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World News

Q+A - How serious is the crisis on the Korean peninsula?

SEOUL (Reuters) - North Korea said on Friday the peninsula was heading towards war after Seoul accused the reclusive state of torpedoing a navy ship near their disputed border, driving tensions to their highest levels in years.

Following are some questions about how serious the crisis is and what may be behind North Korean leader Kim Jong-il’s provocative moves.

WILL THERE BE WAR?

Most analysts believe there will not be war on the peninsula as long as South Korea holds its fire.

North Korea’s obsolete conventional armed forces and military equipment mean quick and near certain defeat if it wages full-scale war, and Pyongyang is well aware of its limits.

Even though it has exploded nuclear devices, North Korea has not shown it has a working nuclear bomb. Experts say they do not believe the North has the ability to miniaturise an atomic weapon to place on a missile, but the secretive state has been trying to develop such a warhead.

North Korea’s ageing fleet of Soviet-era bombers would also have difficulty evading the technologically advanced air forces of regional powers the United States, South Korea and Japan to deliver a nuclear bomb outside the country.

Moreover, South Korea has made clear it will not retaliate after findings showed it was a torpedo fired by a North Korean submarine that sunk the Cheonan corvette, killing 46 sailors.

The greatest risk that could fuel armed confrontation lies in small-scale skirmishes that might develop into larger conflict.

Another risk could be the buildup of U.S. military forces on the peninsula that will be seen by the North as a sign of imminent invasion, something that leaders in Pyongyang are said to be genuinely frightened of.

WHAT IS KIM JONG-IL TRYING TO DO?

The torpedo attack was almost certainly ordered directly by Kim Jong-il. The most likely explanation for the attack is that it was in retaliation for a naval skirmish last November that severely damaged a North Korean vessel. That ship had intruded into the South’s waters and was pounded with thousands of rounds of gunfire.

North Korea had a particularly rough start to the year in terms of economic difficulties after pledging on New Year’s Day to make it a top priority to improve the lives of the people. A botched currency reform in November nearly crippled what little market functions there were, reportedly inciting public unrest in some parts of the country and prompting authorities to ease restrictions on free market activities.

The suspension of aid from the South under President Lee Myung-bak since 2008 has deepened its economic woes. U.N. sanctions imposed after last year’s nuclear test have also cut into the North’s key source of hard cash -- the trade in arms.

Analysts say the North’s leaders often resort to raising regional tensions to divert attention from troubles at home.

Kim, whose own health is in question, is trying to promote his youngest son as heir.

There is concern in the South that Kim may be inclined to more lethal provocations because the routine sabre-rattling of recent years no longer seems to work to force concessions out of the South and regional powers.

WHAT ARE THE RISKS TO INVESTORS?

President Lee’s government has hinted at taking the issue to the international community, mostly likely the U.N. Security Council, rather than taking the law into its own hands.

Market players do not expect the issue to escalate into armed conflict because they believe Seoul will not risk the damage to its own economy and the region as a whole, which accounts for about a sixth of the world’s economic output.

Last year’s nuclear test barely impacted financial markets which have become largely inured to the North’s behaviour.

But South Korean stocks took a dip and the won posted its biggest daily fall in more than 10 months on Thursday following the South’s formal announcement of blame for the ship sinking. Hawkish comments from both sides weighed on investor sentiment, already fragile after lingering concerns over euro zone debt problems.

Financial markets were closed for a holiday in South Korea on Friday but further comments from Lee next week on how Seoul would respond could weigh on sentiment, reflecting the highest levels of tensions in recent years.

On Thursday, five-year South Korean CDS was 10 bps wider at 130/135, the highest since September 2009. Three-year treasury June contracts ended up 7 ticks at 111.14.

Editing by Jonathan Thatcher and Jeremy Laurence

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