a united korea? reassessing north korea risks

A United Korea? Reassessing North Korea Risks

Goohoon Kwon, CFA

Tel: [email protected]

Goldman Sachs Global ECS Research

2

Key topics

North Korea: Risks and opportunities

North Korea’s economy: At a crossroads

North Korea’s long-term growth potential

A united Korea: Projections and integration costs

Appendix


3

North Korea risks

1300

1320

1340

1360

1380

1400

1420

9:01

AM

9:31

AM

10:0

1 A

M

10:3

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11:3

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12:0

1 PM

12:3

1 PM

1:01

PM

1:31

PM

2:01

PM

2:31

PM

-2.6% in a minute

Intraday KOSPI reactions on May 25,2009 to the 2ndnuclear test by North Korea terms


4

North Korea Risks

The day of the event

Date Event KOSPI USD KTB 3yrKOSPI

turnoverKOSPI2 1M

ATM Vol

1998/08/31 Daepodong-1 rocket launch 0.3% 1.0% -10 bp (close: 11.40) +57.2% NA1999/06/15 Naval firefight in Yeon-pyong-do -2.2% -0.4% no chg (close: 6.70) -1.4% NA2002/06/26 Naval clash on the Yello Sea -7.2% -0.8% -3bp (close: 5.83) +21.2% +0.6%2004/09/23 Ballistic missile fire test -0.6% 0.1% +3bp (close: 3.55) -14.3% -1.9%2006/07/05 Daepodong-2 missile launch -0.5% 0.4% -4bp (close: 4.85) -3.5% +2.8%2006/10/09 Nuclear test -2.4% 1.5% +2bp (close: 4.59) +54.3% +25.4%2009/04/05 Long-range missile launch 1.1% -2.4% +4bp (close: 3.95) +1.1% -0.3%2009/05/25 Nuclear test & short-range missile fire -0.2% 0.1% -4bp (close: 3.81) +9.7% +6.2%2009/06/01 Short-range missile fire 1.4% -1.4% -2bp (close: 3.81) -9.8% +0.7%

Days taken to recover to the level of the day before the events

Date Event KOSPI USD KTB 3yrKOSPI

turnoverKOSPI2 1M

ATM Vol

1998/08/31 Daepodong-1 rocket launch NM 1 day NM 0 day NA1999/06/15 Naval firefight in Yeon-pyong-do 1 day NM NM 1 day NA2002/06/26 Naval clash on the Yello Sea 5 days NM NM 4 days 2 days2004/09/23 Ballistic missile fire test 5 days 11 days 4 days 1 day NM2006/07/05 Daepodong-2 missile launch 3 days 4 days NM 2 days 13 days2006/10/09 Nuclear test 5 days 13 days 9 days 0 day 5 days2009/04/05 Long-range missile launch NM NM 1 day NM NM2009/05/25 Nuclear test & short-range missile fire 5 days 4 days NM NM 10 days2009/06/01 Short-range missile fire NA NA NM 1 day 2 days


5

A United Korea could overtake France, Germany and possibly Japan in 30-40 years in terms of GDP

Source: GS Global ECS Research.

0

10000

20000

30000

40000

50000

60000

70000

80000

China

United

Sta

tes

Indi

a

Brazil

Russia

Indo

nesia

Mex

ico

United

Kor

ea

United

Kin

gdom

Turke

y

Japa

n

Franc

e

Germ

any

Nigeria

Philipp

ines

Canad

aIta

ly

South

Kor

ea Iran

Saudi

Ara

bia

2007 US$ bn

World in 2050 and a United Korea: GDP in USD terms (2007)


6


World in 2050 and a United Korea: GDP in USD terms (2007) (excluding China, US, India and Brazil)

0

1000

2000

3000

4000

5000

6000

7000

8000

Russia

Indo

nesia

Mex

ico

United

Kor

ea

United

Kin

gdom

Turke

y

Japa

n

Franc

e

Germ

any

Nigeria

Philipp

ines

Canad

aIta

ly

South

Kor

ea Iran

Saudi

Ara

bia

2007 US$ bn

A United Korea could overtake France, Germany and possibly Japan in 30-40 years in terms of GDP


7

Source: Bank of Korea, IMF, GS Global ECS Research.

