"While Moody's believes that the potential for outright military conflict involving South Korea, the US and possibly others in Asia remains low, it has risen from very low levels," Moody's said in a statement. "Recent developments are consistent with that view."

Financial markets in South Korea have long been vulnerable to geopolitical risks from North Korea as the 1950-53 Korean War ended with a cease-fire, not a peace treaty. About 28,500 US troops are currently stationed in South Korea under a mutual defense treaty.

"In the case of a short, contained military conflict, the credit implications would be limited," Moody's said.

"While such a development would hit financial markets and likely lead to capital outflows," Moody's said South Korea "has significant external liquidity buffers."

"In the case of a longer conflict, the economic and fiscal costs would be significantly higher and Korea's policy-making and -implementing institutions would come under far greater pressure," Moody's said.

"In such a scenario, the sovereign rating would likely move down, potentially by several notches," it said. (Yonhap)