Household Debt, Trump Uncertainty Cited As Biggest Risks To Financial System: BoK Survey

SEOUL – Global investors are watching if South Korea can make company boards more accountable to stockholders. Shares in the country tend to trade at lower valuations than their peers overseas, with analysts saying poor corporate governance is one factor behind what is known as the “Korea Discount.” President Yoon Suk Yeol has made fixing it a priority as he seeks to win favour with a growing base of retail investors. He is not the first leader to try, and he will need to overcome powerful business interests that have benefited from the status quo. 

What is the Korea Discount?

South Korea is home to major companies such as Samsung Electronics, one of the biggest makers of smartphones on the planet, and the Hyundai Motor Group, the world’s third-largest automaker. But investors often price them below their book value and lower than overseas rivals, such as Taiwan Semiconductor Manufacturing or Toyota Motor, even when they achieve a comparable level of profitability.

One explanation is the risk discount placed on South Korean assets because of the country’s standoff with nuclear-armed North Korea. More credible reasons can be found in the corporate structures that were pillars of the nation’s “miracle economy” but may now be holding it back. 

How did we get here?

South Korea’s decades-long transformation from economic minnow to industrial giant owes much to its sprawling, family-run conglomerates known as chaebols. These include LG, Hyundai, SK, Lotte and, largest of them all, Samsung. Now run by the second or third-generation descendants of their founders, the chaebols – meaning “wealth clique” in Korean – enjoy oversized influence and have often had cozy relationships with governments. This has led to a series of influence-peddling scandals.

There are now 64 conglomerates that fit the definition of a chaebol, according to South Korea’s Fair Trade Commission. The combined turnover of the five biggest chaebols is equal to about 45 per cent of South Korea’s gross domestic product as of 2022, according to estimates from the Citizens’ Coalition for Economic Justice, a South Korean activist group.

Chaebols exert control over hundreds of listed companies through a complicated web of cross-shareholding. Their founding families often control the boards and management of those listed firms. Critics say chaebol leaders seek to keep share prices artificially low to avoid the country’s inheritance tax, which is among the highest in the world. 

Why is the Korea Discount a problem?

The Korea Discount dampens economic growth by making it harder for companies to raise affordable capital close to home. Foreign investors are discouraged from holding Korean equities for the longer-term, preferring to flip in and out of stocks for quick gains, in part for fear of being penalised by corporate decisions that go against the interests of minority shareholders.

The relative absence of a large pool of long-term investors is often blamed for making Korean stock prices volatile. The Korea Discount is one reason why many South Koreans have avoided investing in stocks at home, preferring to put their money in real estate or US stocks. This deprives the country’s capital markets of wealth generated by rising disposable incomes.  

How big is the Korea Discount?

Take Samsung Electronics, South Korea’s most valuable company. The world’s largest maker of memory chips trades at slightly below its book value, whereas Taiwanese rival TSMC is worth more than five times the value of its balance sheet assets. If Samsung Electronics matched the price-to-book ratio of US rival Micron Technology, its valuation would be about double.

Overall, companies on the benchmark Korean Kospi share index trade roughly on par with their book value, while Taiwanese stocks change hands for about more than twice their book value. Korea Capital Market Institute researchers who studied the price-to-book ratio of listed companies in 45 countries found in a 2023 report that South Korea sat in 41st place due to weak shareholder returns, low profitability and poor growth prospects. 

What is the government doing about it?

It has been taking steps to improve access to capital markets for investors and revising systems and rules aimed at better protecting the rights of minority shareholders. One move was a “Corporate Value-Up Program” announced in late February for pushing listed companies to voluntarily improve shareholder returns and reform corporate governance in return for tax benefits. The plan has had mixed success so far. Investors are hoping the launch of the new Value-Up Index will spur inflows and give companies the incentive to follow the government’s initiative.

The South Korean program takes a cue from Japanese corporate reforms that helped to push stocks to multi-decade highs. South Korea’s financial regulator says the idea is to propel South Korean stocks higher over the coming decades. President Yoon has zeroed in on reducing the high inheritance taxes that give an incentive to controlling shareholders to keep a lid on stock prices. But the president’s plans to cut the tax took a blow when his conservative party suffered a setback in April elections for parliament. A progressive opposition bloc holds a majority in the body and has no plans reduce the levy.

How did Japan do it?

The chaebols are widely believed to have been influenced by Japan’s zaibatsu – both share the same Chinese characters and meaning. Like the chaebols, zaibatsu were family-controlled conglomerates that dominated Japan’s economy until they were disbanded by the US after World War II. While some Japanese companies have founding families in management, the practice is not as widespread as it is in South Korea. Japan’s corporate reforms began almost a decade ago when the government of Shinzo Abe introduced measures to prod managers to boost the valuations of their companies. At first, many did just the bare minimum to comply with the requirements, which included installing more outside directors on boards. The efforts eventually gained traction, and a tipping point arrived in 2023 when the Tokyo Stock Exchange asked companies to come up with capital efficiency plans, forcing many to turn lip service into action. The growing presence of activist investors in Japan has made chief executive officers more aware that they can lose their jobs if they keep ignoring the demands of investors.  