North Korea’s real GDP is still lower than its 1992 levelOutput correction and recovery in formerly planned economies (real GDP, 1992=100)

The North Korean economy is at a crossroads

60

80

100

120

140

160

180

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Transitional economies (median)

North Korea

Russia

Kazakhstan

Index

-3.7

-6

-2.1

-4.1-3.6

-6.3

-1.1

6.2

3.7

1.2

2.2

3.8

-1.1

-2.3

3.7

1.3

-3.5

-4.2

1.8

-8

-6

-4

-2

0

2

4

6

8

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

3-year moving average

% chg yoy

N. Korea’s economy is stagnating recently


8

Source: CEIC, IMF, Bank of Korea, GS Global ECS Research.

Per capita income of North Korea in USD is similar to that of Vietnam and India

The North Korean economy is at a crossroads

North Korea* Vietnam Mongolia India China Cambodia Philippines Laos1995 1033 288 631 384 603 297 1055 3821996 989 338 598 410 701 295 1152 3881997 812 361 528 426 772 281 1122 3571998 572 357 480 423 819 253 867 2551999 714 374 441 449 865 281 992 2862000 757 402 455 451 949 288 989 3292001 706 413 482 459 1042 309 906 3272002 762 440 518 480 1135 327 958 3312003 818 492 582 559 1274 349 973 3802004 913 553 720 645 1490 394 1040 4332005 1056 639 905 734 1715 455 1159 4852006 1108 723 1224 816 2028 513 1352 5822007 1151 834 1503 1035 2567 649 1624 6752008 1067 1034 1981 1005 3267 818 1845 841

*Bank of Korea's estimates in KRW, which we have converted to USD at market exchange rates.

Note: Caution is needed in its direct comparison with those of other countries as the estimates are based on South Korean price and cost structures.


9

Source: Korea Development Institute, Korea Trade-Investment Promotion Agency, GS Global ECS Research.

Unofficial exchange rates are 20 times higher than the official rates

The planned economy system in N. Korea appears to be on the verge of collapse

1

10

100

1000

10000

1985 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2007

0

20

40

60

80

100

120

Black market premium (x) (RHS)

Official NKW/USD rate (in log)

Unofficial rate (in log)


10

North Korea’s closer economic ties with South Korea

0.0

0.5

1.0

1.5

2.0

2.5

2000 2001 2002 2003 2004 2005 2006 2007 2008

South Korea

Japan

China

Others

US$ bn

South Korea is North Korea’s largest export marketExports of North Korea in US$bn including exports to South Kora

Source: Korea Development Institute, Korea Trade-Investment Promotion Agency, GS Global ECS Research.


11

Source: CEIC, National Statistical Office, GS Global ECS Research.

Rural population in North Korea is at the level of South Korea in the late 1970s

North Korea has abundant and competitive labour force

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

Vietnam

China

South Korea

North Korea


12

Source: Bank of Korea, GS Global ECS Research.

Industrial structure of N. Korea vs. S. Korea

The North Korea’s industrial structure is also similar to that of South Korea in the late 1970s

North Korea ('08)

South Korea ('08)

South Korea ('79)

Agriculture and fishing 21.6 2.5 21.3Mining 12.1 0.2 1.1Manufacturing 22.5 28.1 24.7

Light 6.7 4.6 ...Heavy and petrochem 15.8 23.5 ...

Electricity, gas and water 3.4 1.8 2.2Construction 8.3 7.0 7.9Services 32.2 60.3 42.7

Government 22.8 10.7 ...Others 9.4 49.6 ...

Total 100.0 100.0 100.0


13

Note: Reserves for the South Korea are the sum of confirmed and estimated reserves as of 2007. North Korean data are potential reserves, based on the latest North Korea data

North Korea is rich (and South Korea is poor) in mineral resources

Strong synergies between South and North Korea- Mineral resources

North Korea South Korea

Unit Reserves Value (KRW trn) Reserves Import %

Magnesite bn ton 6.0 1,376 - 100 Limestone bn ton 100 996 10 1 Uranium ore 000 ton 4,000 628 - 100 Lignite bn ton 16 343 - 100 Anthracite coal bn ton 4.5 257 1.4 65 Iron bn ton 5.0 214 0.02 99 Gold 000 ton 2 45.3 0.04 93 Zinc 000 ton 21,000 12.6 588 100 Lead 000 ton 10,600 9.12 404 100 Copper 000 ton 2,900 5.41 56 100 Silver 000 ton 3-5 1.86 1.58 95 Molybdenum 000 ton 54 1.13 22 99 Rosette graphite 000 ton 2,000 0.75 121 100 Tungsten trioxide 000 ton 246 0.39 127 89 Barite 000 ton 2,100 0.22 842 100 Fluorspar 000 ton 500 0.08 477 100 Talcum 000 ton 700 0.06 8,152 92 Kaolinite 000 ton 2,000 0.03 106,335 11 Manganese 000 ton 100-300 0.01 176 100 Nickel 000 ton 10-20 0.00 - 100 Asbestos 000 ton 13 0.00 511 -

Total (times 2008 GDP) 142

Source: Korea Resources Corporation, Korea Institute for National Unification, Hyundai Research Institute, IAEA, EIA, GS Global ECS Research.


