Korea Kim

Korean relations enter a new phase

The death of Kim Jong-il ushers in another period of precarious uncertainty in the Korean peninsula, and rattles markets in Seoul.
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A memorial symbolising the reunification of the Korean Peninsula at the entrance to Pyongyang
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<div style="text-align: left;"> A memorial symbolising the reunification of the Korean Peninsula at the entrance to Pyongyang </div>

North Korea’s official news agency (KCNA) yesterday announced that Kim Jong-il died on Saturday. The death of the country’s dictator had been expected for many months — he had pancreatic cancer — yet markets in Seoul reacted negatively as a fresh period of nervous uncertainty entered the always precarious relationship between the two parts of the Korean peninsula.

The Kospi index of leading South Korean stocks plunged 5% and the won fell by 1.8% against the dollar. Young Sun Kwon, an analyst at Nomura, described Kim’s death as a “black swan” event, and expects geopolitical risks to rise.

The North (or Democratic People’s Republic of Korea) laid the groundwork for a leadership transition back in 2009, naming Kim’s little-known third son, Kim Jong-un, as the country’s next leader. He was named yesterday as the “Great Successor” and all eyes are now on him to see how he responds.

Observers expect something similar to his father’s response to the death of Kim Il-sung in 1994 — military posturing and exploiting emotions to bolster the legitimacy of the state.

South Korea, still technically at war with the North, placed its troops and all government workers on emergency alert, although the government said there were no signs of any unusual North Korean troop movements.

But Seoul is likely to have contingency plans in place — encompassing economic as well as military and diplomatic measures — in order to militate against negative consequences. “The top priority in economic terms would be to limit market volatility and enhance market confidence,” said Young. South Korea already has currency swap lines with China ($56 billion) and Japan ($70 billion), which should help control the won, and if needed it could also reinstate a currency swap agreement with the US.

However, 2012 will be a difficult year anyway. There are presidential elections in the South and in the US, and China’s fifth generation of leaders is likely to take charge of one of the North’s few dependable allies.

Nevertheless, “past experience ... strongly suggests that the market will eventually rebound after an initial substantial sell-off”, said Young, with Kim’s death posing short-term risks only to the economic growth in the South.

The credit rating agencies also responded cautiously. Fitch doesn’t consider Kim Jong-il’s death “as a trigger for negative action on South Korea’s sovereign ratings in itself”.

The credit agency assigned a positive outlook to the country’s A+ rating last month and warned that “the situation with the North” was “a potential source of downside risk”, but yesterday, Andrew Colquhoun, its head of Asia-Pacific sovereigns, said that “for now, it’s much too early to say risks have materially increased”.

Standard & Poor’s stressed that its single-A (stable) rating for South Korea would not be “immediately affected” by the news of Kim’s death. But analyst Kim Eng Tan pointed out that “the event has raised security risks on the Korean peninsula and could have negative rating implications if these risks increase”.

As a matter of course, all the three main rating agencies factor in security dangers which have been a permanent state of affairs between the North and the South since the cessation of military conflict in 1953.

In particular, Young and other analysts warned that security risks and political stability in North Korea could deteriorate rapidly if there are problems with the planned political succession. Any hiccups could pose a risk to the South.

However, Erik Leuth, economist at Royal Bank of Scotland (RBS) reckons that “the chances of a military aggression are limited”. Perhaps counter-intuitively, he suggested that North Korea’s sabre-rattling in 2010, including the sinking of a South Korean warship and the shelling of a South Korean island, were actually indications of the North’s attempts to “bring its opponents back to the negotiating table”.

Nevertheless, Leuth expects that the North will be “prickly over coming months and we should look out for signs that it is withdrawing from low-level diplomatic efforts to mend fences”. Such a reaction could scupper the resurrection of the six-nation talks about the North’s nuclear programme, which were abandoned in 2008.

Pyongyang tested a nuclear device in 2006 and again in May 2009, and last year it unveiled a uranium enrichment facility in addition to its plutonium programme.

Leuth, like S&P, considered the possibility of regime change following the death of Kim. This could happen either by a coup or by a failed attempt to reform the political or economic system.

“There is a slight chance that regime collapse would lead to anarchy and civil war. However, North Korea’s centralised organisation and concentration of power should prevent this worst of all outcomes. It would also call for the deployment of an international army, given the risk of nuclear proliferation,” said Leuth.

A far more benign consequence, “a big bang unification” with the South, is unlikely, according to Leuth. It would simply be too expensive and destabilising for the South. Instead, “long-term association is a much more realistic scenario for the two Koreas and, indeed, the option favoured by Seoul”, he argued.

“This would allow South Korea to spread the costs of lifting Northern living standards over many years and, thereby, cushion the shock for the South Korean economy,” he said.

Although the South hasn’t made any explicit fiscal provision for the collapse of the regime in the North, President Lee Myung-bak has previously proposed a $50 billion reconstruction fund to be financed by private contributions.

It’s possible that the death of Kim could provide an opportunity for improving relations with the rest of the world and attracting funding from international organisations. But China, which shares a 1,400 kilometre border with the hermetic country and gives massive diplomatic and economic assistance, is likely to be the final arbiter.

¬ Haymarket Media Limited. All rights reserved.
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