Korean officials warned that it will take stern steps to prevent one-sided currency moves. Concerns about won strength come just as Korea and the US start trade talks and tensions ease on the Korean peninsula.
The United Nations Security Council approved a new round of sanctions on North Korea late last month by a unanimous 15-0 vote. China and Russia voted with the majority after the US agreed to soften some provisions. Imports of refined petroleum products will be cut drastically and North Korean laborers in other countries will be expelled within two years. This round of sanctions follows two others in August and September.
In his New Year’s Day speech, North Korean President Kim Jong Un surprised everyone by calling for direct bilateral talks with South Korea. He expressed a desire to discuss sending a North Korean delegation to the Winter Olympic Games next month. This opens up a new phase of relations on the Korean Peninsula even as the tougher UN sanctions will bite Pyongyang.
At first blush, one might surmise that these latest sanctions forced North Korea to the negotiating table. On the other hand, some believe that Pyongyang is seeking to drive a bigger wedge between the US and South Korea. Relations between Presidents Moon and Trump have worsened in recent months over how to deal with North Korea. South Korean President Moon favors a conciliatory approach, while President Trump favors a confrontational one.
South Korea responded to the overture positively and proposed talks this week at the border village of Panmunjom. It also invited a North Korean delegation to attend the Olympics. Pyongyang accepted both offers, with talks to be held this Tuesday. These developments seem to lower the odds that it will do something to disrupt the Olympics. The games will be held in Pyeongchang, which is only 50 miles from the border with North Korea.
What is the end game? North Korea is clearly hoping to get sanctions lifted. However, the UN and the US are unlikely to loosen them without getting significant, tangible concessions from Pyongyang. Eliminating its nuclear program is a deal-breaker, so perhaps the best that can be hoped for is a verifiable freeze at current levels.
Pyongyang has long demanded that joint US-South Korean military exercises be halted. This could be one concession from the US, as the joint exercises seem more for show than anything else. If developments warrant, then sanctions could be eased in stages. We think these could all lead to a significant de-escalation of tensions going forward.
South Korean assets typically shrug off any negative news regarding North Korean tensions. However, we think that improved relations between the two could remove potential headwinds to South Korean equities and the won.
The US and South Korea just started talks to amend the existing bilateral free trade agreement (Korus). Both sides acknowledge that a deal will be difficult. Because of these talks, South Korea faces some constraints on influencing the won. Since the government is in the midst of delicate trade talks, any whiff of potential currency manipulation could be used as leverage by the US.
The economy picked up in 2017, but there are some warning signs. GDP growth is forecast by the IMF to have accelerated modestly to 3.0% in 2017 from 2.8% in 2016, but is seen staying at 3% in 2018. GDP rose 3.8% y/y in Q3, the strongest rate since Q1 2014. Monthly data so far in Q4 suggest some slowing should be expected. Furthermore, the manufacturing PMI fell to 49.9 in December, the first time below the 50 boom/bust level since August.