No matter what scenario plays out for North Korea – the status quo, the good or the ugly – South Korea’s currency appears set to remain under a cloud, analysts at Nomura said in a note on Friday.
Tensions over the development of the North’s nuclear missile program have cooled this week, after last week’s dramatic eruption of Pyongyang’s threats to attack the U.S. Pacific territory of Guam and President Donald Trump firing off a war of words.
But this week, North Korea backed off its Guam threats, although the regime’s official news agency reported that its 33-year-old leader wanted to monitor the “reckless Yankees” and left the door open for a strike later.
The relative calm may not last: Analysts at Nomura pointed to a planned large military drill by South Korea and the U.S. next week.
“Another spike in tensions is certainly plausible and, unless there is some resolution, tensions could remain elevated for some time,” Nomura said, but added that its “base case” scenario was that the situation wouldn’t get out of control.
That was likely to continue to weigh on South Korea’s currency. The dollar was fetching 1,141.13 won at 2:27 p.m. HK/SIN on Friday. That compared with as little as 1.110 won in late July.
Nomura was sticking with a bearish economic outlook for South Korea, forecasting its gross domestic growth would slow to 2.3 percent in 2018 from 2.7 percent this year.
It expects the country would face a direct hit to its tourism sector, noting that the number of Chinese visitors to the country in July had already fallen around 68 percent from the year-earlier month.
Nomura also said the tensions would have an indirect impact on private consumption and construction investment, likely exacerbating the hit from new government policies aimed at cooling the housing market.
The Bank of Korea wasn’t likely to increase interest rates to defend the currency as a weaker won would support the country’s exporters, Nomura noted.
The bank also pointed to a risk from the strong foreign fund inflows to South Korea’s stock market since last year, bringing foreign ownership proportion to its highest since 2007.
With net foreign equity selling of $3.3 billion over the tense July 21-August 16 period, “we believe consistent tensions raise the risk of a further unwind,” Nomura said.
But even in a better case, with negotiations and a resolution of the immediate tensions with the North, Nomura said it didn’t expect the currency would perform much better.
“We believe foreign-exchange and fiscal policy will be the same as the base case, because South Korea policymakers will wait and see the how the actual negotiations conclude – which may take quite a long time,” it said.
For both potential scenarios, Nomura estimated the dollar would be fetching around 1,140 won by the end of 2018.
But when it came to the bank’s “ugly” case of military confrontation, it expected the won could tumble by more than 10 percent over the first few trading sessions if there were significant casualties and destruction.
At the same time, Nomura forecast a “catastrophic” impact on the stock market.
However, Nomura said it expected South Korea’s government would “do whatever it takes” to avoid a war.