While the latest ratcheting up in tensions between North and South Korea is starting to make investors jittery, financial markets may be underestimating the risk of a potential conflict on the Korean peninsula, analysts say.
South Korea's benchmark KOSPI stock index fell more than 2 percent on Thursday, before trimming losses, after North Korea barred South Korean firms entry to the Kaesong industrial zone, a jointly-run industrial complex located six miles north of the demilitarized zone, for a second day.
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This followed a warning by North Korea early on Thursday that its military has been cleared to wage an attack on the U.S., while the U.S. said on Wednesday it would deploy a missile defense system to the U.S. Pacific territory of Guam to strengthen the region's protections against a possible attack.
"It's clearly the most serious threat of conflict that we've had in 10 years, since 2002-2003. The market is definitely underestimating the risk," said Uwe Parpart, managing director and head of research at Reorient Financial Markets, referring to the dispute over North Korea's nuclear weapons programs in 2002-2003.
"It has escalation potential. The more military assets that are in motion in the area, the more there's a chance of unintended consequences - you can easily get into the situation of misjudgment which could lead to a conflict situation," he added.
In a sign that markets are jittery about North Korea although not yet in panic mode, the South Korean won weakened 0.6 percent against the U.S. dollar, falling to its lowest level since mid-September. Growing worries over North Korea also pushed Wall Street shares lower overnight.
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"They [North Korea] are choosing to play a very, very strong card. April will be a challenging month between the two Koreas as North Korea seeks to attract attention and more power in the hands of the new leader [Kim Jung Un]," said James P. Rooney, chairman & CEO of Market Force, a company that helps businesses set up and invest in South Korea.
Reorient Financial Markets' Parpart said that while the risk of a broad military conflict remained low, he was not ruling out an incident on a similar scale to the sinking of a South Korean military vessel by a North Korean submarine's torpedo in 2010.
North Korea, which has been threatening to attack the South Korea and U.S. military bases almost on a daily basis since the beginning of March, declared on Saturday that it was entering a "state of war" with the South.
Dennis Gartman of The Gartman Letter, however, disagrees that Pyongyang poses a major threat to the market.
"They have very few capabilities. They have land forces. If they decided to make a rush over the border, they could do that," he said. "They have no real nuclear capabilities whatsoever. Their missiles are very, very old, very immature. They can't move more than 1,500 kilometers.
"It's fun to watch the pictures, but are they going to do anything? No."