won, it is still more than enough to cover short-term external debt. Furthermore, South Korea has none of the high degree of political risk that Pakistan has, despite the apparent illness of Kim Jong Il up North.
So, what does all this this mean? One possible answer is that the Korean won may have fallen too sharply, and could be poised for a short-term bounce. However, beyond the near term, I think that South Korea could see more problems, given that Business Monitor International (BMI) is now predicting US GDP to contract in 2009. This will hurt Korea too. Fortunately for the Koreans, Japan is willing to lend them a lifeline – and not for the first time. Asking Tokyo might be humiliating, given the considerable anti-Japanese sentiment in Korea, but there may not be viable alternatives.
As for Pakistan, the key question is whether it can secure billions of dollars to ward off default. Beyond economics, the situation in Afghanistan is deteriorating, and is heavily intertwined with the insurgency in Pakistan.
Overall, the 5-year Credit Default Swap market seems to have priced risks more accurately than the currency markets. The Pakistani instrument is trading at 2,350 basis points (the highest sovereign premium in the world), whereas Korea is at 316 basis points. However, the Koreans can hardly feel comfortable, since this is more than 10 times its risk premium a year ago, and 85-90 basis points wider than Malaysia and Thailand. Bad Korea move.