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The Republic of Korea (ROK) has made tremendous economic gains, transforming itself from a recipient of foreign assistance to a high technology manufacturing powerhouse and middle-income donor country in a generation. South Korea experienced slower-than-expected real GDP growth of 2 percent growth in 2012, largely due to the effect of the global economic downturn on its export-oriented economy. Growth is expected to remain moderate in coming years, due to the ROK's relatively developed economy, an aging population, and inflexible labor markets. Nonetheless, the ROK has so far weathered the global economic uncertainty and continues to remain a generally favorable destination for foreign investment. Following the 1997-98 Asian financial crisis, South Korea made significant progress in reforming its financial institutions and capital markets. In addition, the Korean government took steps to strengthen its competitiveness, enacting measures to boost foreign investment incentives and allow non-Koreans to own land and real property. With these changes, most Koreans recognize foreign investment as positive for the nation's development, despite continuing protectionist sentiment among certain elements of society. The highest levels of the Korean government remain committed to ensuring a level playing field for foreign investors. However, in the months prior to the December 2012 presidential elections, both domestic and foreign businesses experienced increased scrutiny from regulatory agencies, including pressure to control prices. President-elect Park Geun-hye has pledged to promote "economic democratization," including strengthening regulation of family-run conglomerates (chaebol), increasing support for small and medium enterprises, and increasing social welfare spending. It is unclear at this point how such policies may affect the investment climate.
Capital inflows quickly recovered following the 2008-09 global financial crisis and rose from USD 11.5 billion in 2009 to USD 13.1 billion in 2010. Inbound foreign direct investment (FDI) rose to USD 16.3 billion in 2012, up 19 percent from 2011, and was a record high for capital inflow. Foreign investment in all industries except the real estate sector increased last year, including a notable 31.7 percent increase in FDI in the service sector. The real estate sector has been stagnant throughout 2012. Global liquidity was the main driver of the investment increase. The ROK's recent sovereign debt rating hikes, reflecting its strong fiscal fundamentals, ability to withstand domestic risks and external shocks, and continuation of status quo in North-South Korea geopolitics, also served to burnish the ROK's reputation as a favorable destination for foreign investment. Household debt, while not a threat to the overall economy, has emerged as a growing social concern.
The United States retains the largest single-country share of FDI in Korea, totaling USD 49.8 billion or 24.5 percent of Korea's total stock of FDI since the 1960's. Japan has invested USD 32.8 billion (16.1 percent of the total), followed by the Netherlands with USD 21.7 billion (10.7 percent). EU countries have invested USD 67.4 billion or 33.1 percent of the total. Japan contributed the largest share of FDI in 2012, at USD 4.54 billion, a 98 percent increase from the previous year, due to extra liquidity produced by quantitative easing policies and a desire to diversify supply chains post-Fukushima. The United States recorded USD 3.67 billion of FDI in 2012, while EU contributed USD 2.69 billion; both contributions were less than the half of their investment in 2011. The IT, auto parts, logistics, and other service sectors are expected to absorb the majority of FDI in Korea in the near future, largely through mergers and acquisitions (M&A), in line with global trends.
In recent years, foreign portfolio investment has continued to increase. At the end of 2012, foreign shareholders owned 34.7 percent of Korean Stock Exchange stocks and 8.2 percent of the tech-heavy KOSDAQ Index shares.
Improvement in the consistency of the ROK Government's (ROKG) interpretation, transparency, and timeliness in the application of FDI regulations would enhance the investor climate in Korea. Unclear and opaque regulatory decision-making remained a significant concern, which can discourage FDI by creating uncertainty for investors and fostering an impression that the ROK remains hostile to foreign investment. Investors were also concerned about small but significant interest groups that pressure the government to protect the South Korean market from what is perceived as foreign domination. Regarding labor, South Korea boasts a hard-working, educated and highly productive workforce and high levels of institutional labor protections, but foreign investors cited volatility in labor-management relations as an issue that can hamper FDI.
