South Korea: Gathering pace despite risks

South Korea: Gathering pace despite risks

South Korea: Gathering pace despite risks

Asia Pacific Economic Outlook, December 2013

In Q3, South Korea’s economy expanded at its fastest pace in nearly two years, aided by strong performance in manufacturing and construction. But this masks concerns about exports and consumption.

South KoreaSouth Korea’s economy expanded at the fastest pace in nearly two years in Q3 2013, aided by strong performance in manufacturing and construction. The strong showing, however, masks concerns about exports and consumption. As economic growth in China—a key export market—slows to more sustainable levels, exports have come under pressure. Private consumption has lightened some of the burden of slowing exports, but it faces medium-term headwinds from high household debt and low income growth.

Q3 pickup in economic activity

The economy grew 3.3 percent year over year in Q3 2013, up from 2.3 percent in Q2. Construction led the charge, rising 4.8 percent, followed by manufacturing at 4.0 percent. Manufacturing growth would have been higher but for labor strikes at two major car manufacturers. Due to the strikes and festival holidays, auto production fell 18.6 percent in September from August, thereby pushing industrial output down 2.1 percent. However, near-term prospects in manufacturing appear healthy, with work resuming at automobile plants and new smartphone launches by domestic companies. It’s no wonder then that business sentiment in manufacturing for November rose to the highest level in 17 months.

On the expenditure side, consumption grew 2.2 percent in Q3, up from 1.8 percent in Q2. Consumer confidence has been picking up, with the Bank of Korea’s (BOK’s) composite consumer index in October rising to its highest level since May 2012. Consumers have benefitted from low inflation and loose monetary policy. However, upbeat consumer sentiments need to be viewed with caution, given high household debt and slow real wage growth. On a negative note, export growth fell to 3.9 percent in Q3 from 5.7 percent in Q2 due to slowing demand from China and the South Korean won’s relative strength against the Japanese yen.

Interestingly, the government is trying to develop a broader measure of unemployment.

Twin problems for exports: Slowing China and rising won

As China’s policymakers shift focus to equality, the country’s economy is likely to move to a lower growth trajectory. Although detrimental in the near term, such a shift coupled with a domestic consumption–driven growth model in China could benefit South Korean exporters over a longer period. Meanwhile, the won’s strength, especially against currencies of competitors, is worrisome. The won has gained about 25 percent against the Japanese yen since November 2012, when Japanese Prime Minister Shinzo Abe proposed aggressive quantitative easing in his election campaign. The other factor aiding the won’s rise is continued investor interest in South Korea, based on healthy GDP growth, strong public finances, and a high current account surplus. In September, for example, a 10-year dollar-denominated bond worth $1 billion (the first since 2009) was heavily oversubscribed. In fact, the won has been one of few currencies relatively unaffected by uncertainty over the US Federal Reserve’s asset purchase program.

BOK policy to remain loose despite high household debt

Monetary policy continues to remain accommodative, with the BOK keeping its key policy rate on hold for the fifth time in October. In May the BOK cut the rate by 25 basis points to 2.5 percent. Policy stance is not likely to change until Q1 2014, given the need to support the economy at a time when fiscal stimulus measures will run out. Favorably for the BOK, inflation is at a 14-year low (0.7 percent in October) and much below the central bank’s 2.5–3.5 percent target. A key concern, however, is high household debt, which amounted to 153 percent of disposable income in 2012. This is higher than the 2003 level (130 percent), when the country faced a credit crisis, and is also above the US figure before the subprime crisis (138 percent). Consequently, the BOK is aware that any rise in rates would raise debt servicing costs, thereby hurting consumers.

Consumption risks and the government’s attempts at reforms

Apart from high household debt, slowing income gains pose a risk to consumer spending. Despite low inflation and unemployment, real average monthly household income grew a mere 1.3 percent year over year in Q2 2013, down from 3.8 percent for the whole of 2012. During the same period, growth in labor wages fell to 4.2 percent from 5.3 percent. The trend is not likely to change much without policy reforms to strengthen small and medium enterprises (SMEs) and develop the services sector, where income gains tend to be highest.

Encouragingly, the government has made a start with reforms. With greater focus on employment generation, policymakers have framed a plan to simultaneously generate 476,000 jobs every year until 2017 and force up household income. Support for SMEs is also on the anvil, with aid allocated for those employing 300 people or fewer. This is set to benefit self-employed individuals the most, especially those operating in sectors with thin top lines. Interestingly, the government is trying to develop a broader measure of unemployment. This follows the National Assembly Budget Office’s broad unemployment projection of 7.5 percent, a stark contrast to the current figure (2.7 percent in September).

Rise in social spending in the new budget

In September the government unveiled a deficit budget of 1.8 percent of GDP, with overall spending set to rise 4.6 percent. However, the projected deficit is based on an optimistic estimate of GDP growth (3.9 percent) and hence could end up higher (about 2 percent). In line with the government’s election promise, spending on welfare, health care, and job creation is set to rise 8.7 percent, while local governments will receive funds to spruce up their finances, which have been impacted by higher welfare spending obligations. As a result of higher social spending, the government expects public debt to go up marginally in 2014, to 36.5 percent of GDP.1 However, this figure is much below that of developed-economy peers. On a disappointing note, the budget failed to take forward the government’s pre-election promise of reforms: A pledge to extend old-age pensions to all South Koreans above the age of 65 was diluted, even as the government delayed its plan to eliminate the budget deficit. This follows the breakdown of a tax reform plan over fears that it would increase tax liabilities for the middle class.

Growth to pick up in the coming years

Despite the risks, the economic momentum of Q3 2013 is likely to continue into Q4, with average annual growth ending at 2.4–2.8 percent, up from 2.0 percent in 2012. An improvement in economic conditions in Europe and the United States is likely to push up export growth to 5.5–6.0 percent in 2014–15. Investments could also benefit as businesses respond to growing demand and high capacity utilization. As a result, overall GDP growth is likely to move up to 3.4–3.8 percent in the next two years.


View all endnotes
  1. Ministry of Strategy and Finance (South Korea), The 2014 budget proposal, September 26, 2013,


Akrur Barua

Akrur Barua is a manager at Deloitte Research, Deloitte Services LP.

Asia Pacific Economic Outlook, December 2013: South Korea
Cover Image by Jessica McCourt