CDS premium hike poses no risk, govt. says

A new fear is clouding the local market as the cost of the nation’s sovereign default insurance has hit its highest point in nearly two and a half years.

But government officials, pointing to the deepening sovereign debt crisis in Europe, say the recent hike was an extreme case and does not necessarily indicate that the country is facing a major credit risk. Rather, they say, it simply echoes a global trend.

A credit default swap (CDS) is a financial derivative that acts like an insurance policy by obliging the seller to cover the buyer’s losses in the event of a default, for example by exchanging the loan instrument for a lump sum of cash.

A higher premium indicates that the credit rating of the country or company is falling.

Korea’s CDS premium has been growing since fears of another global recession gained momentum in August, inspired the downgrading of the U.S. credit rating and the exacerbating state of affairs in the debt-riddled euro zone.

Prior to this, analysts were upbeat and issuing reports on the stability and positive outlook of the country’s premium.

But the situation took a turn for the worse in recent months as foreign investors began pulling out of the market and recession-inspired panic started to overwhelm the market.

According to the Financial Supervisory Service, in August alone 4.7 trillion won ($3.9 billion) of European funds withdrew from Korea, while in the first 20 days of last month an additional 1.7 trillion won was cashed out.

As a result, the cost of insuring sovereign debt against default on the nation’s five-year foreign currency bonds gained 91 basis points in September from August.

Friday witnessed a huge loss of confidence in single-day trading as the premium closed 24 basis points higher in New York to stand at 219.

This is the highest register since May 1, 2009, when the premium closed at 246 basis points. Moreover, it is the first time since October 2008 - when the market reeled from the sudden bankruptcy of Lehman Brothers in the U.S. - that the premium has gained almost 100 points in a single month.

To put the situation into a broader context, Korea’s CDS premium was 32 basis-points higher than France’s at the end of play last week despite the latter seeing a climb of 10 basis points. One week earlier, the difference between the two was as little as three basis points.

“Emerging markets [including Korea] were already reflecting risks of contagion from Europe in their markets but were impacted by the growing threat of a double-dip recession [in the global market],” said Jeon Seung Ji, a currency analyst at Samsung Futures. “This is now affecting the credit index.”

But government officials have been keen to play down fears of a heightened credit risk and see the raised Korean premium as the inevitable result of anxiety stemming from Europe.

In the first half of this year some 14 countries have had their credit ratings downgraded, including Japan, Italy, Ireland and Portugal.

“The CDS premium for Korean bonds rose in September amid across-the-board increases due to the uncertainty of the global financial market,” said Jung Eun-bo, head of the finance policy department at the FSC, last week.

“The premium cannot be said to be approaching a dangerous level ... but must be understood in relation to other countries, whose premiums are also on the rise,” he said.

“The shortage of funds and the liquidity crunch is creating additional risk but this is temporary,” he added.

By Lee Ho-jeong [ojlee82@joongang.co.kr]