The Korea-US (KORUS) Free Trade Agreement (FTA), which entered into force on 15 March 2012, is a major step forward in enhancing the legal framework for U.S. investors in South Korea. All forms of investment are protected under the FTA, including enterprises, debt, concessions and similar contracts, and intellectual property rights. With very few exceptions, U.S. investors will be treated the same as South Korean investors (or investors of any other country) in the establishment, acquisition, and operation of investments in Korea. In addition, these protections are backed by a transparent international arbitration mechanism, under which investors may, at their own initiative, bring claims against the government for an alleged breach of the investment. Submissions to investor-state arbitration tribunals as well as their hearings will be made public.
Openness to Foreign Investment
The Korean government's attitude toward foreign direct investment is positive, and senior policy makers clearly realize the value of FDI. Following the 2008-09 global financial crisis, FDI has continued to increase steadily, with USD 13.7 billion in 2011 and USD 16.3 billion in 2012.
Despite these improvements, FDI in South Korea is still at times subject to insufficient regulatory transparency, including inconsistent and sudden changes in interpretation of regulations, as well as underdeveloped corporate governance, high labor costs, an inflexible labor system, and lingering economic domination by chaebol.
All companies operating in South Korea, including foreign ones, were subject to pressure from ROKG agencies to maintain stable prices of certain items, including food, in the months leading up to the 2012 presidential election. Companies that benefited from KORUS or the Korea-EU FTA were also asked by ROKG agencies to demonstrate how they decreased prices of goods to reflect tariff cuts.
The Foreign Investment Promotion Act (FIPA) is the basic law pertaining to foreign investment in Korea. FIPA and related regulations categorize business activities as either open, conditionally or partly restricted, or closed to foreign investment. Restrictions remain for 27 industrial sectors, three of which are entirely closed to foreign investment. The South Korean government reviews restricted sectors from time to time for possible further openings. According to the Ministry of Knowledge Economy (MKE), the number of industrial sectors open to foreign investors is well above the OECD average.
Corporate Governance and Investment Decision-Making
Investors and financial markets remain wary of corporate governance in Korea despite significant improvements since the 1997-98 Asian financial crisis. Concerns about corporate governance often reduce the price to earnings ratios to levels lower than comparable companies elsewhere. Korean policy makers acknowledge that foreign investors often exact a "Korea Discount" when dealing with Korean companies or in making investment decisions. Large gaps continue to exist between the ownership and control of a significant number of firms in Korea, with many chaebol still controlled by their founding families, despite the family's relatively small ownership stakes. Increasing participation by foreign investors and stockholders, modernizing business-government relations, and infusing professionalism in the corporate culture would greatly help improve corporate governance.
Although the Anti-Monopoly and Fair Trade Act has been amended repeatedly - most recently in March 2012 - the practical impact of Korea's laws and policies regulating monopolistic practices and unfair competition, however, has been limited by the long-standing economic strength of the chaebol. Management control at the chaebol continues to involve complicated webs of cross-shareholdings among chaebol affiliates, and many chaebol still conduct business based on family and personal connections. Chaebol-government relations can also sometimes influence the business-government dialogue, to the detriment of foreign and small and medium-sized enterprises (SMEs). Thus, chaebol influence in the South Korean economy may sometimes cause practical business problems for foreign investors. SME suppliers, for example, may be reluctant to deal with foreign firms for fear of jeopardizing a prized chaebol relationship. Obtaining access to credit may be complicated by the privileged relationships competing chaebol enjoy with local banks, although this is mitigated by the fact that regulations limit a bank's exposure to any single chaebol group's companies to 25 percent of capital, and stipulate that at least 25 percent of all banks' lending must go to SMEs.
