Beware political risk, No.1 factor in Korea Discount

Corporate governance and management transparency have long been the big issues influencing the so-called Korea Discount, alongside labor strife and the conflict on the Korean Peninsula.

This year, however, politics has risen to the forefront of risks for South Korean companies, increasing the discount rate on their future cash flows.

About six months before the general election next April, both the ruling and opposition parties are rushing to make populist policy proposals aimed at winning votes.

Some of them — including a labor-friendly law and an eight-month ban on short selling in Korean stocks — passed through parliament or took effect this month.

WINDFALL TAX

One of the controversial policy proposals, pending in parliament, involves windfall taxes.

The country’s main opposition Democratic Party calls for a windfall tax not only on banks and oil companies that have benefited from high interest rates and high oil prices, but also on companies in other industries when they rake in so-called “excess profits” thanks to an unexpectedly favorable business environment.

It is unclear how they define excess profit and how much of it, if defined, can be taxed.

What makes investors really nervous, however, are the signals that politicians are sending the market: that they can neutralize business-to-business contracts and limit corporate profits to win over voters.

RULING PARTY IN A CONTRADICTORY STANCE

The ruling People Power Party, which claims it pursues a free market economy, is no different. It gave the nod to the need to levy extra taxes on what is deemed as excess company profits, even though it opposes the introduction of a windfall tax itself.

Its contradictory stance underscores its desperate efforts to win back a majority in parliament next year, when President Yoon Suk Yeol enters his third year of a five-year term.

DIVIDENDS, LABOR ISSUES

For the banking sector, low dividend payout ratios and policy uncertainties have put downward pressure on their stock prices.

To remove policy risks, Lee Bok-hyun, governor of the regulatory Financial Supervisory Service (FSS), has vowed to give banks leeway to decide their dividend payout ratios.

Such assurances notwithstanding, the regulator continues to intervene in their businesses by criticizing their high lending rates and hefty interest income.

The price-to-book ratio (PBR) of Korean banking stocks remains little changed at 0.3 to 0.4 on average.

Regarding labor issues, the Democratic Party, with a majority in parliament, this month pushed ahead with labor law revision that lets subcontractors directly negotiate with their original employers, not the intermediary companies, about wages and labor conditions.

The revised law could shake up the industrial ecosystem and deal a severe blow to Korean manufacturers, including Hyundai Motor Group.

PRESIDENT

President Yoon Suk Yeol adds to the political uncertainty in the Korean stock market.

The former public prosecutor general this month publicly criticized Kakao Mobility Co. for its pricing policy. He labeled the taxi-hailing app’s commission fee system as “unethical” and demanded that sanctions be imposed on the business practice.

In response, Kakao announced the revision to its pricing policy, without arguing whether its business model is ethical or justifiable.

I vaguely expect that populism will subside after next year's general election. But I know from experience that such populist policies will reappear in the next election.

It’s not short-selling itself that drives stock prices lower, but the unexpected policy moves such as the recent ban on short-selling that have sounded the alarm on political risk for the Korean stock market.

Write to Chang Jae Yoo at yoocool@hankyung.com
 

Yeonhee Kim edited this article