What are the next steps for South Korea?

The government will seek rule changes to protect the rights of minority shareholders against those of controlling shareholders who use mergers and acquisitions, as well as spinning off units, to advance their own interests. The main opposition Democratic Party, which controls parliament, vowed to pass the Commercial Act revision during this year’s regular parliamentary session. The measure is aimed at preventing power abuse by controlling shareholders.

What is a recent example of volatile shares?

Shares in Korea Zinc have been on a roller coaster ride due to a spat between the two wealthy families of the company’s two founders. They are battling over the future of the US$15 billion (S$20.14 billion) metals empire with the issuance of shares being used as a cudgel. The dispute has implications far beyond South Korea. Including affiliates, the company accounts for 12 per cent of the world’s zinc produced outside of China, according to Bloomberg analysis using data from consultancy CRU Group. 

The firm’s chairman in November said he would step down from his role as the head of the board after scrapping a planned US$1.8 billion share sale, a blow to his efforts to fend off a bid for control from the company’s largest shareholder. The dramatic turnaround came just weeks after Korea Zinc announced its planned share sale, prompting a sell-off in the stock and triggering an investigation by the country’s financial watchdog that put its corporate governance into the spotlight. 

Source: Straitstimes

[Today's Focus]

West Texas Intermediate (WTI), the US crude oil benchmark, is trading around $68.95 on Thursday. The WTI price trades flat as small US crude oil inventories built last week offset the escalating war between major oil producers Russia and Ukraine.The Energy Information Administration's (EIA) weekly report showed crude stocks rose last week, which weighs on the black gold price. Crude oil stockpiles in the United States for the week ending November 15 increased by 0.545 million barrels, compared to a rise of 2.089 million barrels in the previous week.

The market consensus estimated that stocks would increase by 0.400 million barrels. Weak Chinese demand contributes to the WTI’s downside as China is the world's largest crude importer. Data released earlier this week showed that China's crude oil demand fell -5.4% YoY in October.  Chinese demand growth is set to reach just 140,000 bpd this year, a tenth of the 1.4 million bpd demand growth of 2023, according to the IEA. On the other hand, the worries about the intensifying war between major oil producers Russia and Ukraine, and subsequent concern around potential oil supply disruption might boost the WTI price. On Tuesday, Russia’s defense ministry said that Ukraine hit a facility in the Bryansk region with six ATACAMS missiles. In response, Russian President Vladimir Putin lowered the threshold for a possible nuclear strike.

"These risks to supply are definitely keeping the support here and offsetting to a degree concerns around the global demand outlook," said John Kilduff, partner at Again Capital in New York.

WTI Oil FAQs

What is WTI Oil?

WTI Oil is a type of Crude Oil sold on international markets. The WTI stands for West Texas Intermediate, one of three major types including Brent and Dubai Crude. WTI is also referred to as “light” and “sweet” because of its relatively low gravity and sulfur content respectively. It is considered a high quality Oil that is easily refined. It is sourced in the United States and distributed via the Cushing hub, which is considered “The Pipeline Crossroads of the World”. It is a benchmark for the Oil market and WTI price is frequently quoted in the media.

What factors drive the price of WTI Oil?

Like all assets, supply and demand are the key drivers of WTI Oil price. As such, global growth can be a driver of increased demand and vice versa for weak global growth. Political instability, wars, and sanctions can disrupt supply and impact prices. The decisions of OPEC, a group of major Oil-producing countries, is another key driver of price. The value of the US Dollar influences the price of WTI Crude Oil, since Oil is predominantly traded in US Dollars, thus a weaker US Dollar can make Oil more affordable and vice versa.

How does inventory data impact the price of WTI Oil

The weekly Oil inventory reports published by the American Petroleum Institute (API) and the Energy Information Agency (EIA) impact the price of WTI Oil. Changes in inventories reflect fluctuating supply and demand. If the data shows a drop in inventories it can indicate increased demand, pushing up Oil price. Higher inventories can reflect increased supply, pushing down prices. API’s report is published every Tuesday and EIA’s the day after. Their results are usually similar, falling within 1% of each other 75% of the time. The EIA data is considered more reliable, since it is a government agency.

How does OPEC influence the price of WTI Oil?

OPEC (Organization of the Petroleum Exporting Countries) is a group of 12 Oil-producing nations who collectively decide production quotas for member countries at twice-yearly meetings. Their decisions often impact WTI Oil prices. When OPEC decides to lower quotas, it can tighten supply, pushing up Oil prices. When OPEC increases production, it has the opposite effect. OPEC+ refers to an expanded group that includes ten extra non-OPEC members, the most notable of which is Russia.