Foreign ownership is also playing a significant role in promoting corporate governance reform in Korea. Korean firms with significant foreign investment, for example, are generally understood to be more reluctant to participate in government-sponsored bailouts of troubled firms, impacting the evolution of Korean financial markets. As foreign investors now own about 60 percent of the shares in some of Korea's top companies and nearly 33 percent of stock listed on Korea's main stock exchange, the rights of minority and non-Korean stockholders are becoming more clearly expressed.
Under Korea's 2005 Securities Class Action Act, minority shareholders are able to file class action suits for manipulation of share prices, false disclosure of information, and accounting malpractice. However, in large part due to rather stringent and complex procedural requirements, only one class-action suit has been filed since the law came into effect.
Transparency of the Regulatory System
The Korean regulatory environment can pose challenges for all firms, both foreign and domestic. Laws and regulations are often framed in general terms and are subject to differing interpretations by government officials, who rotate frequently. Regulations are sometimes promulgated with only minimal consultation with industry and with only the minimally required comment period. The KORUS FTA includes many provisions designed to address such issues.
According to Korea's Administrative Procedures Act, proposed laws and regulations (Acts, Presidential Decrees or Ministerial Decrees) should be published and public comments solicited for at least 40 days prior to promulgation. Draft bills are often available on the web sites of relevant ministries without notice that they have been published. The rule-making process often remains non-transparent, particularly for foreigners. Proposed rules are sometimes published with insufficient time to permit public comment and industry adjustment. For example, regulatory changes originating from legislation proposed by members of Korea's National Assembly are not subject to public comment periods. When notifications of proposed rules are made public, they usually appear in the Official Gazette, but not consistently, and only in the Korean language; thus, much of the 40-day comment period can be exhausted translating complex documentation.
Country Risk Issues
The Democratic People’s Republic of Korea (DPRK, or North Korea) and the ROK technically remain in a state of war. There is general peace and stability on the Korean peninsula because of an armistice agreement that has lasted for close to 60 years. From time to time incidents involving military and political provocations have contributed to increased tension between the countries. For example, the unprovoked sinking of a ROK naval vessel by the DPRK in March 2010 and the artillery shelling of an island off the northwest coast of the ROK in November 2010 resulted in increased tensions. Military incidents have remained limited to the area surrounding the five geographically isolated Northwest Islands.
Free Economic Zones and Free Trade Zones
The Foreign Investment Promotion Act (FIPA) is meant to support potential investors and create a business environment conducive to increased foreign investment. FIPA offers foreign investors various incentives including tax breaks and cash grants for projects.
Korea aims to attract more foreign investment by promoting its six Free Economic Zones (FEZ): Incheon (near Incheon Airport, to be completed in 2020); Busan/Jinhae (in South Gyeongsan Province, to be completed in 2020); Gwangyang Bay (in South Gyeongsan Province, to be completed in 2020); Yellow Sea (in South Chungcheong Province, to be completed 2025); Daegu/Gyeongbuk (in North Gyeongsan Province, to be completed in 2020); and Saemangeum/Gunsan (in North Jeolla Province, to be completed in 2030). The FEZs differ from other zones designated for foreign investment in their focus on creating a comprehensive living and working environment with biotechnology, aviation, logistics, manufacturing, service and other industrial clusters as well as international schools, recreational facilities, and international hospitals. In 2009, the National Assembly passed the Special Act on Free Economic Zones to increase tax benefits for investment, increase the FEZ infrastructure budget, and streamline the approval process for land development. On December 28, 2010, the government announced a plan to abolish inefficient, underperforming, and unfeasible portions of the nation’s free economic zones as part of its efforts to reorganize the specially created districts. By the plan, the Ministry of Knowledge Economy removed the FEZ status from 90.51 square kilometers (22,366 acres), or 15.9 percent of the total land in the zones in February 2012. According to the ministry, the six FEZs have attracted just USD 2.73 billion in investments since 2003, yet the country has spent 85.4 trillion won (USD 74.3 billion) on their infrastructure and promotion.
Source: US Department of State (Mar. 11, 2013)