FACTBOX - Five political risks to watch in South Korea

Tue Nov 3, 2009 12:11am EST

SEOUL, Nov 3 (Reuters) - Besides the threat posed by the unpredictable regime of North Korean leader Kim Jong-il, South Korean investors face risks from the country's volatile politics, with policymaking often stalled due to political disputes. Following is a summary of key South Korea risks to watch:

* THE NORTH

North Korea's second nuclear test in May and always unpredictable behaviour have raised tensions on the peninsula. The greatest risk to regional economies would be a brief but intense military conflict -- North Korea could lob tens of thousands of artillery rounds into the Seoul region that is home to about half of South Korea's population, and fire hundreds of missiles at major cities in South Korea and Japan. Such an attack might take less than an hour but would do severe economic damage. It would also mean suicide for the North's leaders who would be hit by a U.S.-led counterattack. Another key risk is that the sudden implosion of the North Korean regime leads to a difficult reunification process that undermines the South Korean economy. [ID:nSP522703]

Key issues to watch:

-- Results of the North's recent overtures. In the past few weeks, North Korea has sent a nuclear envoy to the United States for a rare visit and a confidant of leader Kim Jong-il to Beijing for high-level discussions. This dispatch of envoys indicates a willingness to resume nuclear discussions, which would defuse tension in the region, but it by no means that Pyongyang will strike a deal to give away its biggest negotiating card by ending its nuclear threat.

-- North Korea has recently test fired missiles and threatened the South with a naval battle over a disputed sea border. It has also agreed to talks with the South that have decreased tensions. Analysts believe the North will increase its provocations in order to better its leverage in any talks. The risk to the region comes from the North raising the stakes too high, which then could crush the immediate chances for any form of dialogue.

-- Clues on the stability of the North Korean regime. South Korean assets would dive if it seemed North Korea was set to implode and reunification was likely. [ID:nSP544468]

* GOVERNMENT EFFECTIVENESS

-- After suffering a collapse in his popularity upon taking office, President Lee Myung-bak has seen a surge in his support rate as South Korea's economy posted strong growth figures in the third quarter and the country seems to be among the first major economies to emerge from the global economic downturn. But Lee's business-friendly reform agenda was dealt a blow by parliamentary by-elections in late October where his ruling, conservative Grand National Party lost two hotly contested races in urban areas. Lee is also likely to face continued difficulties maintaining support even within his own party -- several figures are jockeying for prominence as they eye a run for presidency when his single, five-year term expires in 2013. A parliament described by local media as dysfunctional has stymied many of the economic reforms proposed by Lee to make the economy more competitive and open to foreign investment. The inflexible bureaucracy adds to policy delays and inefficiency.

Key issues to watch:

-- A significant change in government effectiveness would impact investor perceptions. Most of the risk may be on the upside, as markets have priced in a fairly high degree of government inefficiency and policy delays. Lee's support rating has been on the rise in recent weeks and hit 44 percent in a major tracking poll this week. The rise in support betters the chances for reforms proposed by Lee to make their way through parliament, including a law that doubles the term companies can hire contract workers to four years.

* ECONOMIC REFORM

The economy remains dominated by large chaebol conglomerates, and highly dependent on exports. The government's interventionist attitude to the economy often comes at the expense of longer-term reforms. Foreign investors often encounter informal barriers to entry, and the government has not shown any particular desire to strongly encourage foreign capital. [ID:nSEO314453]

Key issues to watch:

-- Progress, or lack thereof, in passing the delayed economic reforms promised by Lee but yet to be implemented.

* CORRUPTION

Transparency and corruption remain an issue in South Korea, and the suicide of former President Roh Moo-hyun while he was under investigation for graft focused more attention on this divisive subject. But for foreign investors, the biggest threat is the hidden barriers rather than corruption which is seen as less of a problem than in many regional countries.

Key issues to watch:

-- South Korea's rank in global corruption perceptions indices -- signs it was slipping back in the rankings could impact investor decisions.

-- Any return of strong nationalist criticism of foreign company profits.

* TRADE

The government is trying to press ahead with free trade deals but this is a contentious issue both within South Korea -- where the opposition has repeatedly tried to block deals --and abroad, where Seoul is frequently accused of protectionism.

Key issues to watch:

-- The government's success in agreeing more bilateral free trade agreements -- and getting them passed by parliament. In October, South Korea and the EU signed off on a free trade deal that could be worth potentially $149 billion to both economies. The agreement increases the focus on a bilateral deal South Korea has with the United States reached more than two years ago but has since stalled in the legislatures of both countries. That deal will come into greater focus due to the agreement with the EU and a visit this month by U.S. President Barack Obama.

(Compiled by Andrew Marshall and Jon Herskovitz)