'The golf has to go'

Continuing our series on the world's stock markets, Liam Robb sees troubled times in Korea

Kim Young-sam, President of South Korea, believes his country's economy is in trouble. Korean industry would appear to concur: last year, Samsung, the giant electronics company, was sufficiently worried about not being able to meet profit targets that it ordered all its top executives to give up playing golf.

This mammoth sacrifice, unfortunately, was not enough to prevent the Korea Composite Stock Price index (Kospi) from plummeting over 30 per cent during the past 12 months, making it one of the world's worst-performing equity markets. Several reasons lie behind the decline.

"One is that the economy relies heavily upon the success of exports like steel, petrochemicals, automobiles and shipbuilding and many of the companies within these sectors are in direct competition with their Japanese counterparts," explains Alfred Ho, fund manager for Invesco, based in Hong Kong.

"The depreciation of the yen over recent months has made Japanese goods much more competitive and this has hit Korean exporters very hard indeed."

Korean companies are unusually highly geared, with much of their long- term debt in US-dollar-denominated instruments. "Korean corporates are therefore very sensitive to interest rate movements and the appreciation of the Korean won against the US dollar caught many by surprise," he says. "It forced many companies to take quite big losses on their US debt and, to a large extent, this contributed to poor corporate earnings."

Korea's reliance on a US-dollar debt cannot be overestimated. Kia Motors, the country's second-largest car marker, increased sales by 16 per cent last year, while announcing a 39 per cent drop in profits - the result, almost entirely, of its dollar positions.

In spite of having one of the world's highest savings rates, Korea also suffers from a capital shortage, with many of the banks having run up bad loans which the government is urging them to write off. There is also a striking absence of small entrepreneurial companies with the large state- subsidised conglomerates - or chaebol - still dominating the economy.

In addition, Korea's attempts to join the OECD have not been helped by a series of strikes over new labour laws which prevent workers from collective bargaining; the imprisonment of union leaders is not uncommon. Wages have been rising by 15 per cent annually while economic growth has declined and the ensuing inflation rate has ensured that productivity has not kept pace with production costs. Korean companies also pay very high interest rates; 12 per cent is twice the level of the country's main economic rivals, Japan and Taiwan.

Despite its recent poor form, Korea can be proud of its economic record. The country is the world's leading supplier of computer memory chips, the second-largest shipbuilder, the third-biggest producer of semiconductors, the fourth-largest maker of electronics, the fifth-biggest car maker and the sixth crude steel producer.

Of the 700 or so quoted Korean companies, many are now household names; Daewoo, Hyundai Motors, Kia Motors, Korean Air Lines and golf-starved Samsung are among the most widely traded by international investors. High interest rates are expected to fall slightly as companies borrow less due to the economic slump and merger activity could provide the fillip the market needs - the banking sector looks particularly ripe for takeover activity.

However, most brokers - Salomon Brothers, for example - believe that any steep upturn in equities will not arrive until the second half of the year. The market is still driven by domestic demand, largely due to the 20 per cent limit on the amount of any Korean company foreign investors can own. This acts as a deterrent to international institutional investors and changes to the law are unlikely to be implemented until after the new administration arrives in 1998.

The strength of the yen will also have an important part to play. "If it continues to appreciate then Korea could see a much better year," says Invesco's Alfred Ho.

"If that happens we should witness a broad-based recovery. Blue chips like Korea Electricity Power Company (Kepco) and Posco, the largest steel producer in Korea, should do particularly well"

Performance figures: Datastream

Country-specific investment trusts include Schroder's Korea Fund, Jupiter's Korea Liberalisation Fund and lnvesco's Korea Fund. Among the unit trusts are Barings Korea, GT Korean Securities Fund, Save & Prosper Korea Fund and Schroder's Seoul Fund