Blowout South Korea stock rally on a knife-edge over tax plans
Foreign investment flows into South Korean equities totalled $4.52 billion in July, LSEG data showed - the fastest pace in almost a year and a half - as the prospect of corporate reforms and a trade deal with the Trump administration lured overseas money.
However, the KOSPI index (.KS11), opens new tab, which had risen 33.3% so far this year, leading gains across the region, experienced its sharpest one-day drop since April on Friday. The index slumped 3.9% following the announcement of tax measures.
Foreign analysts are uncertain if the "Korea discount" - a steep valuation gap with other Asian markets - will narrow as the government begins to implement reforms, but some institutional investors regard the changes as positive in the long run.
Many of the country's biggest multinationals, the family-owned conglomerates known as chaebols, tightly control voting power and lack independent boards to safeguard minority investor interests.
"We've been victims of poor corporate governance in Korea for over a decade," said Jonathan Pines, head of Asia ex-Japan at Federated Hermes. "Even though the market is up significantly, we believe it has further to go," he said.
"The news flow is likely to remain positive, and Korean market valuations are still among the cheapest in the world."
Korean stocks trade at a 12-month forward price-to-earnings ratio of 10.1, the lowest of any major market in Asia, according to data from Goldman Sachs. The investment bank gives the country an "overweight" rating and a target level of 3,500 in the next year, implying a 9.4% gain from current levels.
South Korean equities gained momentum after the Financial Services Commission introduced its Corporate Value-Up Programme in February last year, aimed at improving corporate governance standards.
The rally last month culminated with the announcement of a trade deal between Seoul and Washington on July 31, with a summit planned this month to finalise the agreement.
However, tax reforms last Friday prompted mixed reactions. The government raised the peak corporate tax rate to 25% from 24% and the securities transaction tax to 0.20% from 0.15%.
"While in general we think that tax changes do not impact markets for very long, we do think these measures are 180 degrees opposed to the sentiment of the 'Korea Up' programme, which was meant to boost valuation," Citi said in a note dated August 3, cutting its allocation. "Given how important this programme was in the recent large KOSPI outperformance, we think more downside is likely."
Since then, the index has recovered some ground, advancing 2.5% this week.
The reforms "proved underwhelming for the market", J.P. Morgan analysts said in a note. "Positive news on reform implementation, additional earnings improvements or repatriation flows will be needed to further the re-rating."
Others were more sanguine. The creation of a separate tax rate for dividend income could boost the payout ratio of Korean companies, Societe Generale analysts said.
"While the taxation details came with some negative surprises, we view the tax reform as a win-some-lose-some event, and not entirely a lose-lose situation," they said.
Activist investors and corporate governance advocates remain hopeful about reforms under President Lee Jae-myung.
Manoj Jain, co-CIO of Hong Kong-based Maso Capital, remains cautiously optimistic. "In conversations with management teams, pleasingly, we have sensed a change in tone where boards are now more receptive to shareholder views and feedback," Jain said.
"We are in the second inning in terms of corporate governance reform," said Namuh Rhee, chairman of the Korean Corporate Governance Forum. "The biggest headwind is strong lobbying by chaebol and their lobbying agencies."
The government may yet amend its tax plans. Jung Chung-rae, the leader of the ruling Democratic Party, said on Monday the party will hold internal discussions over the proposed levies.
Finance minister Koo Yun-cheol, facing a grilling from Korean opposition lawmakers in parliament on Wednesday, said he would listen to public opinion, including a suggestion from a lawmaker to revise the rules constituting "large shareholders" subject to capital gains taxes.
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