14

North Korea has more favorable demographics than the South (2007)

Strong synergies between South and North Korea:demographic

South Korea

North Korea

United Korea

Demographic composition (in % of total)0-14 years 18 23 2015-64 years 72 68 7165 or over 10 9 9

Birth rate per 1000 9.9 15.1 11.6Death rate per 1000 6.0 7.2 6.4Annual population growth 0.4 0.8 0.5

48.1 48.9 49.3 49.3 49.1 48.6 47.7 46.342.3

2324 25 26 27 27

27

28

25

0

10

20

30

40

50

60

70

80

2005 2010 2015 2020 2025 2030 2035 2040 2050

0.0

0.5

1.0

1.5

2.0

2.5

South Korea North Korea South/North ratio (RHS)

Population of a United Korea could near 80million at its peak in 2030

Source: UN, CIA, GS Global ECS Research. Source: UN, National Statistical Office, GS Global ECS Research.


15

Strong synergies between South and North: productivity gains

Source: IMF, GS Global ECS Research.

Trough year in

real GDP

Total declines since 1992

before recovery

Avg growth from the trough year or 1992 to

2008

Real GDP in 2008

(1992=100)

Armenia 1993 -14.1% 8.8% 305Azerbaijan 1995 -46.3% 12.1% 236Belarus 1995 -27.6% 7.5% 185Albania 1992 NM 6.4% 269Georgia 1994 NM 6.5% 242Kazakhstan 1995 -27.2% 6.6% 168Kyrgyz Republic 1995 -34.2% 5.1% 125Bulgaria 1997 -27.5% 5.2% 126Moldova 1999 -41.9% 5.9% 98Russia 1998 -29.2% 6.8% 137Tajikistan 1996 -41.5% 7.3% 137Turkmenistan 1997 -42.8% 14.1% 243Ukraine 1999 -50.4% 6.8% 90Uzbekistan 1995 -8.3% 5.3% 180Czech Republic 1992 NM 3.2% 167Slovak Republic 1993 NM 5.2% 229Estonia 1994 -1.6% 6.2% 201Latvia 1993 -11.4% 5.6% 201Hungary 1993 -0.6% 3.6% 168Lithuania 1994 -24.4% 5.9% 170Croatia 1993 -8.0% 4.3% 172Slovenia 1992 NM 4.3% 195Macedonia, Former Yugoslav Republic of1995 -10.2% 2.8% 129Poland 1991 NM 4.5% 211Romania 1992 NM 3.5% 173Europan average -24.8% 6.1%

China na NM 10.2% 470

Mongolia 1993 -3.0% 5.5% 217Vietnam na NM 7.6% 323Asian average -3.0% 7.8%Asian and European average -13.9% 6.9%

Memorandum item:

United States na NM 2.9% 159North Korea 1988 NM 2.0% 98South Korea na NM 5.0% 219

Output decline and recovery in transition economies


16

Strong synergies between South and North Korea- productivity gains

Source: IMF, GS Global ECS Research.

Growth Environment Scores for BRICs and N-11 (2008)*

0

1

2

3

4

5

6

7

8

9

South K

orea

China

Mex

ico

Brazi

l

Turkey

Vietn

am

Russia

Phillphin

esIra

nIn

dia

Indonesi

a

Egypt

Bangl

adesh

Pakist

an

Nigeria

North K

orea

* The North Korea score is a tentative one, based on our estimates of the 13 GES indicators.


17

Currencies in most transition economies strengthened more rapidly than output growth

Strong synergies between South and North Korea -currency appreciation

Real appreciation accounted for 80% of USD GDP growth in transition economies over 1993-2007

Source: IMF, GS Global ECS Research. Source: IMF, GS Global ECS Research.

Real Appreciation and Real GDP Growth: Transitional Economies (average per annum,1993-2006)

2523

19 18 18 1816

15 14 14 1312 12 11 11

9 9 9 8 8 7 6 6 5 43 2 2

7

3

5

43

1

1 5

-1

3

6

6

1

-1

3

1

53

3

03

1

8

5

4

10

35

-5

0

5

10

15

20

25

30

35

Real GDP

Real appreciation

% USD GDP Growth in Transition Economies

-18-11

-1 2 3 3 3 6 6 6 8 9 8 10 10

97

4640

14

-9-3

4 6

16 1611 11

20

21

-20

0

20

40

60

80

100

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Real Exchange Rate

Real GDP


18

Strong synergies between South and North Korea- currency appreciation

Source: IMF and SNU (2009), GS Global ECS Research.

