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Moody's: Vietnam most exposed to potential Korean conflict

Released at: 09:55, 05/10/2017

Moody's: Vietnam most exposed to potential Korean conflict

Illustrative image (Source: htv.com.vn)

Lower capital flows and exports from South Korea would have a substantial impact on Vietnam's economy, credit ratings agency warns.

by Quang Huy

Moody’s Investors Service has said that uncertainty over the potential for military conflict on the Korean peninsula is rising with the increasingly strident rhetoric. A conflict would have a high credit impact on South Korea, and Vietnam and Japan would the most exposed of other countries.

Foreign direct investment (FDI) has been essential to Vietnam’s move up the value chain and its strong growth, and around 25 per cent of FDI inflows into Vietnam come from South Korea. A drying-up of capital from the country could therefore weigh significantly on Vietnam’s economy. Combined with lower exports to the country and globally, diminished FDI inflows would impinge on Vietnam’s balance of payments.

Vietnam has the largest proportion of non-commodity exports to South Korea globally, amounting to close to 6 per cent of its GDP last year. Electrical machinery and equipment parts make up more than one-third of its exports to the country, followed by apparel and clothing accessories, at almost 14 per cent.

In a conflict, for every 10 per cent fall in South Korea’s GDP, Moody’s estimates that Vietnam’s GDP would decline by around 0.7 per cent to 1.0 per cent. Two factors would add to the economic impact of a Korean conflict on Vietnam. First, Vietnam’s exposure to some of the other countries that would likely be involved in a conflict and incur an economic loss is also large. Exports to the US are worth around 19 per cent of Vietnam’s GDP, to China around 11 per cent, and to Japan around 7 per cent. Second, weaker exports would weigh on investment and consumption.

Given the size of the country’s exports to and imports of intermediate goods from South Korea, Vietnam’s economy would be vulnerable to any conflict. Total government debt was 52.6 per cent of GDP in 2016, and public debt, which includes debt guaranteed by the government, was 63.7 per cent, approaching the government’s own 65 per cent limit. Moody’s believes Vietnam’s policymaking institutions would likely face significant challenges in defining and implementing a rapid yet effective response, and the government may not be able to buffer the economic shock without a material weakening of fiscal strength.

It also said that Vietnam would be the most vulnerable to any disruption in global supply chains caused by a cessation or weakening of production in South Korea. Around 20 per cent of its intermediate goods imports are from the country, implying a significantly negative second-round effect on trade and domestic production in the event of prolonged disruption to South Korean supplies.

IT products and machinery made up the majority of goods imported from South Korea in the first half of 2017, according to the General Department of Vietnam Customs. Overall, a conflict in Korea would materially and potentially durably undermine Vietnam’s GDP growth, the strength and stability of which has been a significant support to credit quality.

Moody’s assessment of Vietnam’s fiscal strength at “Moderate (-)” highlights the government’s limited scope to ease policy to weather the economic shock related to a Korea conflict and mitigate its credit-negative implications. Absent a conflict, however, Moody’s assessment is that external vulnerability risks are very low for Vietnam. Only a very significant shift in trade and capital flows would raise external vulnerability materially.

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