South Korea Risks a Disappointment Trade

South Korea is attracting plenty of hot money, which may end up fleeing if the country doesn't bring about economic reforms.

As the world staggers from one crisis to another, Morgan Stanley recommends a rather unlikely haven: an economy whose capital sits 124 miles away from a tyrannical, nuclear-armed dictator threating to bomb the place.

Even threats by North Korean leader Kim Jong Un can't keep investors away from South Korea's financial markets. Overseas investors bought $4.8 billion more stocks on exchanges in Seoul than they sold last month, staying net purchasers for an unprecedented 44 days through Oct. 30. Korea is hot because in a world of sluggish growth and fiscal imbalances, it is running a current-account surplus and, according to the International Monetary Fund, its economy is poised to expand 3.7 percent in 2014.

Yet as much asSouth Korea deserves this moment in the spotlight, there is reason to worry that it's pulling in more capital than its $1.1 trillion economy can productively use. We're not talking about giant asset bubbles, per se, just the risk that markets could get shoulder-checked should South Korea disappoint fickle markets in any way. It's impossible to know how much of this money is of the overheated kind that would flee at a moment's notice. But Asia's experience over the last two decades suggests the proportion could be sizable.

How might Korea disappoint the bulls? The economic restructuring that Park Geun Hye, president since February, pledged remains in neutral at best. She plans to rein in the family-run conglomerates, the chaebol, that tower over the nation and suck up all the economic oxygen. Reducing their role is central to making the nation more dynamic and entrepreneurial. It's also vital to ending the so-called Korea Discount in equity markets once and for all. The chaebol, let's face it, aren't known for state-of-the-art corporate governance.

The risk is that the cascade of money flowing into Korea will come up against inflated expectations. Not with the macro-economy, which relative to peers not only in Asia but within the Organization for Economic Cooperation and Development, is quite solid. It's the micro-economy that needs work -- work that Park hasn't dealt with amid the distractions of North Korean leader Kim and domestic politics. If there's any message Park's team should take it's this: Get to work.

That means doing more to force huge business groups bearing names like Daewoo, Hyundai, LG, Lotte orSamsungto become more transparent, give shareholders a bigger voice and end their monopolistic ways; adopt policies to aid small- and medium-size companies and encourage start-ups; and promote risk-taking among young South Koreans.

All this is easier said than done. Park has a single five-year term to alter South Korea's economic course and the first 12 months are almost over. The country has come too far to grow complacent now. Park must act boldly and put some flesh on her ideas so that investors herding into South Korea's markets don't end up disappointed. Failing to get it right would be the ultimate disappointment trade.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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    Willie Pesek at

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