Opinion

South Korea and Indonesia: a capital match

Mutually beneficial Jakarta-Seoul relationship could develop further with an upgrade in Jakarta’s sovereign debt.

By: and Date: November 23, 2016 Topic: Banking and capital markets

This op-ed was originally published in Nikkei Asian Review.

nikkei

South Korea and Indonesia look as though they were made for each other. South Korea has become a net exporter of capital, given its increasingly low return on assets, while Indonesia has a young population and huge capital needs, which ensure a high return on investment. Given its relatively low savings ratio, Indonesia’s current account deficit is understandable. It needs foreign investment – and that is where South Korea comes in.

South Korea is increasingly looking like Japan in the 1990s, although it has higher growth potential and fewer deflationary pressures. Current account surpluses are the source of capital that has allowed Japan, and now South Korea, to become huge net external creditors. Few other countries are in that situation, although Germany and Taiwan are other examples.

In terms of demographics, aging South Korea has huge savings. Its current account surplus has been substantial for many years, and is still growing. It could reach 8% of gross domestic product this year. This has allowed South Korea to shift from being a net external debtor to a net external creditor in only two years.

What is even more amazing is that the total amount of net external wealth has reached $200 billion, a similar level to that of Japan. The key driver behind investment overseas, other than current account surpluses, is low returns on assets domestically. South Korea’s return on assets has fallen rapidly since 2011, pushing savings out of the country – as happened in Japan decades ago.

Using equity indices as a benchmark, the return on assets for the Korea Composite Stock Price Index 200 is 2.1% as of October 2016 – lower than the 2.5% return for the Nikkei 225 Index. As a result, companies are seeking higher returns through a massive increase in outward foreign direct investment, and South Korean institutional investors are looking for outward portfolio investment to secure higher yields for their clients.

High returns

Looking across Asia, Indonesia is the perfect partner for South Korea. Strong population growth drives huge infrastructure needs, while its very small stock of capital ensures high returns. Indonesia’s annual economic growth is estimated to hover between 5% and 6% depending on how much it manages to limit growth bottlenecks in infrastructure and human capital.

What Indonesia needs is what South Korean companies are looking for. The Indonesian government has prioritized investment in energy, utilities and logistics infrastructure, while interest in further exploiting mining opportunities has fallen. This set of preferences is much more akin to South Korean companies’ comparative advantages. In fact, their share of global outward foreign direct investment in construction and utilities surged to 12.4% in 2015, compared with just 3.4% two years ago.

Also, given Indonesia’s relatively low level of domestic savings, it remains dependent on foreign capital to finance some of its investment needs. About 40% of securities issued by the Indonesian government is bought by foreign investors. This structural need for foreign capital means that Indonesia will continue to run current account deficits and will remain a higher-yield economy than those with excess savings.

Given their complementary needs, the final question is how the growing financial relationship between the two countries can be nurtured. One answer would be an upgrading of Indonesian sovereign debt by one notch to investment grade. Many South Korean institutional investors are restricted to countries awarded investment grade ratings.

A better investment environment and better enforcement of the rule of law in Indonesia would also be welcome, as would deeper liquidity in financial markets offering greater hedging opportunities. But these things can come later as the country and its financial markets develop. Investment grade status should come first, and Indonesia is clearly not far from achieving it.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More by this author
 

Opinion

European governance

Can the EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event More on this topic
 

Upcoming Event

Oct
28
14:00

Can climate change be tackled without ditching economic growth?

What will be necessary to achieve climate goals and keep growing?

Speakers: Francesco Starace, Simone Tagliapietra and Guntram B. Wolff Topic: Green economy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More on this topic More by this author
 

Opinion

What Evergrande signals about China's economic future

Under Xi Jinping's new economic agenda 'common prosperity', China is cracking down on indebted real estate developers like Evergrande.

By: Alicia García-Herrero Topic: Global economy and trade Date: September 30, 2021
Read article More on this topic
 

Opinion

Can climate change be tackled without ditching economic growth?

The ultimate answer to the question on whether climate change can be tackled without ditching economic growth depends on our willingness to step up climate action massively.

By: Klaas Lenaerts, Simone Tagliapietra and Guntram B. Wolff Topic: Green economy Date: September 27, 2021
Read article More on this topic More by this author
 

Opinion

Europe doesn’t need a ‘Mega-Fab’

Europe should defend its existing dominance in equipment manufacturing for semiconductors and invest in chip design instead of luring high-end fabrication to its shores.

By: Niclas Poitiers Topic: Global economy and trade Date: September 22, 2021
Read article More on this topic
 

External Publication

Investing in China: myths and realities

Concerns are real, but the country fares as well as peers at similar levels of development. Analysis published in fDi Intelligence.

By: Uri Dadush and Pauline Weil Topic: Global economy and trade Date: September 20, 2021
Read article Download PDF More on this topic
 

Working Paper

Can climate change be tackled without ditching economic growth?

The notion of degrowth to reduce greenhouse gas emissions appears unrealistic; decoupling of emissions from growth is in principle possible but requires unprecedented efforts.

By: Klaas Lenaerts, Simone Tagliapietra and Guntram B. Wolff Topic: Green economy Date: September 16, 2021
Read article Download PDF
 

Policy Contribution

European governance

A green fiscal pact: climate investment in times of budget consolidation

Increasing green public investment while consolidating deficits will be a central challenge of this decade. A green fiscal pact would address this tension, but difficult trade-offs remain.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: September 9, 2021
Read article More by this author
 

Podcast

Podcast

Environmental, societal and governance criteria: hit or miss?

Is sustainable investing contributing to society’s climate and social goals, or preventing systemic change?

By: The Sound of Economics Topic: Banking and capital markets, Green economy Date: August 26, 2021
Load more posts