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Summit Helps, But South Korea Still Faces Regional Tensions

ETF Professor

The iShares MSCI South Korea ETF (NYSE: EWY) is modestly higher year-to-date, but the exchange-traded fund slipped Monday, giving back some gains accrued following the summit between the leaders of North and South Korea.

Some market observers believe South Korea, Asia's fourth-largest economy, still faces regional tensions that could weight on financial markets there.

The recent summit “does not eliminate risks associated with the military stand-off,” said Fitch Ratings in a recent note. “The process of normalizing relations is likely to be lengthy and unpredictable, even if begun in earnest.”

What Happened

Although tensions with the north are elevated, EWY is ahead of broader emerging markets benchmarks over the past year. Over the past 12 months, EWY, the largest ETF tracking South Korean stocks, is higher by 26.1 percent compared to 20.5 percent for the MSCI Emerging Markets Index. South Korea is one of the largest country weights in that index.

 EWY has been more volatile than the MSIC index over that period, which is notable because South Korean stocks are often embraced by foreign investors for favorable volatility traits. EWY's three-year standard deviation is 18 percent, while below the comparable metric on a slew of other single-country emerging markets ETFs.

Why It's Important

“The long-term stand-off results in geopolitical risks to South Korea's sovereign balance sheet,” said Fitch. “These relate not only to the potential for conflict, but also to the possibility of reunification costs arising over the long term.”

The ratings agency rates South Korea's sovereign debt AA-, which is well into investment-grade territory. Although it's a long way, reunification costs, assuming reunification between the two Koreas even materializes, would be substantial, according to Fitch.

What's Next

For now, South Korea's economy is in solid shape with expectations in place for steady GDP growth this year.

“The economy expanded by an above-trend 3.1 percent last year, bolstered by supportive economic policies and financial conditions, and by the pick-up in global trade,” said Fitch. “The Bank of Korea's advanced estimate of 1Q18 real GDP growth, released last week, showed economic growth up by 1.1 percent quarter-over-quarter, and we forecast 2.9 percent growth in 2018 and 2.7 percent next year.”

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