This week we focus on South Korea, where ongoing political uncertainty continues to weigh on the economy. The Korean won remains under pressure, and equities are struggling to mount a meaningful recovery (Chart 1). The political instability has also dampened both consumer and business sentiment (Chart 2), posing a risk to economic activity if the situation persists or worsens. Focusing on the manufacturing sector, recent PMI readings indicate that the economy has struggled to maintain expansion, suggesting that factors beyond political instability, including external pressures, have been contributing to the challenges (Chart 3). Despite these headwinds, the Bank of Korea (BoK) opted to hold interest rates steady last week, pausing its easing cycle for now, despite the aforementioned economic constraints (Chart 4). A closer look reveals both domestic and external factors likely influenced the BoK’s decision. Domestically, the interim political flux has certainly played a role. Externally, considerations include more muted market expectations of Fed rate cuts this year (Chart 5) and potential trade-related actions from the newly re-elected Trump administration (Chart 6).
Impacts of recent political developments Political uncertainty continues to weigh heavily on South Korean financial markets, with the won remaining on the back foot after being the worst-performing Asian currency last year. The South Korean won has weakened significantly in recent months, particularly against the US dollar (Chart 1), depreciating by around 11% since early October. While the broader impact of a strengthening dollar has contributed to this decline, the won has been especially impacted by domestic political turmoil, notably following President Yoon's short-lived declaration of martial law last December. Although the currency saw some temporary relief after Yoon's impeachment and arrest, it has yet to mount a substantial recovery, reflecting ongoing instability in South Korea’s political landscape. Meanwhile, equities are still struggling to recover from last year's losses. For context, Yoon declared martial law in early December of last year, accusing the main opposition party of engaging in "anti-state activities" and collaborating with "North Korean communists." This drastic decision followed months of Yoon's deep unpopularity, which some political commentators believe contributed to the opposition party's landslide victory in the parliamentary elections earlier that year. However, Yoon quickly rescinded the declaration just hours after it was made, following its overwhelming rejection by lawmakers and widespread public protests.