"Watching Instead of Panic Selling at KOSPI Yearly Low"... Ultimately the 'Key' Is Foreigners "Focus on CDS and Oe-pyeong-chae"

Despite the KOSPI plunging to its lowest level of the year on the 9th due to the aftershocks of the impeachment political turmoil, experts advised responding with 'watchful waiting or phased buying' rather than a 'fire sale.' They also suggested that for the Korean stock market trend to change, foreign investors need to return, and whether they do so will be assessed through the credit default swap (CDS) premium and the foreign currency bond spread to see if the fundamentals of the Korean economy are under threat. The government announced that it will actively pursue meetings with global credit rating agencies to prevent the current martial law situation from leading to a downgrade of Korea's external credit rating.

Due to prolonged instability caused by the impeachment political turmoil, on the 9th, both the KOSPI and KOSDAQ in the domestic stock market fell sharply, hitting their lowest points of the year, and the won-dollar exchange rate rose to the 1,430 won level. Employees are working in the dealing room at the Euljiro Hana Bank headquarters in Seoul. Photo by Heo Young-han

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On the 9th, Lee Woong-chan, a researcher at iM Securities, said, "From the start, the situation surrounding the stock market was not easy due to the Trump administration's tariff warnings and the sluggish performance of semiconductor stocks like Samsung Electronics," adding, "If political uncertainty is resolved and Korea's resilience is proven, the KOSPI is expected to recover to pre-impeachment levels." He suggested the KOSPI bottom at 2250 points.

On the same day, the KOSPI closed at 2360.58, down 2.78% from the previous trading day, marking a new yearly low on a closing basis. Experts recommended watching or phased buying rather than selling held stocks. They reasoned that engaging in a fire sale at a historic low would only result in realized losses without any practical benefit.

Lee Kyung-min, a researcher at Daishin Securities, said, "In the worst case, it is necessary to refrain from new investments until recovery and stabilization around the 2450-2500 level are confirmed in the short term," adding, "If preparing for new investments, phased buying during increased volatility below the 2400 level would be advantageous."

Han Ji-young, a researcher at Kiwoom Securities, also explained, "Considering that the political impact on the mid-to-long-term market direction is not long-lasting, it is reasonable to respond with watchful waiting or phased buying rather than joining in sell-offs with a strong fire-sale character amid increased market volatility during the week."

Experts believe that for the KOSPI's downward trend to stabilize, foreign demand must recover. Foreign investors have sold stocks worth over 1 trillion won for four consecutive days since the martial law was lifted on the 4th.

Kim Dae-jun, a researcher at Korea Investment & Securities, said, "Although the financial authorities' market stabilization measures limited the index's decline, if foreign investors continue their net selling trend, market turbulence will inevitably continue," noting, "Regarding the stock market going forward, the biggest concern for foreigners will be whether the economic fundamentals are damaged."

Lee Kyung-min added, "Since the third-quarter earnings season, foreign investors have been leading sector and stock rotation," and predicted, "Selling pressure is expected to ease, focusing on sectors that are undervalued relative to their earnings despite excessive declines."

Experts view that the return of foreign investors will depend on whether the fundamentals of the Korean economy are impaired. However, when examining the damage to economic fundamentals, there has been no movement yet from global credit rating agencies such as S&P. Nonetheless, these agencies have warned that prolonged political uncertainty could exert downward pressure on Korea's creditworthiness.

On the 6th (local time), Fitch stated in its report titled 'Korea's Credit Fundamentals Remain Intact Despite Political Volatility' that "If the political crisis prolongs or political division undermines policy execution, economic performance, or fiscal management, downward pressure could increase." However, under the base scenario, it does not expect significant impact on Korea's sovereign credit rating of 'AA-/Stable' supported by economic and external creditworthiness.

Another rating agency, Moody's, also pointed out that if the aftereffects of the martial law situation prolong, it could negatively affect government capacity. Moody's Analytics told Bloomberg News, "If political conflict prolongs and affects economic activity, it would be negative for credit." Moody's has maintained Korea's sovereign credit rating at Aa2 since upgrading it from Aa3 in December 2015. Aa2 is the third-highest rating in Moody's scale. S&P and Fitch have also maintained Korea's sovereign credit rating as stable. S&P assigned Korea an AA rating, the third-highest among 21 ratings, in August 2016.

The government plans to communicate more actively with overseas institutional investors to prevent the political risk escalation from the impeachment turmoil from leading to a decline in national creditworthiness. A Ministry of Economy and Finance official said, "We plan to actively engage in meetings with credit rating agencies to minimize the economic impact caused by the impeachment turmoil." Former Deputy Prime Minister Yoo Il-ho sent letters under his name to the three major rating agencies after the impeachment decision of former President Park Geun-hye to actively respond to political instability. Deputy Prime Minister Choi Sang-mok is also interpreted as intending to make every effort to maintain national creditworthiness, similar to Yoo's approach.

However, experts say that credit ratings change over a long period, so to capture rapidly changing market sentiment, other indicators should be examined. Those indicators are the CDS premium and the foreign currency bond spread, which can be monitored daily. These two indicators are representative measures of external creditworthiness in international financial markets: the former is the insurance premium to hedge default risk, and the latter is the additional interest rate Korea pays over the benchmark U.S. Treasury rate when issuing foreign currency bonds. The higher these indicators, the greater the credit risk of the issuing country or institution.

A Ministry of Economy and Finance official said, "No unusual trends have been detected yet regarding the CDS premium, and the foreign currency bond spread has also shown no significant changes."

The market is also paying attention to the foreign exchange reserves disclosed monthly by the Bank of Korea. Maintaining stable foreign exchange reserves is essential to adequately respond to exchange rate volatility. According to Bank of Korea statistics, at the end of last month, foreign exchange reserves stood at $415.4 billion, down $53.8 billion (11.5%) from the record high of $469.2 billion in October 2021. If the Bank of Korea and authorities continue to intervene in the foreign exchange market to defend the won's value by selling dollars, foreign reserves could decline more rapidly. There are concerns that the $400 billion level, maintained for six years and five months since first surpassing $400 billion in June 2018 ($400.3 billion), could be breached.

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