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South Korea struggles to retaliate in missile spat with China

By Cynthia Kim and Hyunjoo Jin

SEOUL (Reuters) - South Korean firms have had a torrid time in China since Seoul dismissed Chinese objections and approved a new missile defense system, but for all the discriminatory tactics Korean firms say they are victims of, there is little Seoul can do to retaliate.

South Korea sold $124 billion worth of goods and services to its western neighbor last year, about five times the amount exported to its eastern neighbor, Japan, and double that shipped to its second-biggest market, the United States.

But the amount could drop this year after China's state media orchestrated a boycott on Korean produce in protest at a missile system designed to thwart any North Korean assault, but whose radar China says is capable of penetrating its territory.

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Korea's Lotte Group has suffered cyber attacks and said some of its stores in China have been fined or closed by authorities, while some shops have been hit by anti-Korean demonstrations.

Korean airlines have been refused permission to increase China-Korea flights, cosmetics firms have reported increased scrutiny at customs, and Chinese travel agents have been ordered to stop tours to South Korea.

China's foreign ministry said law-abiding foreign firms were welcome and would be protected. But South Korea's ruling party said the government will actively consider complaining about "unfair retaliation" to the World Trade Organization (WTO).

The WTO previously chastised China for restricting exports of rare earth minerals during a 2010 row with Japan over disputed islands, and then curbing global shipments.

But the organization would find it far more difficult to penalize more subtle forms of perceived retaliation, current and former South Korean government officials told Reuters.

"We need some official proof," Chang Do-hwan, a director at South Korea's finance ministry, told Reuters. "Taking diplomatic action without confirming (that such tactics stemmed from central government) could just spread anger."

WEAPONS

Conditions for South Korean firms in China have deteriorated since Seoul agreed in July to deploy the U.S.-made Terminal High Altitude Area Defense (THAAD) system. The situation became acute last week after a Lotte Group company decided to supply land for the system.

Any means of fighting back could lie in South Korea's biggest shipments to China - semiconductors and displays, which make up over one-third of total exports to the mainland.

But any legal means of Korea risking one of its most profitable sectors by restricting such exports is unrealistic, said analyst Piao Ren-Jin at NH Investment & Securities.

"Seoul can continue to express its concern, and take this to the WTO, but that's about it at the state-level," Piao said. In a worst case scenario, the spat could reduce the size of South Korea's economy by as much as 0.25 percent, she said.

Instead, the government has advised firms to devise countermeasures such as diversifying markets.

One company considering such a move is Le Belle Cosmetics, whose sales are "grinding to a halt" at a duty free shop in central Seoul as Chinese tourist numbers fall, said the firm's chief executive, Cathy Lim.

"We cannot just look at China," Lim said, highlighting emerging markets such as Vietnam as options for expansion. "But at the same time, no market can replace China."

Lee Hang-Koo, a senior research fellow at state-funded Korea Institute for Industrial Economics & Trade, said the government suggesting companies diversify markets to minimize any impact from difficulties in China was "absurd and irresponsible".

"China is just too big," he said, adding a WTO complaint was not feasible considering lack of evidence and could take years. "It's better to just talk through diplomatic channels."

Any complaint can only worsen relations with South Korea's biggest customer, which bought around a quarter of total exports last year from around 10 percent at the turn of the century, showed data from the Korea International Trade Association.

Over the same period, China's exports to South Korea have moved little from about 4.5 percent, according to think tank Hyundai Research Institute.

DESIGNER RETALIATION

At present, there is little evidence of WTO rule-breaking. Chinese authorities closed stores belonging to Lotte Group and others due to fire-safety concerns, and cosmetics firms have said Chinese market access has been tightened by stricter customs and sanitary approval procedures.

"China, which has been lax about imposing rules, are just applying those rules," said former South Korean foreign ministry official Choi Won-Mog.

However, Korean authorities have said Chinese tour operators have been given official "verbal" orders to halt Korean tours.

"China has carefully designed retaliation against South Korea so that it does not violate international laws," having learnt its lesson from the rare earths restrictions during the Japan dispute, said Choi, a professor at Ewha Law School.

One of the most notable victims of the Japan dispute was the automobile industry, with widespread vandalism of Japanese cars.

South Korea's Hyundai Motor Co is monitoring the situation, a person familiar with the matter told Reuters.

"We have not seen any major impact so far, but we are worried about how the situation will unfold," the person said. "There is not much that individual companies can do."

(Reporting by Cynthia Kim and Hyunjoo Jin; Editing by Christopher Cushing)