The ratcheting-up of tensions between North Korea and the US is invariably focusing analysts on the unthinkable.
Initial reactions to the crisis led to a flight from equities into traditional safe havens - gold, sovereign bonds, the Swiss franc and Japanese yen - encouraged by profit-taking on what have been decent returns from risky assets.
The risk of conflict is higher than at any point previously now that the North has advanced its weapons technology, and there are not one, but two unpredictable leaders.
However, a slightly more conciliatory tone in recent days is sending out some reassurance to investors, with the revelation that background diplomacy has been underway for some time signalling a way out of the crisis.
Will they, or won’t they?
It remains extremely difficult to read Kim Jong-un’s intentions, not least since China’s decision to ban North Korean imports of coal, iron, lead and seafood in line with the new, tighter UN sanctions will deprive the regime of foreign exchange.
Han de Jong, chief economist with ABN Amro, says: “I still find it hard to imagine that North Korea would use a nuclear device. Surely, the leadership realizes the rest of the world will not tolerate that and it would be the end of the current North Korean leadership.
“Equally, military intervention by the US is unthinkable due to the vulnerability of Seoul.”
Any attack on South Korea with such tremendous potential loss of life and financial implications would have global implications, forcing a bigger flight to safety.
The won has been factoring in the risks, falling 2% last week and leading most Asian currencies lower, except for the yen which is trading higher on its safe-haven status.
China would be hugely affected too. Its risk score has fallen slightly further this year, extending a longer-term downward trend as the economy adjusts to a lower economic growth trajectory, and debt rises, heightening bank sector instability risk – the one economic factor still being downgraded in Euromoney’s survey.
Japan’s five-year score trend is flatter, making it a bigger risk than South Korea thanks to government policy failing to tackle the debt burden, eradicate deflation properly, or until recently producing GDP growth.
However, the experts remain confident in South Korea’s immediate prospects. Its risk score of 71.3 in Q2 2017 reveals it to be the 20th safest country worldwide for investors, with Japan, 26th, on a score of 67.8, still some way off, and China languishing further below:
Alicia Garcia Herrero, chief economist for Asia at Natixis, believes the most likely scenario is a “muddle-through”, leaving South Korea on high alert, but with no change of direction or military event.
She says investors share that view, and consequently while foreign policy risk has increased, investment will continue to rise, comforted by the large current-account surplus (7% of GDP in 2016), and cyclical economic upturn due to reduced domestic political risk and robust global trade.
Business and consumer confidence levels have been rising, and export growth is in double-digits. Additionally, a fiscal stimulus package was passed recently, and with interest rates assumed to remain stable Natixis is expecting 2.9% GDP growth for 2017, with a small rise to 3% in 2018.
Still, the longer-term outlook for South Korea is blighted by its demographics - the lowest-scoring structural factor in Euromoney’s survey.
Analysis published by the IMF describes how the working-age population ratio is projected to peak at 66.5% this year, and then fall rapidly to 56% in less than two decades, with a distinctive feature for South Korea being the fall in population expected from 2025-2035.
It’s a big issue for many, though not all countries in the region, and it will constrain South Korea’s GDP growth potential, impact on savings and investment, and begin to weigh on fiscal and external balance indicators.
South Korea has survived missile strikes from North Korea before, and endured domestic political crises, but with high and rising household debt, and entrenched opposition to structural reform, the demographic shift seems to be the single biggest risk to longer-term returns.