North Korean Economy Watch
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Global Equity Research Global INVESTMENT STRATEGY & MACRO North Korea: Through A Glass Geopolitics Darkly* Industry Overview An "Issues Which Keep Me Awake At Night" Special Report KEY JUDGMENTS “The only predictable thing about the Kim regime is its unpredictability.” The Economist, 29 May 2010 ! The sinking of the South Korean corvette, the Cheonan, has been a sharp reminder to Alastair Newton markets – which had for some years been relatively muted in the face of rising tensions +44 20 7102 3940 on the Korean peninsula – that regional stability cannot be taken for granted. [email protected] NI plc, London ! We believe that there are several possible reasons for North Korea’s recent “bad behaviour”, not least South Korea’s hosting of the G20 summit in November, and that Young Sun Kwon 852 25367430 at least the majority of those reasons are unlikely to ease soon. [email protected] NIHK, Hong Kong ! However, we think it probable that tensions will ease somewhat shortly, albeit with relations between the two Koreas remaining very volatile. ! More widely, if the six-party talks resume – and we believe they may as China in particular looks to keep Pyongyang in check without risking regime collapse – we are doubtful that North Korea will be prepared to make and/or deliver on meaningful concessions in response to the demands of the international community. ! Whether the six-party talks resume or not, Beijing has a careful balancing act to sustain over North Korea given the – in our view – already greater and still growing Analyst Certification importance of China’s bilateral relations with both the US and South Korea. I, Alastair Newton, hereby certify (1) that the views expressed in this ! Despite significant internal stresses in North Korea – perhaps especially around the Industry Report accurately reflect my succession to Kim Jong-il and in the run-up to the 100th anniversary of the birth of Kim personal views about any or all of Il-sung in 2012 – we see a low probability of imminent regime collapse. the subject securities or issuers ! referred to in this Industry Report, We doubt, however, the political status quo in Pyongyang is sustainable for more than (2) no part of my compensation a short period now and note three possible scenarios for regime “evolution” over the was, is or will be directly or coming years. indirectly related to the specific ! recommendations or views Any one of these scenarios could precipitate regime collapse with consequent potential major security risks in the absence of coordinated contingency planning expressed in this Industry Report and (3) no part of my compensation among the regional powers. is tied to any specific investment ! We also weigh the potential cost of various reunification scenarios, even though we banking transactions performed by place a relatively low probability on such an event in the foreseeable future. Nomura Securities International, *“Through a glass darkly” is an abbreviated form of a phrase from the King James Bible version of the New Testament, Inc., Nomura International plc or Corinthians 1.13 which has come into common usage as a metaphor for limited vision and understanding. any other Nomura Group company. ANY AUTHORS NAMED ON THIS REPORT ARE RESEARCH ANALYSTS UNLESS OTHERWISE INDICATED. June 02, 2010 PLEASE SEE IMPORTANT DISCLOSURES BEGINNING ON PAGE 38 Nomura International plc http://www.nomura.com June 02, 2010 Table of Contents Introduction....................................................................................................... 3 Is history repeating itself?..................................................................................... 4 A turbulent 20th century ...................................................................................... 6 The Korean Peninsula 1900-1945: United But Not Independent .................... 6 A Divided Peninsula ............................................................................... 7 North Korea Turns To Communism ............................................................ 8 Resort To War ...................................................................................... 8 Still Technically At War........................................................................... 9 Nuclear aspirations .......................................................................................... 11 Talks and tests................................................................................................. 13 Sanctions start to bite hard................................................................................. 15 “Self-sufficiency” on the road to impoverishment ..................................................... 17 Debt Default… .................................................................................... 18 …And Geopolitical Shifts...................................................................... 18 Natural Disasters… .............................................................................. 18 …And Donor Fatigue ........................................................................... 20 Caveat Emptor? .................................................................................. 20 Turmoil in 2010 .............................................................................................. 21 Political Hardball ................................................................................. 21 Possible Political Tensions In Pyongyang................................................... 21 Is It The Economy? ............................................................................... 23 Shifts In Seoul’s Policy........................................................................... 25 South Korea In The Limelight .................................................................. 25 Waving To Washington ....................................................................... 26 At a turning point? ........................................................................................... 27 Beijing’s Near-Term Balancing Act.......................................................... 27 The Going Could Yet Get Tougher.......................................................... 29 Is Regime Collapse Imminent And/Or Inevitable? ...................................... 30 Contingencies For Collapse................................................................... 32 The cost of reunification: comparisons with Germany .............................................. 33 The German Experience: Putting Political Considerations First ....................... 33 Korean Reunification: Scenarios And Costs............................................... 33 Bibliography ................................................................................................... 37 2 Nomura Equity Research June 02, 2010 Introduction “Something unusual seems to be happening in Pyongyang and it’s probably time to think about the future a bit more seriously. We are heading towards serious changes, and nobody seems prepared.” Andrei Lankov (March, 2010)1 Against a backdrop of significantly heightened geopolitical tensions on the Korean peninsula, this special report examines in some depth political and other factors which underpin those tensions and considers possible developments in North Korea in particular over the coming months and years. It is based in part on research carried out during a visit to Pyongyang in March 2010. For our latest assessment of the economic and market implications of the current crisis, we recommend Brinkmanship returns to the Korean peninsular, Nomura Global Economics, 26 May 2010. 1 A crisis in the North Korean leadership?” by Andrei Lankov, East Asia Forum, 12 March 2010. Nomura Equity Research 3 June 02, 2010 Is history repeating itself? For the Republic of Korea (RoK), ie South Korea, 1988 was a watershed year. For that was the year that Seoul hosted the XXIV Olympiad, or Summer Olympics. The rationale behind the original bid to host, which had been submitted in 1981 included: legitimisation of the authoritarian regime of that time; showcasing South Korea’s economic progress; and increasing international awareness of the threat posed to the South by its northern neighbour, the Democratic People’s Republic of Korea (DPRK), ie North Korea.2 North Korea played its part in highlighting that threat by claiming that it should have co- host status then boycotting the Games entirely when the International Olympic Committee (IOC) declined to make more than minimal concessions.3 Furthermore – and much more seriously – on 29 November 1987, Korean Air Flight 858 en route from Baghdad to Seoul was downed by a terrorist bomb, killing all 115 people on board. One of the bombers, Kim Hyon Hui, later confessed to being a North Korean agent and claimed that the order to bomb the plane had been “personally penned” by Kim Jong-il; and that discouraging teams from attending the Seoul Olympics had been among the latter’s motives.4 Fast forward to the next major global sporting event to be held in South Korea. In 2002, South Korea co-hosted the soccer World Cup with Japan.5 Ironically given what had happened around the 1988 Olympics, this time North Korea rejected offers by the Japan and South Korea to join them in co-hosting – a bid by the two which was explicitly aimed at trying to promote peace on the Korean peninsula in the context of the latter’s “Sunshine Policy” towards the North. Worse, on 29 June 2002, the day before the final of the tournament was played in Japan, North