OREANDA-NEWS. Fitch Ratings has affirmed Korea's Long-Term Foreign Currency Issuer Default Rating (IDR) at 'AA-' and Long-Term Local Currency IDR at 'AA'. The issue ratings on Korea's senior unsecured foreign- and local-currency bonds are also affirmed at 'AA-' and 'AA' respectively. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at 'AA+' and the Short-Term Foreign-Currency IDR at 'F1+'.

KEY RATING DRIVERS
The Korean sovereign ratings reflect a strong macro-economic performance, moderate government debt and strong external balances, while exposure to geopolitical risk arising from the longstanding conflict with North Korea and low per capita income weigh on the rating.

Korea's macroeconomic performance is strong compared with peers, as illustrated by generally solid and stable real GDP growth combined with low inflation and unemployment. Fitch has adjusted its forecast for real GDP growth in 2015 to 2.9% from 3.5% in early 2015, as external demand for Korean exports has weakened and domestic demand has been affected by the outbreak of the Middle East Respiratory Syndrome virus in May 2015. The government has announced a number of measures, such as a fiscal stimulus package of KRW22trn (1.4% of GDP), including a supplementary budget of KRW12trn, which should contribute to an improvement in consumer confidence. Fitch expects GDP growth to pick up to 3.4% in 2016 and 3.6% in 2017, as both external and domestic demand are likely to recover.

Per capita income of USD33,440 is one of the lowest in the 'AA' category and well below the 'AA' median of USD53,780, which is a rating weakness. At the same time, Korea is generally more developed than income levels alone would suggest. Per capita income will likely continue to be low compared with peers for a long time, as sustaining high GDP growth levels in the longer run will be challenged by a fast-ageing population, relatively low labour productivity and a growth model based on manufacturing exports that may be less successful in the future.

Public finances generally support the rating profile, as government debt at 35.4% of GDP is close to the 'AA' peer median of 36%. The consolidated central government budget (including social security) has been in surplus since 2000 except in 2009, during the global financial crisis. Due to the recently announced supplementary budget Fitch expects a small deficit of -0.1% in 2015. The government's resolve to continue reducing debt held by state-owned enterprises is positive from a credit perspective.

Korea is less vulnerable than many of its peers to external financing risk, such as the risks emanating from normalisation of monetary policy by the U.S. Federal Reserve. It benefits from persistent current account surpluses, high foreign reserves (7.8 months of current account payments, higher than the 'AA' peer median of 5.0 months) and net external asset positions (although the net external assets of 23.8% of GDP are lower than the 'AA' peer median of 27.4%). At this rating level a number of peers have even stronger external balance sheets, for example, those driven by large oil-related foreign currency inflows, but Korea is less dependent on commodity exports.

High and rising household debt (164.2% of disposable income end-2014) increases Korea's vulnerability to shocks, although household assets are also relatively high, which, to some extent, limit the risk to financial stability and the economy. The authorities are taking measures to reduce the weaknesses related to household debt, with attention is given to vulnerable loans, such as through stronger supervision of borrowing from the non-banking sector and through financial assistance to exposed households. High and increasing household debt limits policy flexibility, because it appears to constrain the Bank of Korea from further loosening its monetary policy stance at a time when average inflation of 1.1% in the previous two and a half years has been well below the inflation target of 2.5-3.5%.

Geopolitical risks are a weakness in the credit profile given the long-running conflict with North Korea and the accompanying uncertainties, which are exacerbated by the opacity of developments in North Korea. Risks to the sovereign balance sheet and the economy relate to both the short- to medium-term risk of increased tensions and a long-term scenario of reunification. However, reunification would also provide opportunities in terms of political stability and relatively cheap labour during a transition period of integration for manufacturing export-led growth.

RATING SENSITIVITIES
The main factors that, individually or collectively, could trigger positive rating action are:
- A convincing strategy to reduce the broader public debt burden, which would be reflected in lower debt to GDP ratios for the general government or state-linked enterprises
- Evidence that the economy can continue to grow over time, thereby narrowing the per-capita income gap with rating peers, without deterioration in the combined household balance sheet

The main factors that, individually or collectively, could trigger negative rating action are:
- An unexpected large rise in the public-sector debt burden caused by a deviation from the current prudent fiscal policy framework or crystallisation of financial sector or other contingent liabilities
- Evidence that GDP growth will be structurally lower than expected, potentially reflecting medium- to long-term challenges for Korea's economic model

KEY ASSUMPTIONS
- No significant change in the relationship between North and South Korea, such as a full-scale military conflict, or the sudden collapse of the regime in the North leading to instability on the Korean peninsula.
- The global economy performs broadly in line with Fitch's Global Economic Outlook, including a gradual slowdown of growth in China to 6% by 2017 and average Brent oil price assumptions of USD65 per barrel in 2015 and USD75 in 2016.
- Normalisation of monetary policy rates in the U.S. begins toward end-2015 and proceeds in an orderly manner.