"COVID-19, a Slap to the Fragile Han Economy"... Real and Financial Two-Track Crisis

Expert: "Financial + Real Economy Compound Crisis, What Was Inevitable Has Come"

Economy Propped Up by Debt After Financial Crisis
COVID-19 Adds Fuel to Exposed Weaknesses

[Asia Economy Reporter Kim Eun-byeol] The economic crisis caused by the novel coronavirus infection (COVID-19) is hitting both the financial and real sectors. The shock to production and consumption due to COVID-19 has already become visible, and recently, the financial markets have plunged sharply, showing a panic market.

Regarding the financial and real sector complex crisis caused by COVID-19, economic experts say, "What was bound to come has come." The economy, which had been propped up by liquidity feasts and essentially supported by debt since the 2008 global financial crisis, is now collapsing. In particular, the Korean economy had already weakened its fundamentals before the COVID-19 outbreak; with the outbreak, the real economy contracted, and as the market shook, financial shocks have now been added.

◆ US Financial Market Bubble Bursts... Investors Sell Gold and Bonds Too = On the 13th, the Korea Exchange triggered a 'circuit breaker' for the first time since September 12, 2001, the day after the 9/11 terrorist attacks, as the KOSPI fell more than 8% immediately after opening and broke below the 1700 level. The KOSDAQ market also triggered a circuit breaker after briefly falling below the 500 level during the session. This was the first time in history that circuit breaker measures were implemented on the same day in both markets. The KOSPI closed at 1771.44, down 62.89 points (3.43%), and the KOSDAQ index closed at 524.00, down 39.49 points (7.01%).

As stock prices fell, the won-dollar exchange rate in the Seoul foreign exchange market rose to 1,226.0 won per dollar during the session, the highest intraday level in four years since March 2016. Investors sold even safe assets like bonds to secure cash, causing a 'triple weakness' phenomenon where stock prices, exchange rates, and bond prices all fell simultaneously. According to the Korea Financial Investment Association, the 3-year government bond yield recorded 1.149%, up 8.7 basis points (1bp = 0.01 percentage points) from the previous trading day. Gold prices in the Korea Exchange gold spot market also fell by 1,170 won (-1.84%) to 62,240 won per gram compared to the previous day.

The most concerning aspect is the massive withdrawal of foreign investors from the securities market. According to the Korea Exchange, foreign investors have net sold more than 5 trillion won in the KOSPI this month alone amid growing fears of the COVID-19 pandemic. Since January 20, the cumulative net selling amount by foreigners has surpassed 11 trillion won.

The panic among foreign investors began as COVID-19 spread worldwide. Even though the U.S. Federal Reserve (Fed) lowered the benchmark interest rate, it failed to quell market fears, and investors instead sought to secure cash. It is said that Korea was the place investors turned to for cutting losses. Professor Shin Se-don, emeritus professor of economics at Sookmyung Women's University, said, "Because the Korean economy was internally vulnerable and was considered a major outbreak country of COVID-19, foreigners used this as an opportunity to exit."

[Image source=Yonhap News]

◆ Soaring CDS Premium... Over 50% Increase in One Month = The evaporation of market capitalization in the KOSPI and the deterioration of financial markets lead to worsening funding conditions for domestic companies. Companies already hit in sales by COVID-19 may face difficulties in raising funds, which could lead to financial institution insolvencies. Credit rating agencies have already been downgrading domestic companies' credit ratings one after another, which could cause a credit crunch for companies that had been raising funds by issuing bonds at low interest rates.

Korea's credit default swap (CDS) premium has also jumped more than 50% in a month. The CDS premium is a derivative product that guarantees the principal repayment if the issuing country or company defaults. As default risk increases, financial institutions naturally demand higher CDS premiums. In Korea's case, the default risk is rising.

According to the International Financial Center, on the 13th, Korea's 5-year CDS premium recorded 53.27 basis points (1bp = 0.01 percentage points). Compared to January 17, before COVID-19 spread significantly in Korea, when it was 20.90bp, and February 6, when COVID-19 seemed somewhat stabilized (24.05bp), it rose more than 30bp in about two months. Korea's CDS premium had surged to 76bp in September 2017 amid heightened geopolitical tensions but had been stable since then.

This is why the government and financial authorities are closely monitoring the corporate bond market. Currently, the rise in CDS premiums appears to be due to growing concerns about the U.S. corporate bond market, leading to increased risk-asset avoidance, but there is a possibility this could be prolonged.

◆ The Broken Real Economy Feels Like a Slap from COVID-19 = In fact, the weakening of Korea's economic fundamentals had already been evident before the COVID-19 outbreak. The reduction in working hours and the increase in minimum wage imposed labor cost shocks, making the overall economy vulnerable. After maintaining a growth rate in the 3% range, the growth rate fell to the 2% range last year, with generally sluggish sales in self-employed and small and medium-sized enterprises, and rising labor costs making the situation even more fragile.

The industrial structure was also vulnerable. Korea is highly dependent on exports, and last year, semiconductor prices plunged, already damaging exports. The current situation is expected to further block export routes. As Korea was identified as one of the major COVID-19 outbreak countries, human and material exchanges were cut off, and with COVID-19 spreading to the U.S. and Europe, trade conditions now also need to be a concern.

If this situation continues, there are concerns that debt could eventually burst. Not only household debt but also repayment rates for debts of self-employed and small businesses could sharply decline, leading to insolvencies in financial institutions and large corporations. At the end of last year, Korea's household debt reached a record high of 1,600 trillion won. Korea's private credit ratio to gross domestic product (GDP) was 195.0% as of the end of the third quarter last year. This means nearly twice the amount of the real economy is piled up as corporate and household debt. The private credit ratio rose 13.1 percentage points since the fourth quarter of 2017 (181.9%), ranking second among 52 countries surveyed by the Institute of International Finance (IIF), following Sweden. This is the result of household debt continuing to rise and corporate debt, which had stalled, starting to increase again.

Professor Sung Tae-yoon of Yonsei University's Department of Economics said, "The shock to the real economy caused by COVID-19, combined with the sharp decline in global financial markets and Korea's isolation, has caused a greater impact." He added, "The damage will sequentially appear in self-employed individuals, small business owners, small and medium-sized enterprises, and companies affected by the global value chain (GVC)."

This content was produced with the assistance of AI translation services.