[The Editors' Verdict] Gangwon Province Undermines Credit of All Local Governments

Repayment Was Possible, But Political Judgment Took Precedence
Trust in Local Government Creditworthiness Deteriorates
Burden of Project Financing for Local Governments Expected to Grow

Gangwon Province is shaking the capital market, which operates based on credit, by failing to timely fulfill the payment guarantee it provided to Chuncheon Legoland. Gangwon Province's stance is to repay the principal and interest of the loan after proceeding with the court management process of the Legoland developer (SPC). However, the market already perceives this as a default situation on the local government (municipal) guarantee.

The ripple effect extends not only to Gangwon Province but also to the entire credit market. Amidst the tightening of the fund market due to rising market interest rates, the default by the local government, which did not consider the market at all, has widened credit spreads on corporate bonds and commercial papers (CP), pushing the market into a panic state. Since the credit of the local government, which holds the highest credit rating, has been broken, it is natural that trust in the creditworthiness of financial institutions and companies with lower credit ratings is also damaged.

It is unclear how much Gangwon Province has influenced the tightening of the general corporate bond or CP market. The credit tightening was somewhat anticipated as the fund market was heading toward a difficult phase due to interest rate hikes in major countries including South Korea, a slump in the real estate market, and the risk of project financing (PF) defaults by financial companies. Therefore, the blame for the fund market tightening cannot be placed solely on Gangwon Province. However, there is no room for debate that the Legoland incident acted as a trigger for the market, which had been barely holding on.

Although financial authorities have expressed their intention to provide liquidity support through the Chaean Fund and securities finance, it is uncertain whether the market can calm down. Liquidity from securities firms' PF-ABCP (project financing asset-backed commercial paper) purchase commitments alone returns nearly 1 trillion won per day, so it does not seem that a few trillion won in liquidity will easily resolve the situation. The Bank of Korea’s active injection of money through repurchase agreement (RP) purchases contradicts the current monetary policy stance aimed at fighting inflation. It is also difficult for the government to decide on large-scale liquidity support as it did during the COVID-19 crisis.

Even if the situation calms down with emergency liquidity support, problems remain. Gangwon Province has set a precedent for the first default by a local government in South Korea due to the Legoland incident. The 1994 Orange County default in the United States was caused by the financial collapse of a local government, but this default is unrelated to Gangwon Province’s fiscal condition. Although it could sufficiently repay the approximately 200 billion won borrowed for the Legoland project, it deliberately involved political judgment and devastated a market that operates on credit. It did not accept the market’s advice to issue local bonds to prioritize repayment of the loan if cash was unavailable. If there were issues such as corruption or illegality during the development project, they should have been resolved through legal procedures.

Gangwon Province’s decision is expected to have adverse effects on projects by local governments nationwide. When local governments promote major projects such as infrastructure construction for roads, ports, subways, tourism complex development, and industrial complex formation, they provide payment guarantees to project SPCs to raise loans. However, as the market loses trust in local government payment guarantees, local governments across the country will inevitably face significant difficulties in raising project funds in the future. If arbitrary defaults are possible depending on political changes, anxiety about local government credit ratings will persist. This will inevitably lead to increased costs for local government projects nationwide.

The stone Gangwon Province threw to settle the Legoland project is no different from throwing a boulder not only at the fund market but also at local governments nationwide. The burden on the central government, which must support the market and local governments, has also increased.

Lim Jeong-su, Head of Capital Markets Department

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