Regime collapse bigger threat than bomb
Last week, North Korea (unrated) launched its fourth underground nuclear test, claiming that the country had successfully tested a hydrogen bomb. In response, South Korea (Aa2 stable) resumed propaganda broadcasts against the North Korean capital of Pyongyang along the 38th parallel. This could escalate tensions further since North Korea has threatened to respond to the resumption of such broadcasts with “strong military action.”
These developments heighten geopolitical risk, which is the most salient event risk for South Korea. Although our central scenario is that the status quo will prevail, a direct military conflict remains a risk that would have widespread and disruptive effects on the functioning of the government in the South Korean capital of Seoul and on the country’s payments system. We expect Korea’s robust alliance with the United States (Aaa stable), as well as China’s (Aa3 stable) influence, to contain the risk of such a scenario.
North Korea’s infuriation with South Korea’s border broadcasts stems from its concern that an influx of outside information would threaten North Korean leader Kim Jong-un’s rule. This is in line with our view, which is that geopolitical event risk lies more in the potential for an internal regime collapse in North Korea, which risks generating acute financial strains for South Korea’s government, rather than a direct military confrontation.
A regime collapse in North Korea would likely lead to a disorderly reunification on the peninsula, weighing on South Korea’s creditworthiness. The North Korean regime has survived for more than 65 years, but internal economic and political strains could eventually lead to a sudden collapse. Such a development is a risk that would pose enormous challenges for South Korea.
Estimates of reunification costs vary considerably, and as a result the government in Seoul does not maintain an official assessment. The Korean Association of Public Finance estimates it would cost Seoul’s government from 1.3 percent to 6.6 percent of GDP annually for 10 years following reunification, while the National Assembly Budget Office (NABO) estimates it would cost an annual average of 3.9 percent of GDP for 45 years. The NABO also estimates that South Korea’s national debt would reach 134 percent of GDP by 2040 under such a scenario, versus 85 percent if the two were to remain divided. Through 2060, the NABO expects the benefits of reunification to outweigh its costs.
North Korea’s economy remains feeble and dependent on external aid, increasingly from China, though relations have deteriorated between China’s leadership and Pyongyang. Economic reform, which would diffuse power and constitute an admission of shortcomings in North Korea’s ideology, could delegitimize and destabilize the regime. Former South Korea President Lee Myung-bak offered to provide massive economic assistance to the North, similar to the U.S. government’s Marshall Plan for Europe after World War II, conditional on Pyongyang agreeing to abandon its nuclear weapons program. Pyongyang spurned the overture. The administration of current President Park Geun-hye has been pursuing a trust-building process that leaves the door open for dialogue and the development of inter-Korean relations.
Shirin Mohammadi Associate Analyst, Sovereign Risk Group, Moody’s Investors Service, Inc.
Steffen Dyck Vice President and Senior Analyst, Sovereign Risk Group, Moody’s Deutschland GmbH
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