Price structures of North and South Korea differ widely

Item UnitSouth Korea (KRW;2008)

North Korea (NKW;2002)

PPP rates (KRW/NKW)

Electricity kwh 55 2.1 26

Diesel kl 1,465 38 39

Rice kg 2,705 43 63

Bus Fare 1 use 1,000 2.0 500

Subway fare 1 use 1,000 2.0 500

House rent 1/ m 2̂ 19,697 2.0 9,848

House rent 2/ m 2̂ 179,341 2.0 89,670

1/ Pyongyang for North Korea, and minimum nation- wide Apt prices for South Korea.

2/ Pyongyang for North Korea, and average Seoul Apt prices for South Korea.


19

A United Korea – growth potential


The GDP (in USD terms) of a United Korea could exceed that of France, Japan and Germany in 30-40 years

1000

2000

3000

4000

5000

6000

7000

United Korea

J apan

Germany

France

Transition phase Consolidation phase Maturing phase

US$ bn (2007)


20

A United Korea – the potential size of the economy

Source: Bank of Korea, UN, GS Global ECS Research.

Indicative long-term projections

Real GDP Index (2008 trn KRW) yoy% (average per annum)United Korea

South Korea

North Korea

United Korea

South Korea

North Korea

2010 1090 1062 28 2% 2% 1%2015 1353 1317 35 4% 4% 5%2020 1609 1559 49 4% 3% 7%2025 1855 1786 69 3% 3% 7%2030 2097 2001 96 2% 2% 7%2035 2324 2197 128 2% 2% 6%2040 2570 2405 165 2% 2% 5%2045 2793 2600 193 2% 2% 3%2050 3027 2812 215 2% 2% 2%

USDGDP (2007 USD bn) yoy% (average per annum)United Korea

South Korea

North Korea

United Korea

South Korea

North Korea

2010 $943 $917 $26 -1% -1% 2%2015 $1,643 $1,596 $47 12% 12% 12%2020 $2,077 $1,964 $113 5% 4% 19%2025 $2,574 $2,299 $274 4% 3% 19%2030 $3,280 $2,645 $635 5% 3% 18%2035 $4,176 $3,051 $1,125 5% 3% 12%2040 $4,956 $3,448 $1,508 3% 2% 6%2045 $5,519 $3,747 $1,772 2% 2% 3%2050 $6,056 $4,073 $1,982 2% 2% 2%

Per capita income (2007 USD1000) Real appreciation yoy%United Korea

South Korea

North Korea

United Korea

South Korea

North Korea

2010 $13 $19 $1 -2% -3% 1%2015 $22 $32 $2 7% 7% 7%2020 $28 $40 $4 1% 1% 12%2025 $34 $47 $10 1% 0% 12%2030 $43 $54 $23 1% 1% 11%2035 $55 $64 $40 1% 1% 6%2040 $66 $74 $53 1% 1% 1%2045 $76 $84 $62 0% 0% 0%2050 $86 $96 $70 0% 0% 0%

Total population (mn) North/South ratio

United Korea

South Korea

(mn)

North Korea

(mn)Population

per capita

income

USD GDP

2010 73 49 24 49% 6% 3%2015 74 49 25 51% 6% 3%2020 75 49 26 52% 11% 6%2025 76 49 27 54% 22% 12%2030 76 49 27 56% 43% 24%2035 76 48 28 58% 63% 37%2040 75 46 28 61% 72% 44%2045 73 45 29 64% 74% 47%2050 71 42 28 67% 72% 49%


21

A United Korea – Growth potential of the mineral sector

Source: Korea Resources Corporation, GS Global ECS Research.

