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Q+A - South Korean markets trade at discount on North
Reuters - Tuesday, December 28
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By Yoo Choonsik
SEOUL, Dec 28 - South Korean share prices look set to post their biggest gains in three months, more than recovering losses suffered after North Korea shelled an island in November, raising the risk of a broader military conflict.
Following are questions and answers on how markets reacted to the tension:
WHY IS THE WON MORE SENSITIVE?
Data compiled by Reuters shows the won and stocks have reacted more than bonds <0#KRCOMP1=KQ> to tension with North Korea, with the impact lasting for about one week on average over the past decade.
Stock prices fell more sharply after attacks by North Korea, whereas it took longer for the won to recover. Bond prices tended to trade in a more stable manner as foreign ownership remains low.
This is due to the fact that South Korea's financial system is more heavily exposed to short-term foreign borrowings than regional rivals such as Taiwan, whereas state-run funds have huge amount of money to support stocks.
Markets may show a stronger reaction for a long period if North Korea carries out bigger attacks on the mainland, but will largely shrug off other behaviour on its own territory such as another nuclear test.
WHAT IS THE KOREA DISCOUNT?
South Korea is the world's seventh-largest exporter and home to leading makers of chips, cars, ships and mobile phones but its assets are trading at a so-called Korea discount as investors price in the chance of losing money in case of an all-out war with the North.
It is not easy to quantify the discount but comparisons with Taiwan are useful because of the similarity between the two of the region's four newly industrialised economies as classified by the International Monetary Fund.
Reuters data shows South Korean shares are trading at about 10 times their expected earnings per share, or 1.7 times their book value, a steep discount from 12 times and 2.2 times for the Taiwan stocks respectively.
Major international credit ratings agencies place South Korea one notch below Taiwan, citing Seoul's exposure not only to the risks from living next to an extremely unpredictable neighbour but to future costs of integrating with the impoverished North.
Credit default swaps on South Korean sovereign debt -- the cost of insuring against a possible default -- have hovered around 100 basis points on average for the past year, above around 90 basis points for Malaysia which has lower credit ratings.
WILL PEACE END THE KOREA DISCOUNT?
The discount has been in place for decades and will not disappear even in the absence of conflict with the North. The South will have to shoulder the cost in the event of reunification.
The two Koreas remain technically at war because their 1950-53 conflict ended in a truce, not a treaty. South Korea's per-capita income is 18 times that of the North while its annual foreign trade value is more than 200 times higher.
Estimates vary widely, but the South will have to put several times its annual gross domestic product now, totalling nearly $1 trillion, not only into rebuilding infrastructure in the North but on setting up a proper economic system.
Ratings agencies have said this financial burden falling almost wholly on the South is a key difference from the case of Taiwan, which despite its history of confrontation with China, which considers the island a runaway province, is seen as facing a low financial burden in the future.
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