South Korea’s economy appears to be on its way up, as economic indicators and policy action point to improving growth prospects. Quarterly GDP growth hit a two-year high in the first quarter of 2013, aided by strong showing in construction, investment, and exports. Encouragingly, the pace of expansion is expected to pick up as fiscal stimulus measures and monetary policy easing start to have an impact. Among the key components, consumption spending is likely to benefit from low unemployment and a boost to real wages from low inflation. Despite a better showing in Q1 2013, investment remains relatively weak. However, it is expected to edge up as domestic consumer sentiment improves and the global trade cycle moves up. On the exports front, recovery in the near term is likely to be muted given continued Eurozone weakness and declining growth rates in China.
Improving prospects for industry and consumer spending
Economic activity has got a boost from a gradual strengthening of industrial output and consumer sentiment. Industrial production growth turned positive (1.7 percent year over year) in April after two previous contractions. On similar lines, purchasing managers’ index figures for the month show manufacturing activity expanding at the fastest pace in more than two years. Growth was driven by new orders, both domestic and foreign, although the former’s pace of expansion was higher. This augurs well for domestic consumption growth in the second quarter, given its subdued performance in Q1 2013. This view is supported by growing consumer sentiment: The Bank of Korea’s (BOK’s) composite consumer-sentiment index went up to 104 in May from 102 in April, and matches the one-year high in March. Along with improving perceptions of economic activity, consumption growth is also likely to benefit from low inflation (which aids real wage growth) and low unemployment. Most importantly, both consumption and investment are likely to benefit from a recently approved fiscal stimulus plan as well as monetary policy easing.
The twin policy push: Fiscal and monetary policy gear up to support the economy
In May, the South Korean parliament ratified a $4.8 billion stimulus plan to aid small and medium enterprises, prop up worker incomes, and boost corporate investments and the real estate sector through tax incentives. The government expects these measures to push up GDP growth by 0.3 percentage points and create 40,000 jobs. The stimulus package is part of a $15.4 billion supplementary budget by the new government, to be funded entirely through new borrowing. As a result, the fiscal deficit is projected to rise to about 1.8 percent of GDP in 2013 from a previous target of 0.3 percent. However, the deficit is manageable, and sovereign risk perceptions are not likely to rise given the low level of public debt (36 percent of GDP), current account surplus (3.8 percent of GDP), and high total reserves ($323 billion excluding gold).
The fiscal push this quarter has been complemented by monetary policy easing. With inflation at a 14-year low (1.0 percent year over year) in May and well below its target rate of 2.5–3.5 percent, the BOK eased its policy rate by 25 basis points in May to boost growth and prevent the South Korean won’s sharp rise against the Japanese yen. In the six months prior to the rate cut, the yen had fallen more than 20 percent against the won, denting South Korea’s export competitiveness vis-à-vis Japan. The BOK’s move is likely to help break this trend.
Quarterly GDP growth hit a two-year high in the first quarter of 2013, aided by strong showing in construction, investment, and exports.
No sharp uptick in export growth in the near term, though prospects seem better for 2014–2015
Demand for South Korean exports remains subdued, given economic weakness in key export destinations. Deteriorating price competitiveness in relation to Japanese firms (due to strong yen depreciation) has not helped either, although the recent BOK rate cut is likely to help partially bridge the gap. In such a scenario, a sharp recovery in exports is not expected. However, the country is likely to benefit from a gradual improvement in the global trade cycle in 2014–2015 due to recovering global growth. Also providing encouragement is the fact that the US economy has proved resilient against sharp fiscal cuts. Signs of improving export fortunes for South Korea are already visible, with exports rising 3.2 percent year over year in May on the back of surging shipments of mobile and telecommunication goods. Most importantly, demand seems to have risen sharply in two key markets: the United States (21.6 percent year over year) and China (16.6 percent year over year).
The country faces both economic and political risks
The economy, however, continues to face near- and medium-term risks. On the external front, any growth destabilization in the United States and China will hit exports. Things could get worse if the BOK’s recent rate cut fails to dent appreciation of the won. On the domestic front, high household debt poses a risk to consumer spending in the medium term. Household debt as a share of disposable income currently stands at about 150 percent, and any potential bout of deleveraging would dent consumer spending and thereby GDP growth. Other irritants likely to weigh on growth include the lack of reforms to boost the country’s services sector, the high concentration of economic power in a few large corporates (chaebol), and reconciling social-sector spending objectives with greater fiscal prudence. In addition to economic factors, the risk from a conflict with North Korea seems elevated. However, any full-scale conflict with the North is not likely (despite rising rhetoric from that country), although small skirmishes cannot be ruled out.
Despite risks, growth is likely to pick up in 2013
These risks notwithstanding, economic growth is likely to increase in 2013 and then accelerate in 2014–2015. GDP growth is expected to be in the range of 2.5–3.0 percent this year (up from 2.0 percent in 2012), aided by a policy push and consumer spending recovery in the latter half. The pace is then expected to accelerate to 3.5–4.0 percent in 2014–2015, as export growth picks up due to faster global economic growth. Export recovery and improved consumer sentiment will also push up domestic investment. However, growth is not likely to move above the levels witnessed prior to the global economic crisis.