Country Risk in South Korea and Neighouring Countries SKCC - General Assembly - April 28, 2004 Adrian Lüdi WMI Japan & Korea

1 Definition: Country risk  Country risk measures changes in the value of foreign exposures due to country-specific political and economic conditions  It consists of several risk dimensions as shown on the following chart

2 Country Risk Dimensions Sovereign Risk Transfer Risk Political Risk Institutional Risk Systemic Counterparty Risk

3 Definitions  Political risk: the possibility that political decisions or events in a country will affect the value a creditor's exposure  Transfer risk: the risk that a transfer covered by a contract cannot be effected between one currency area and another, or that such transfers are restricted as a result of state intervention  Sovereign risk: the risk that the government of a sovereign state may default on its financial obligations  Systemic counterparty risk: the possibility of widespread insolvencies of financial institutions  Institutional risk: the risk that the creditor cannot access the collateral in the event of default, because of an unsatisfactory development of bankruptcy laws or weak courts for their enforcement

4 Risk Factors  Internal Political and Social Risks  External Political Risks  Economic Policy  Financial System / Corporate Sector  External Finance  Structural Characteristics  Economic Performance  Debt and Liquidity Political & Social Indicators Qualitative & Quantitative Economic Indicators

5 Country Risk Monitor - Indicators for country risk  Domestic Economy — Real GDP Growth — Investment as a share of GDP — CPI — Money Supply Growth — Fiscal Balance  External Economy — Real Effective Exchange Rate — Trade Balance — Exports/Imports — Current Account Balance — Current Account as a share of GDP — Export Concentration — Net Foreign Direct Investment

6 Country Risk Monitor - Indicators for country risk  Debt & Liquidity — Total External Debt/ST Ext Debt, ST Debt as share of Exports — External Debt Service, Ext Debt Service as a share of Exports — International Reserves  Additional — International Reserves/Imports — International Reserves/ST Debt — General Government Debt/GDP

7 South Korea - Selected CR indicators *Estimate

8 South Korea - Risk Assessment  Macroeconomic Baseline scenario — Exports accounting for 45% of GDP — Domestic demand remains relatively weak — Heavy household indebtedness — Investment dampened if firms continue totake „wait and see“ attitude  Country Risk — Slight deterioration during 2003 (political infighting, rise in labour militancy) — Election Result reduces political uncertainty for 2004 — Strong external liquidity position/declining ext debt ratio/resilient financial system keep transfer risk/systemic risk at acceptable levels — Risk of sovereign crisisis mitigated (fiscal surplus, stable public debt ratio) — North Korea remains key risk driver

9 South Korea - Key Developments  Political risk — Election result makes Roh's return to office more likely — Uri party's control of Nat Assembly promising strong backing for Roh's social/economic reforms  Major Challenge — Balancing alliance with US & policy of engagement with North Korea  Strong exports drive economic recovery — Economic downturn in first half of 2003, rebounded in H2 boosted by rapid export growth — China accounts for 19% of Korean exports, about to overtake US as main export market — Build-up in international reserves, hitting record USD 158 bn in Jan 04  Credit Card debt crisis — reveals structural weakness of financial system (Risk Control, Supervisory weakness

10 Institutional Investor Credit Rating (March 2004) Source: Institutional Investor

11 Rating Comparison: Moody's, S&P and Fitch

12 Various Country Rankings in Comparison

13 Emerging Asia: Spreads over U.S. Treasuries

14 Asia: Credit Strengths & Weaknesses Source: CCRC

15 Balance of Payments & Trade Openness, 2003

16 Change in Reserves: Dec Feb 2004 (%)

17 Share of Global Foreign Exchange Reserves

18 Major Foreign Holders of U.S. Treasury Securities

19 External Solvency & Liquidity Ratios, 2003

20 External Debt Burden, 2003

21 Emerging Asia: Major Export Destinations

22 Important Challenges & Risks  Emerging Asia's expansion is still too reliable on exports and thus heavily vulnerable to a weakening of external demand  The growing regional interdependence also bears downside risks - the possibility of a much sharper slowdown in China  Asia needs to maintain control of public debt burden, which is - on average - larger than in Latin America or Eastern Europe  The region also needs to continue with its agenda of domestic structural reforms, in particular completing corporate & financial sector restructuring, and advancing legal & regulatory reforms  Advocating greater exchange rate flexibility (China, Japan) would contribute to the global adjustment and monetary stability  Asia is also faced with some important local and geopolitical risks: North Korea issue, Cross-strait tensions, Kashmir conflict, Terror threat and potential election-induced social & political turmoil