The International Monetary Fund (IMF) adjusted downward its Korean economic growth forecast for 2014 from 4.0% to 3.8% on July 9, taking into account the slow recovery of the global economy and the country’s high dependence on overseas markets. Two days later, The Bank of Korea predicted that the domestic economic growth rate for this year would be higher in the second than the first half. Private-sector experts, meanwhile, are giving ambiguous predictions, that is, the economy is likely to rebound in the latter half of this year but the pace will be very slow.
On July 11, The Bank of Korea raised its economic growth estimate from 2.6% to 2.8%, 0.1 percentage point higher than the government’s announcement in June. At the same time, the central bank revised its estimated inflation rate by 0.6 percentage points to 1.7%, while raising economic growth and inflation estimates for next year from 3.8% to 4.0% and from 2.8% to 2.9%, respectively.
“The domestic economy is definitely on a recovery track, though at a slow pace,” said The Bank of Korea governor Kim Choong-soo immediately after a Monetary Policy Committee meeting held on July 11, adding, “The quarteron-quarter growth rate was 0.8% in the first quarter of this year, with the percentage expected to be higher in the following quarter.” He added that the GDP gap, which is the difference between potential and actual growth rates, has decreased since the last quarter of 2012.
In the meeting, committee members unanimously froze the benchmark rate at 2.50%. The governor explained that the decision was based on the key rate cut in May, the effects of the revised supplementary budget that are now appearing and the recent global economic rebound. Furthermore, he refuted comments that the market rate has gone up since May, saying, “That is true but what we need to see is that the benchmark rate cut in May has resulted in a slower rise in the market interest rate when compared to other countries.” Concerning a possible impact from the Fed’s exit strategy, he remarked, “It seems that many people identify the exit strategy with a decrease in liquidity, but overall liquidity does not decline and it is expected that the Fed will maintain its loose monetary stance at least for a while.”
In the meantime, major economic research institutes in Korea are also predicting that the Korean economy will be able to achieve at least 3% growth in the latter half of 2013. Still, they are pointing out that this does not mean a fullscale recovery when allowing for the base effect from the 1.5% growth recorded in the second half of 2012. “The weak yen trend and the slowdown of the Chinese economy are happening at a faster-thanexpected pace and the issue of reduction in the quantitative easing has popped up to pose greater risks on the domestic economy,” said Kim Hong-dal, director of the Woori Finance Research Institute, adding, “Recovery will be feeble at best during the second half.”
Chinese Economic Slowdown, the Biggest Risk for Korean Economy
Economists’ consensus is that the biggest risk for the remaining period of this year will be the slowdown of the Chinese economy. “The Chinese market accounts for 25% to 30% of Korea’s total exports, with the figure rising to over 50% when other Asian countries such as Taiwan, Hong Kong and those in the ASEAN region, which are in close trade relations with China, are taken into consideration,” said JP Morgan senior economist Im Jiwon, adding, “This means that a decline in the Chinese economy could deal a blow to Korea’s exports.”
These days, the prospect of the Chinese economy is becoming dimmer due to the Xi Jinping administration’s strong anti-corruption drive and economic restructuring. The growth rate totaled 7.7% in Q1 and is estimated to fall to 7.5% in the subsequent quarter. Nomura Securities recently predicted that the rate could dip below the 7% mark in Q3 or Q4.
Meanwhile, China’s exports are also showing some signs of decline. The General Administration of Customs of the People’s Republic of China announced on July 10 that monthly exports and imports for June decreased by 3.7% and 0.7%, respectively, from a year ago. This is the first time in 17 months that the export growth rate has fallen below zero percent. The rate was -0.5% in January 2012.
Fed’s Exit Strategy and Abenomics; Two Additional Risks
Other major risks lie in the Fed’s exit strategy and the depreciation of the Japanese currency.
Although the US economy is showing some good signs this year thanks to the improvement in employment index, the turnaround is not enough to give rise to a worldwide recovery. The IMF lowered the US economic growth forecast from 3.3% to 3.1% on July 9, while adjusting the global forecast to 1.7% from 1.9%, taking the federal budget sequester that kicked off in March into consideration. The reduction in the quantitative easing scheduled from September this year is also posing concerns for many countries around the world.
“If the slowdown of the Chinese economy is an unfavorable factor on the real economy side, the Fed’s exit strategy is exacerbating the instability of the local financial markets,” said Shin Min-young, head of the Economic Research Department at the LG Economic Research Institute.
Japan is likely to enjoy an increasing economic growth rate, building on the Abenomics policy, but the problem is that the interest rate hike could result in larger government debt interest and deterioration in fiscal soundness. Even the IMF, which has been rather favorable in regards to Abenomics, highlighted it as one of the three biggest risks for the global economy. Once the government bond interest rate soars and investors begin to lose trust in the fiscal soundness of Japan, they could flock out of the country and cause turmoil in the global financial market. The yen-dollar exchange rate, which has surpassed 100 yen per US dollar, is another cause of anxiety for Korean exporters.
“Few expected earlier this year that the 100 yen mark would be broken at such a rapid pace,” said Kwon Soon-woo at the Samsung Economic Research Institute. He went on, “If the trend continues, Korea’s major export items, such as automobiles and electronics will suffer decreasing price competitiveness.”
External risks such as the Chinese economic slowdown and the Fed’s exit strategy are out of the control of the Korean government. This is why economists are calling upon the government to focus on boosting domestic consumption by means of such measures as stronger tax incentives in the housing market. “Domestic consumption is shrinking as middle and working classes tighten their purse strings for rent deposits,” senior economist Im explained, adding, “The government would be wiser to encourage more and more people to buy homes, instead of leasing, by cutting transaction costs, such as the acquisition tax.”