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Economics: Korea Economics – Markets – Strategy KR: Surviving • Despite strong exports, domestic demand growth has fallen due to higher energy prices, financial market volatility and political troubles • But there is room for both fiscal and monetary stimulus to help the economy survive the current difficulties • We have lowered our 2008 GDP forecast to 4.6% from 4.8% last quarter, but maintain our 2009 forecast at 5.0% for now 1Q08 Recap GDP growth slowed to a sub-par 3.3% (QoQ saar) in 1Q08, significantly down from the robust 6%-7% rates of the previous three quarters (Chart 1). Exports preformed well in line with our expectations, but domestic demand deteriorated unexpectedly. Private consumption growth fell to 1.8%, the slowest pace since the 2004 credit card crisis. Fixed investment declined 3.4% QoQ saar, marking the sharpest contraction over 13 quarters. Chart 1: Growth slowed on domestic demand % QoQ saar 18 14 10 6 2 -2 -6 GDP PCE GFCF -10 1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 Chart 2: Labour market deteriorating %YoY,sa 2.5 2 1.5 1 0.5 0 %, sa Employment 4.5 Unemployment Rate (RHS) May-04 May-05 May-06 May-07 May-08 4 3.5 3 2.5 The labor market also lost steam. Employment growth dropped to below trend levels earlier this year while the jobless rate has started to rise since March (Chart 2). KOREA Still exposed to external risks The markets (including us) have been focusing on assessing the impact of exports slowdown on Korean economy as a result of US subprime crisis. There are two other external risks - oil prices and financial market volatility – which have been underestimated previously. Global crude oil prices continuously broke record over the past few months and now stand at all-time highs of USD130/barrel. The adverse effects from oil prices on economic growth emerged fast in Korea, as it Ma Tie Ying • (65) 6878 2408 • matieying@dbs.com 88
Economics – Markets – Strategy Economics: Korea is one of the few countries in the region adopting floating oil pricing mechanism, while the oil-intensive industry is also important for Korea compared to its counterparts such as Hong Kong and Singapore. High oil prices squeeze consumer purchasing power and corporate profit margins. From a macro perspective, the surge in oil prices has resulted in the worsening of terms-of-trade. Meanwhile, concerns over external debt have also triggered some volatility in financial markets amid global financial turmoil. Short-term external debt has risen since 2006 and reached 16% of GDP in 2007, double the steady 8% pace seen in 2000-2005 (Chart 3). Importantly, foreign reserves remain sufficient to cover such a debt level, substantially different from the situation ahead of Asian financial crisis. More importantly, a large portion of today’s external debt is caused by the banks’ hedging of long-USD positions following the exporters’ USD forward selling, which is also different from decade ago when companies heavily borrowed from overseas to fund domestic investment expansion. We do not think the problem of external debt is alarming, but markets are pricing in higher risk premium. Short-term money market rates have risen, boosting bank lending rates by an additional 20bps since the last BOK rate hike in Aug07 (Chart 4). The Korean won depreciated sharply since March and accumulated a loss of 10% (against USD) by beginning-June. Higher borrowing costs and weaker currency should both have played a role in weighing down domestic demand. Oil prices hit domestic demand quickly External debt is not high but triggered financial volatility Chart 3: External debt rising % 20 15 10 5 Short-term External Debt / GDP Short-term External Debt / Foreign Reserve (RHS) % 350 300 250 200 150 100 50 Chart 4: Lending rates elevated % 10 8 6 4 2 Policy Rate Lending Rate: New Loans CD Rate: 3m 0 1995 1997 1999 2001 2003 2005 2007 0 0 May-00 May-02 May-04 May-06 May-08 And, some internal noises Since the government agreed in April to lift bans on imports of US beef, there has been widespread criticism due to public worries over the beef safety. Opponents have held large-scale street protests demanding that the US deal be scrapped or renegotiated. Combined with the oil prices pain and financial volatility, public sentiment has been hit further. Consumer confidence which started to weaken since March dropped sharply in May, touching its lowest level ever since 2004 (Chart 5). The intensifying protests finally triggered political storm. The Prime Minister and the entire Cabinet offered their resignations on June 10, holding themselves responsible for the dispute. It is reported that the president will accept the resignations selectively and a cabinet reshuffle is likely to occur soon next week. The beef deal caused protests and a cabinet reshuffle, further hitting public sentiment 89
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