Korean Economy In Dire Straits

The fear of recession stoked by the European fiscal crisis is continuing to affect major economies such as the United States and Japan, while also pulling down the growth rate of emerging nations like China. Under such circumstances, experts are concerned about deflation in the Korean economy.

They are not mentioning theoretical deflation yet, which can be defined as consumer price growth dipping below 0%. However, the downward trend in asset prices may combine with the current downturn both at home and abroad to give rise to an unprecedented situation in which total household debts amount to 1,000 trillion won.

The Bank of Korea has revised its growth estimate for this year from 3.7% (announced December 2011) and 3.5% (April 2012) to 3.0% (this month). The IMF has followed the central bank by cutting its figure from 4.4% (September 2011) and 3.3% (January 2012) to 3.25% (last month). The OECD recently lowered its 2012 growth forecast for Korea from 3.5% to 3.3%, while also reducing the number for next year by 0.3 percentage points to 4.0%. Global bank UBS, gave the most pessimistic view about the Korean economy this year, reducing its estimate from 2.8% to 2.1%.

Although Korea’s GDP increased 0.9% in Q1 from the previous quarter, the rate is likely to be lower than that in Q2 as the crisis in the eurozone has led to a shrinkage in trade, investment and consumption. Regarding this point, China International Capital Corp., the biggest investment bank in China, has predicted that China’s export growth rate would fall to around 4% and the GDP growth to 6.4% if Greece left the eurozone. If this happens, Korea cannot avoid repercussions. According to Hyundai Research Institute (HRI), Korea’s total export and economic growth rates fall by 1.7 and 0.4 percentage points, respectively, when China’s economic growth declines by one percentage point. If Greece left the eurozone, causing China’s GDP growth to fall from 8% to 6.4%, Korea’s GDP growth would stand at around 2%.

The IMF is predicting that global trade growth will slow to 3.8% this year, contracting significantly from 2010’s 12.8% and 2011’s 5.9%. Total exports from Korea in the first half of this year edged up just 0.6%, approximately one-thirtieth of that of the previous year, to US$275.2 billion. Furthermore, all of its raw materials, capital goods and consumption goods imports decreased last month for the first time since October 2009. Listed companies’ new facility investment plummeted 70% from one year ago in H1 owing mainly to dim economic prospects and the upcoming presidential election. Households tightened their purse strings as well due to the burden of their liabilities and faltering consumer sentiment.

Domestic asset markets are taking a direct hit from the slowdown in global demand. For example, the market capitalization of KOSPI slid from close to 1,178.14 trillion won to 1,050.09 trillion between April 3 and July 17, when the index fell from this year’s high of 2,049.28 to 1,821.96. Approximately 130 trillion won went up in smoke in less than four months.

The housing market is no exception either. In June, a total of 37,069 apartment units changed hands to record a 32.9% year-on-year decrease. Furthermore, the overall housing transaction volume fell 29.3%, leading actual sales prices to drop mainly in those complexes waiting for reconstruction and remodeling in the Gangnam area. According to KB Kookmin Bank’s housing market data, the number of potential purchasers decreased for eight consecutive months until June 2012. The market consensus is that prices will continue to fall and that more and more people are hesitating over purchasing houses.

The eurozone predicament dates back to 2008, when the US subprime mortgage resulted in financial turmoil, fiscal policy coordination and large-scale quantitative easing. The current economic downturn, demand slump and falling asset prices can be considered some of the aftereffects of this.

The Korean government is saying that the country is not yet in a deflationary situation. However, it is watching the housing market and household debts very closely since falling home prices and rising consumer debt are sure to deliver a staggering blow.

As of the end of March, the household credit balance was 911.4 trillion won, swelling 34.6% or 234 trillion won from Q1 of 2008. The mortgage loan delinquency rate as of the end of May surged for a fifth consecutive month to 0.85%, the highest since October 2006.

“Concerns about debt deflation are rising, led basically by falling real estate prices, and the policy plans already announced by the government are not enough to deal with it,” said Korea University professor Oh Jung-keun. He added, “The price ceiling for new apartments should be abolished and the acquisition tax should be reduced.” HRI researcher Im Hee-jung stated, “Not a few households may be pushed into a corner when the prices of indebted assets fall, leaving less room for spending.”

With the situation as it is, the government is planning to provide financial assistance to low and middle income classes and small and medium enterprises (SMEs), as well as go ahead with the policy plans announced in H1, e.g. the provision of loans to SMEs without any review procedure. The government is not mulling over artificial economic stimulation though, with the exception of 8.5 trillion won worth of additional treasury investment scheduled for H2 and some small ball measures for deregulation and system improvements next month.

However, industry experts are pointing out that such measures are insufficient to tackle the imminent signs of recession preemptively. They are saying that the current global economic recession is a result of more reasons than just the European fiscal crisis.

The causes are complicated and require time to be properly addressed. Unemployment rates are still high in major nations and job creation is slow. Their housing markets are also in the doldrums, affecting consumption, employment and finance alike. Banks in developed countries as well as Korea are reducing their lending in an attempt to constrict spending. International oil prices, though having fallen slightly recently, still remain high and are unlikely to be brought down due to the structural imbalance in supply and demand, as well as geopolitical risks. The US, European and Japanese governments have very limited room for expenditure as they exhausted their resources in the previous financial crisis, with most interpreting the current situation in different ways, thus making policy coordination more difficult than ever before.

In the event of another recession, there indeed is no card to play. Governments are under severe financial pressure and it is almost impossible for them to collect extra taxes. Treasury bonds issued for funding will be of no avail, as seen in the cases of Southern European nations. The super-low interest rate has been continuing and monetary supply cannot be hiked because it will result in inflation, turning the fear of recession into that of a worldwide crisis. The Korean economy, dependent on exports by nature, is seeing a bumpy road ahead. More thorough preparation is needed to overcome it.