By Jack Kim
SEOUL, Aug 2 (Reuters) - North Korea faces more sanctions as punishment for its alleged sinking of a South Korean navy ship, with the United States planning financial and travel restrictions on companies and individuals suspected of involvement in illicit activities. Pyongyang has reacted angrily.
Sovereign 5-year credit default swap spreads KRGV5YUSAC=R for South Korea have tightened to around 100 basis points, after surging well above 150 during tense times in May and June.
Following is a summary of key South Korea risks to watch:
* THE NORTH
Tensions with the North have ratcheted up the risk level across north Asia, which accounts for one-sixth of the global economy. The greatest risk would be war. North Korea could lob thousands of artillery rounds into the Seoul region, home to about half South Korea’s population, and fire missiles at cities in South Korea and Japan, causing crippling economic damage.
Analysts believe war to be unlikely. North Korea’s obsolete conventional armed forces and military equipment mean quick and near certain defeat if it wages full-scale war, and Pyongyang is well aware of its limits. Even though it has exploded nuclear devices, North Korea has not shown it has a working nuclear bomb. Experts say they do not believe the North has the ability to miniaturise an atomic weapon to place on a missile.
Moreover, South Korea has made clear it will not retaliate after findings showed it was a torpedo fired by a North Korean submarine that sunk the Cheonan corvette, killing 46 sailors.
The greatest risk that could fuel armed confrontation lies in small-scale skirmishes that might develop into larger conflict. Another risk could be a buildup of U.S. forces that will be seen by the North as a sign of imminent invasion, something leaders in Pyongyang are said to be genuinely afraid of.
Besides war, another risk scenario for markets would be the implosion of the North Korean regime, leading to sudden reunification. Most estimates say it could cost Seoul more than $1 trillion to absorb its impoverished neighbour. [ID:nSP522703]
What to watch:
— The leadership succession. Kim Jong-il’s youngest son is believed to be in training to take over power from his father, who by all appearances is firmly in charge of the reclusive state but is clearly in failing health. South Korea’s spy chief has said that there is urgency in the North to move on with succession plans because of Kim’s questionable health. The North has called an extraordinarily rare session of its ruling Workers Party general convention for September for what is widely seen as an announcement of Kim Jong-un’s nomination to a key party post. Such a move will be in line with how Kim Jong-il began on the road to power three decades ago to eventually take over from his father and state founder Kim Il-sung in 1994. [ID:nSGE65P012]
— Clues on the stability of the North Korean regime. South Korean assets would dive if it seemed the North was imploding and reunification was likely. Some analysts see the torpedo attack as a sign of desperation. The North’s decision to revalue its currency in late 2009 sparked rare internal protests, and Kim Jong-il’s efforts to pushes through new measures to reassert control over the economy may further destabilise his regime. [ID:nTOE61402G]
* FALLOUT FROM SHIP ATTACK
The sinking of the Cheonan in late March has the potential to spark conflict with the North and the expected addition of more sanctions by the United States is certain to escalate Pyongyang’s anger. A key U.S. arms control envoy, Robert Einhorn, and the Treasury Department’s terrorist financing section chief Daniel Glaser are visiting Seoul to coordinate sanctions that will be aimed at cutting off earnings from illicit activities.
Glaser was behind the U.S. measure in 2005 freezing the North’s assets at a Macau bank, which angered Pyongyang and drove it to boycott six-party disarmament talks which had just reached a breakthrough deal to disable the communist state’s nuclear programmes in return for massive economic and energy aid, beginning with the shipment of 1 million tones of heavy fuel oil. U.S. Secretary of State Hillary Clinton said the new sanctions are aimed at cutting off the flow of cash to the North’s leaders.
What to watch:
— Einhorn may unveil the details of fresh U.S. sanctions. They will likely involve freezing of assets believed to be tied to the North’s illicit activities, imposing restrictions on financial institutions involved in those businesses and a ban on travel for North Korean officials suspected of involvement.
— South Korea has yet to implement the strongest of the measures it has announced, such as propaganda broadcasts through loudspeakers set up along the border, which the North’s military has threatened to open fire on.
— Trade across the border has slowed, and movement of people has also been cut back sharply. — South Korea says it will clamp down on its land and sea border with the North, and that raises the risk of further clashes which, with its more advanced weaponry, the South would probably win. More losses would embarrass North Korea’s powerful military and put pressure on Pyongyang for a counter-strike.
* GOVERNMENT EFFECTIVENESS AND ECONOMIC REFORM
After suffering a collapse in popularity upon taking office just over two years ago, President Lee Myung-bak has seen a surge in his support as South Korea’s economy emerges from the global downturn more quickly than other major economies.
The government has upgraded its 2010 job creation target to 300,000, and the finance ministry recently raised its GDP growth forecast for 2010 by 80 basis points to 5.8 percent.
But Lee’s plans for job creation and his business-friendly reform agenda have been blocked for months in parliament due to a row over plans to move some ministries to a new administrative capital. A vote in June marked the end of the plan by rejecting Lee’s initiative. It also brought the end of the tenure of Prime Minister Chung Un-chan, an economist who had been expected to take charge of Lee’s pro-business policy agenda but has announced his resignation. Lee is expected to appoint a replacement and also reshuffle the cabinet and name new people to the national security portfolios.
Lee’s ruling Grand National Party had a strong showing in parliamentary by-elections in late July, giving fresh momentum for his legislative agenda as he begins the second half of his single five-year term. A new cabinet is likely to provide a fresh push for his reform plans.
What to watch:
— A new parliamentary session. The GNP and the opposition are likely to agree to hold an extra session of parliament. It should provide the greatest chance Lee has had in several months to process a legislative agenda that includes tax cuts. But it is likely to fall short of a vote to ratify a free trade deal with the United States.
— Labour laws and policies. A key indicator of Lee’s political clout can be seen in his ability to push through his plans on job creation and adding greater flexibility into what is regarded as a rigid labour market. [ID:nSEO41621]
— Opposition in disarray. A power struggle in the Democratic Party is likely to intensify before it holds a national convention to pick a new leader in September. (Editing by Andrew Marshall)