Following the political developments in South Korea and martial laws being put in place and then revoked, the Samsung stock is under heavy selling pressure. How do you expect global investors to react in the short term? Could this spark a broader risk aversion in emerging markets?
Ajay Bagga: The Korean exchange has said they will function as normal. The party leader of the president has opposed this on a Facebook post and the defence minister has called for the military. So, we really do not know what is happening right now. It actually came out of the blue. There have been political wranglings on the budget and this is a minority government which would not survive a floor test. So, overall, it is a very big surprise and I am sure the allies of South Korea from Japan to Europe are working on the back channels to see how this situation can be diffused. It is not a dictatorial country. It is a very strong democracy standing up to its communist neighbours. So, it is very critical that democracy is protected.
In terms of risk assets, there is an impact. South Korea is a big part of the global supply chain and anything disruptive would see a fair bit of risk off happening. But again, the democratic institutions are strong enough and the army will really not intervene out of the blue like this, that is the best scenario we can have. There is a big US military presence in South Korea as well. There’s a very strong treaty in place and I’m sure telephones are being worked on right now.
South Korea is a critical hub for semiconductors and tech supply chains. How vulnerable are global tech markets to prolonged political instability?
Ajay Bagga: Firstly, my assessment is that the president will be on his way out because the ruling party, as well as the opposition, the Democratic Party, both have come together against martial law. This is unheard of in a democracy where they are putting media controls, where political expression is being curbed and emergency has been declared, martial law has been declared. It would not stay for too long, that is the assessment right now that the markets are making, that this is a transient phase. A change of government that will come through. Perhaps you will need one more election to be called and with a caretaker president in place. We are hoping that this does not get prolonged.
Korea is a big supplier, both of high-end technology and tertiary technology. Its two biggest trading partners are the US and China. So, a lot of the finished high-end Chinese goods depend on tertiary Korean goods, as do finished Japanese goods. So, it is a big part of the global electronics, semiconductors, high-end value chain. There will be some amount of disruption, but the sentiment is the bigger issue. We were seeing better sentiment with the Israel-Hezbollah 60-day ceasefire. We were seeing better sentiment with Ukraine talking about truce and putting some conditions. But definitely everybody is talking about a stop to that shooting war. So that risk-on could move to risk-off very fast if this crisis deepens or continues.
Right now, our assessment is it will not continue for too long and saner voices will prevail. Korea today could not withstand North Korea and China combined without the US might behind it. There are over 29,000 US soldiers in South Korea. The US nuclear umbrella protects South Korea from being overrun by the North Korean army. So, clearly the US will have a voice at the table and you can expect that diplomatic channels would be working on resolving this issue.We have seen geopolitical shocks. Historically, they drive investors to safe havens. Like the dollar, like gold, like treasuries. What are the immediate safe haven trends that you are observing or anticipating after this martial law was put in place in South Korea?
Ajay Bagga: So, you are spot on. I am expecting cryptos to go up, for example. I am expecting gold to go up. There will be a flight to safety. Both the yen and the dollar will get bought into. In US treasuries, you can expect the yields to go down. It is a very difficult world. Today we saw French yields reaching the Greece yield levels. We are seeing China borrowing at cheaper rates than Japan. We are expecting the Bank of Japan to come in and raise rates at its next meeting in the next fortnight. So, a lot of things were already moving for the markets apart from the year-end coming and profit booking, setting in tax years, ending in a lot of countries. All that was being factored in and we could have done without this, but safe haven buying will come in. I cannot see the US markets right now. Perhaps you can tell us how the US markets are reacting. But people will be taking out their contingency plans and those plans are quite robust because the probability of a North Korean horde attacking South Korea or a North Korean missile bombardment of South Korea is always factored in.
When I was working for foreign banks, you would never offshore functions into South Korea because you were so close to the North Korean and the Chinese borders, so that way there will be robust contingency plans for global business, but it will impact the risk sentiment. Hopefully this will be a short-lived move and we will see the US exerting some pressure to bring back sanity.
How does this situation in South Korea compare to any of the past political crises that we have seen in other developed economies? Are we likely to see a similar pattern of asset rotation, volatility?
Ajay Bagga: EMs have been seeing outflows and even the Korean markets have been seeing outflows this year. So, there will be a part going out. The other part is that ETFs are available. People will be shorting those ETFs to cover their exposure within Korea itself. That is why we are seeing these 5% moves on the ETFs. And there will be derivatives wrapped around these ETFs as well. But in a broad macro sense, there will be a flight to safety. So, US treasuries, US dollar, Japanese Yen, gold, and crypto will be rallying today.