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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