North Korea’s mineral wealth could provide sizeable income in the long run

0

50

100

150

200

250

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050

0

50

100

150

200

250

Mineral sector income under even use of mineral wealth

Non-mineral sector income

Total Incomes under incremental use of mineral wealth

Benchmark GDP projections

W trillion (2008) W trillion (2008)


22

A United Korea – comparison with other economies

Selected indicators of North and South Korea

Economic growth of two integration economies

Source: Bank of Korea (2009)

1994 2008 1989

North South N/S North South N/S East Ger West Ger E/W

Population (million) 23.0 44.5 51.7% 23.3 48.5 48.0% 16.7 61.4 27.2%Per capital income (US$) 923 10076 9.2% 1064 19231 5.5% 12700 38500 33.0%Gross National Income (US$bn) 21.2 448.4 4.7% 24.9 928.7 2.7% 212 2364 9.0%External trade (% of GNI) 9.9 52.5 18.9% 15.4 92.3 16.6% 50 80.9 61.8%Exports ($ bn) 0.9 96 0.9% 1.1 422 0.3% n.a. n.a. n.a.Exchange rate against USD 2.16 802 0.3% 130 1100 11.8% n.a. n.a. n.a.Government budget (US$ bn) n.a. 88.3 n.a. 3.5 212.6 1.6% 46.5 78.7 59.1%

Before Integration After(-5 to -1 year) (1 to 5 years) (6 to 10 years)

East Germany 2.7 1.4 1.9West Germany 2.3 -0.5 1.8

Hong Kong 4.9 1.4 6.4China 12.4 8.2 10.6

Source: Bank of Korea, UN, OECD.


23

Integration costs: vary a lot depending on the speed and policy assumptions

Inter-Korea integration costs – survey of literature

SourcesResearch

yearIntegration

period Costs Note

Korea Development Institute 1993 2000-2010 $286bn German style unification

Korea Development Institute 1994 2000 $1000bn German style unification

Korea Development Bank 1994 1994-2004 $805bnGerman style unification (60% income differential)

Korea Development Institute 1997 1995-2005

9-11% of GDP for the first 5 years;7.5% of GDP for the second 5 years 50% income differential

FitchRatings 2003Over 10-15 years $15-20bn per year

Rand Institute 2005 Over 5 years $50bn-$670bnTo double North Korea GDP within 4-5 years

Samsung Economics Research 2005 2015 $546bnTo provide for social safety net and industrialization

Bank of Korea 2007Over 13-39 years

German style: $500-900bn over 22-39 years; Economic zone style: $300-500bn over 13-22 years

To reach North Korea's per-capita income of $10,000

Source: Korea Tax Institute (2008), GS Global ECS Research.


24

A United Korea – income convergence

Illustrative scenario of a North-South income convergence(Number of years for North Korea’s per-capita income to reach half of the South Korea level)

Source: Bank of Korea, GS Global ECS Research.

41

21

13

0

5

10

15

20

25

30

35

40

45

Case I Case II Case III

Case I: North Korea's output is growing 6% points faster thanSouth

Case II: Case I and the North Korean currency is appreciating 6%faster than the South currency

Case III: North is growing 3% points faster than South, and theNorth currency appreciating 5% faster than the South currencyplus annual transfers of 1% of South Korean GDP to North Korea


25

Appendix: Korea at a glance

45%

46%

47%

48%

49%

50%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000S Korea (RHS) N Korea (RHS) N Korea to S Korea (000)

-8

-6

-4

-2

0

2

4

6

8

10

12

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

S Korea

N Korea

Population Real GDP yoy growth rate

Source: Bank of Korea Source: Bank of Korea


26


Gross National Income per capita North Korea’s GDP yoy growth (% chg by industry)


-20

-15

-10

-5

0

5

10

15

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Agriculture, Foresty, Fishery Mining & Manufacturing GDP

0%

4%

8%

12%

16%

20%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-

400

800

1,200

1,600

2,000

2,400

S Korea (RHS) N Korea (RHS) N Korea to S Korea

(W 10K)


27


North Korea’s industrial structure

South Korea’s industrial structure


0%

20%

40%

60%

80%

100%

2000

2001

2002

2003

2004

2005

2006

2007

2008

Services

Construction

Electricity,Gas &water

Mining &Manufacturing

Agriculture,Foresty, Fishery

0%

20%

40%

60%

80%

100%

2000

2001

2002

2003

2004

2005

2006

2007

2008

Services

Construction

Electricity,Gas &water

Mining &Manufacturing

Agriculture,Foresty, Fishery


28

Appendix: The Gaesung Industrial Complex

The GIC’s output is growing rapidly(in US$mn and in % of N. Korea exports)

Investment in the GIC(Investment in KRW bn)

Source: Ministry of Strategy and Finance, GS Global ECS Research.

0

50

100

150

200

250

300

2005 2006 2007 2008

0%

5%

10%

15%

20%

25%

In US$ million

In percent of total exports (RHS)

0

50

100

150

200

250

300

350

400

450

500

Private companies Government Land corporation KEPCO Korea Telecom

In KRW bn


29

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