North Korea: The Country That Never Pays You Back
"You don't get back to international credit markets by showing utter contempt for creditors," say experts.
Editor's Note: This is a companion piece to Risky Business: Investing in Cuba is More Than Just a Financial Gamble.
A few years back, Felix Abt, a Swiss entrepreneur doing business in North Korea, discovered one of the unintended consequences of investing in "frontier markets."
In an email to Curtis Melvin, a PhD candidate in economics at George Mason University and the man behind the highly regarded North Korean Economy Watch blog, Abt wrote:
A message from LinkedIn (LNKD) sent to Abt explained that “per the terms of our User Agreement, use of LinkedIn services, including our software, is subject to export and re-export control laws and regulations. … As such, and as a matter of corporate policy, we do not allow member accounts or access to our site from Cuba, Iran, North Korea, Sudan, or Syria.”
A European life insurance company cancelled my life insurance because I am a dangerous person living in a dangerous country. Credit card organisations cancel credit cards for such persons in such countries, health insurance companies come up with other reservations and limitations and the latest organisation that has just expelled me is LinkedIn with a very curious explanation.
With a miniscule business community operating entirely under the auspices of the state (and Web access restricted to all but a handful of resident foreigners and the most trusted members of the party elite), one might wonder why a professional networking site would be of any use in North Korea. But the country’s dilapidated command economy has created a situation so dire, it has even forced overseas diplomatic staff to fend for themselves financially (in Moscow, embassy staff were caught running a gambling casino to keep the lights on, and in Berlin, I was told by a North Korean diplomat that they had rented out two-thirds of the building to a bar and a youth hostel.)
Described as "an economic basket case if only it could afford the basket," North Korea has gotten rather creative in its quest for hard currency, as the country, Curtis Melvin tells me, “has a terrible reputation with its creditors,” exemplified by missing a $5.83 million loan payment to South Korea just last Thursday.
From South Korea's Chosun Ilbo:
Deafening silence from North Korea greeted the first repayment date on Thursday for loans given by the Kim Dae-jung and Roh Moo-hyun administrations. The Export-Import Bank of Korea faxed a notice to North Korea's Foreign Trade Bank on behalf of the South Korean government on May 4 informing them of the date of maturity and amount, but Pyongyang ignored it.
Stephen Haggard and Marcus Noland of the Petersen Institute for International Economics, widely considered to be the among the world's foremost North Korea watchers, have referred to "the spectacle of a whole new round of debt follies," and wonder why anyone imagined things would be different this time.
"We have good friends -- who will remain unnamed -- who argued with a straight face this was not aid to North Korea but only a financial transaction," they write. "The North Koreans were presumably either laughing out loud or scratching their heads at the fiction."
They contend North Korea "has a real issue," pointing out that "you don’t get back to international credit markets by showing utter contempt for creditors."
North Korea's access to world equity markets is currently restricted by UN resolutions, not to mention its appalling credit history. However, the country that simply refuses to honor its debts was once able to offload its worthless paper on unwitting buyers.
So How Does North Korea Pay the Bills?
Believe it or not, there is such thing as a North Korean government bond. No, really.
An in-depth analysis of North Korea's external debts by Professor Yang Moon-soo of the University of North Korean Studies and published in the March, 2012 KDI Review of the North Korean Economy, explains that North Korea got itself into money trouble in the 1970s.
What did it, Yang says, were "massive imports of machinery and plant facilities from advanced economies, including Japan, France, West Germany and Britain, beginning in 1972. What was surprising was that trade with these capitalist nations were made with loans."
North Korea’s foreign debt problem was exposed for the first time in 1974. In July that year, the North failed to make an initial down payment for steel products from Japan and the shipment was suspended. As the news was reported, North Korea’s other trading partners in Japan and Western Europe pressed Pyongyang for payment for their exports and some banks dispatched their representatives to Pyongyang to demand early settlement of its liabilities. To raise capital, the North issued bonds and obtained new loans but failed to elicit any significant support from the international financial community. Thus, in June 1975, North Korea began negotiating payment deferments with major creditor nations.
After reaching debt rescheduling agreements with Sweden, West Germany, France, Switzerland and Austria, Pyongyang simply strung them along until 1987, when they were finally declared to be in default (three years after they stopped paying Japan altogether, under the guise of "political reasons"). Ten years later, French bank BNP (now BNP Paribas, Paris Exchange: BNP.PA) repackaged the loans and offered them to investors. They now trade at pennies on the dollar and attract fresh interest whenever there is potentially market-moving news from the Korean peninsula -- the death of Kim Jong Il being one example.
"A lot of the domestic attention is going to be on the funeral, the transition, and securing the son's transition. That succession, which the regime has been planning for years, is likely (to be) completed in the next few months so nothing happens, but investors will be thinking what comes next," Stuart Culverhouse, chief economist at London’s Exotix Ltd., told Reuters in December.
North Korean financial instruments, like all frontier assets, are not for everyone. First and foremost, Culverhouse said, they “tend to suffer from illiquidity.”
“It is necessary to have quite a long investment horizon with something like this; sometimes the stories that are politically driven tend to be longer, event driven stories,” he explains. “Trading can be thin and prices can vary; sometimes there might not even be a price. Offsetting that is the potential return, which can be, over time, quite significant.”
In the meantime, North Korea is estimated to owe roughly $20 billion as of 2012, according to Seoul's Chosun Ilbo newspaper. And they're still bobbing and weaving with creditors. Russia has reportedly written off a portion of the $8 billion it is owed, Iran has been asked to accept a fleet of small submarines in exchange for debt forgiveness, and Pyongyang offered to ship about 40 tons of ginseng to the Czech government, which would have knocked 10% off the $10 million Communist-era loan still outstanding.
The Czechs didn’t bite.
“We have been trying to convince them to send, for instance, a shipment of zinc, which is mined there. We would sell it ourselves,” Tomas Zidek, deputy finance minister, told the MF Dnes newspaper.
With China tiring quickly of playing Pyongyang's rich uncle and a worn-out welcome with most of the rest of the world, North Korea will one day likely be forced to access the global capital markets again. But, in order to do that, it will have to make its existing creditors whole.
“Countries like North Korea tend to eventually reach an agreement with creditors, usually through institutions like the IMF, and they can finally resolve their debts,” Culverhouse says.
Until then, the North Korean leadership has had to raise cash in a variety of other ways. And though North Korea’s Civil Law Dictionary once called for the eradication of merchants because they “buy goods from producers at a low price and sell them to consumers at a high price by way of fraud, deceit and spoils,” the state has had no choice but to sell themselves not necessarily to the highest bidder, but rather, to anyone simply willing to pay.
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