South Korea's martial law crisis is making the 'Korea discount' in stocks harder to shake off

• South Korea's political turmoil is likely to make the 'Korea discount' in stocks harder to shake off.
• South Korean President Yoon announced martial law late on Tuesday, shocking markets.
• The Kospi Index slumped as much as 2.2% amid political turmoil and protests against Yoon's decision.

South Korean President Yoon Suk Yeol's short-lived martial law announcement is undoing one of his top goals: boosting the value of stocks.

On Wednesday, South Korea's Kospi Index fell as much as 2.2% and closed 1.4% lower. The Kospi is already the worst-performing major Asian stock index this year, trading about 7% lower this year to date.

Shares of Samsung Electronics, South Korea's largest company, tumbled as much as 3% before paring losses.

Late on Tuesday, Yoon — who has been under political pressure —declared martial law in a shock address, citing threats from "anti-state forces" and a need to counter North Korea.

The stunning announcement triggered market losses in US-listed South Korean stocks and sent the country's currency to a two-year low.

Hours later, Yoon reversed his decision on martial law amid protests in Seoul, but the immediate damage has been done.

The latest political turmoil in South Korea isn't going to help — particularly since South Korean stocks have already been plagued by the so-called "Korea discount" for decades.

The 'Korea discount'

The "Korea discount" refers to the phenomenon whereby South Korean shares generally trade at lower valuations than their overseas peers. Analysts attribute the gap to factors including poor corporate governance and geopolitical risks.

Yoon's administration has set out to narrow the discount. But his surprising action on Tuesday is likely to only make the "Korea discount" harder to shake off, wrote Vishnu Varathan, Mizuho Securities' head of Asia macro research excluding Japan, in a Wednesday note.

"This attempt at martial law retards attempts to diminish the Korea risk premium," wrote Varathan.

South Koreans are still protesting on Wednesday, and the political uncertainty is likely to continue weighing on the country's markets.

"The political fallout is far from over — increasing the risk of a deeper slowdown in growth," said Hyosung Kwon, an economist at Bloomberg Economics.

Rory Green, the head of Asian research at GlobalData.TS Lombard, wrote that he expects volatility and negative price action across South Korean assets and interlinked markets, particularly in the Asian foreign exchange markets.

Green said he expects Yoon to face impeachment and a presidential election to take place next year.

"Markets will prefer a quick resolution to the stand-off and for political stability to return, but for now, it seems that the uncertainty over his leadership may continue to drag on for some time," wrote Yeap Jun Rong, a market strategist at IG.

Broader Asian markets were rattled by the uncertainty in South Korea but regained some ground after South Korea's finance ministry and central bank pledged to maintain market stability.

"We will inject unlimited liquidity into stocks, bonds, short-term money market as well as forex market for the time being until they are fully normalized," the ministry said in a statement.

Citi economist Kim Jin-wook wrote in a research note viewed by Reuters that the political turmoil could have "short-lived" effects for the market and economy with "proactive policy response."

Japan's Nikkei 225 ended the day little changed. Hong Kong's Hang Seng Index closed flat, while China's CSI300 closed 0.5% lower.

Australia's ASX200 closed 0.4% lower.