Source: FXSTREET

We have revised our view of the most likely scenario for the path of the RBA’s cash rate, pushing out the start date of the rate-cutting cycle from February to May. Similar to the pattern in some peer economies, we expect the initial moves to be somewhat front-loaded, with consecutive cuts in late May and early July. This is also a change from our previous expectation of a moderate pace of decline of one cut per quarter. We continue to expect the terminal rate to be 3.35%, to be reached by year-end 2025.

As always, our view on the cash rate is predicated on things turning out broadly as we expect, which can differ from the RBA’s own view. An earlier start in February or March is still possible, but it is no longer more likely than a May start date. A later start date is also a risk scenario, if inflation does not decline as the RBA is currently forecasting, let alone our own marginally more dovish expectation. That said, the longer the RBA Board waits, the faster they will need to move thereafter, as it would then be more likely that they have hesitated too long.

The minutes of the RBA Board meetings often provide important colour about the Board’s deliberations, going beyond what is already covered in communications immediately after the meeting. While the post-meeting communication was still broadly in line with our earlier expectation, subsequent public appearances and the minutes now suggest that the balance of probabilities has shifted. The recent sharp increase in consumer sentiment – though still to a below-average level – and ongoing resilience in the labour market will have also tilted the balance of probabilities to waiting longer.

The minutes note that ‘staff forecasts were consistent with the Board’s strategy of aiming to return inflation to target within a reasonable timeframe while preserving as many of the gains in the labour market as possible’. This is important confirmation that, if things turn out as the RBA expects, it will eventually become time to normalise policy. Policy is restrictive, and if it were to stay where it is for an extended period, inflation would undershoot the target sooner or later. The path for interest rates assumed in the forecasts is a technical assumption, and small changes in timing are not that consequential. Even so, recent RBA communication does suggest that they are more comfortable with the later date embedded in recent market pricing than the late-2023 timing implied by market pricing not so long ago.

Market participants and other observers have also pointed to the language in the latest meeting Minutes that the Board ‘would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable’. This has been interpreted as saying that the RBA needs to see at least two more quarterly CPI (and more importantly, trimmed mean) outcomes from here before being confident of their forecasts. This is almost certainly how the Board and staff are thinking about the outlook. It suggests that they will wait for longer than we previously believed.

We are mindful, though, that things can pivot quite quickly, and that the RBA’s view of the economy looks somewhat more hawkish than we think is warranted.

Recall that as late as February 2022, the RBA was not signalling that it expected to increase the cash rate anytime soon. At the time, then-Governor Lowe was reported as saying, “I think these uncertainties are not going to be resolved quickly. Another couple of CPI’s would be good to see.” Yet it raised rates in May of that year. When the facts change – it became apparent that wages growth had actually picked up at last – you have to change your mind.

Recall also that the RBNZ pivoted quickly this year, too. Only a couple of months before the first cut in August, it was looking like it was going to stay on hold for all of 2024.

The language of the minutes emphasised that trimmed mean inflation was high and declining more gradually than the rebates-affected headline CPI. No mention was made that their near-term forecast for trimmed mean inflation over the year to December 2024 was shaved down slightly to 3.4% from 3.5% in the August round, as was the end-2025 forecast. This was characterised as being ‘little changed’. It does raise the question of what constitutes a ‘good quarter’ for inflation. Indeed, our own near-term view is a touch lower still. And if the December quarter outcome turns out to be a little lower than even our own view, it would take the annual rate to 3.2%, just barely above target. In that scenario, one would have to start wondering exactly what they are waiting for.

As the minutes highlighted, the RBA’s forecasts hang crucially on a relatively bullish view of the potential for consumption growth to pick up as inflation declines and real incomes recover. Our own view incorporates a more modest recovery, noting the relatively subdued response so far to the income boost from the Stage 3 tax cuts. And while public demand (and non-market employment) is sustaining some demand growth for now, this will not last forever. When the outsized growth in this area does eventually fade, it will take time for other sectors to recover in compensation. Australia could end up with an extended period of lacklustre growth.

Another area where the RBA could end up revising its view is on the labour market. Employment growth has been unexpectedly robust. It is important to remember that, with labour force participation rates trending up over many decades, employment has to run very hard to avoid an increase in the unemployment rate. While the unemployment rate has levelled out recently, the underlying trend has been an upward drift for precisely this reason. If employment growth slowed even moderately, things could unravel quite quickly.

Related to this, RBA has (correctly) avoided being too focused on a single number in assessing full employment. But in doing so, it has down-weighted the fact that wages growth has already turned down. Its assessment of the level of full employment could be too hawkish as a result. As we noted last week, the RBA already had to downgrade its wages growth forecasts in the November round. It will need to do so again following the September quarter WPI result.

Taking all these factors together, we assess the risks around our revised view of the rates outlook as two-sided.