Subject to Chain Reaction

In the sphere of the economy, uncertainty is one of the things people love to hate most. Unfortunately for Korea, the situation is poised to haunt its economy, which was characterized by its heavy reliance on overseas market conditions throughout 2012. If the financial crisis in the eurozone results in a cascade of sovereign defaults, a lost age could draw near, as warned by IMF chief Christine Lagarde. Korea would be dealt a staggering blow if any one of the four pillars of the world economy; the US, Europe, Japan and emerging nations, crumbled. The list of potential threats goes on and on. Business Korea selected 10 keywords for the Korean economy in 2012 in regards to domestic and foreign economic predictions.

Eurozone Reaching Flashpoint

It is beyond controversy that the financial catastrophe in Europe is the most dangerous global economic time bomb for 2012. The problem is that everyone knows how grave it is but nobody knows what to do to deal with it. The calamity has spread from Southern Europe to Eastern Europe and more recently Germany, France and Great Britain. Lately, the European Commission adjusted its annual economic growth estimate for the EU region downward to 0.6%, while more than a few agencies are forecasting negative growth.

Disasters in Europe are likely to abound, from Greek default and a bailout request by Italy to the downgraded credit rating of France and financial crisis sprawling to Western Europe. The tight sovereign debt maturity schedule for the first half of this year is also compounding the matter. “The continent is where lots of countries’ banks are intertwined with one another. The debt crisis may become contagious, causing a banking-sector credit crunch and slowing down the real economy. It will not be easy to get out of the problem unscathed,” said deputy department head Park Jin-ho at The Bank of Korea (BOK).

If under pressure eurozone nations choose fiscal austerity, their domestic consumption will shrink and recovery will take longer. Nevertheless, France is planning to reduce its budget deficit by 12 billion euro between 2011 and 2012, while Italy passed a 30 billion-euro retrenchment bill, effective for two years, through the senate on December 23. According to media reports, those in the eurozone have already decided on at least 10% fiscal tightening and the figure may rise at any time.

Elongated Recession in US Economy

In the meantime, the US economy has deteriorated so much that some are concerned about a double dip. The Samsung Economic Research Institute (SERI) stated that though the possibility of a double-dip recession fell temporarily after the announcement of 3Q economic growth rate at 2%, its conditions, such as high unemployment and a sluggish housing market, remained worrisome. No viable solutions have as yet been found.

The first and second quantitative easing programs were stop-gaps, and the country has no more fiscal or monetary room for maneuver. The national debt-to-GDP ratio skyrocketed from 63% to 100% between immediately before the crisis and 2011.

Under such circumstances, the US is tightening its purse strings by reducing fiscal expenditure, raising taxes, cutting public employee wages and reforming the pension system. According to the Budget Control Act of August 2011, it is to save US$2.4 trillion in fiscal spending over the next 10 years. However, the Republican and Democratic Parties remain against each other regarding future economic policies, suggesting a fast recovery is unlikely and no stimulus package in sight. Economic organizations and investment banks predict the US economic growth rate will be 2% or less.

Is Chinese Economy Crash-Landing?

Another potential threat to the global economy is whether China will make a hard landing. Last year, the country saw its growth lose steam in the wake of a global downturn and tight-money policies. For example, the rate stood at 9.1% in Q3, 2011, the lowest since 2009. Meanwhile, Korea’s exports to China increased at the slowest pace since September 2011.

However, there is a consensus that the Chinese government will halt its tight budget policy sooner or later. “It will focus more on stability with a regime change coming up, and there seems to be no hard landing in the near future,” said the POSCO Research Institute (POSRI). In fact, the government declared that it would pursue stable growth down the road at the China Central Economic Work Conference held in Beijing in December, 2011.

“Exports from China will decline to some extent due to concerns surrounding advanced economies, but China has enough monetary and fiscal room to cope with such a situation,” said BOK deputy department head Han Jae-hyun, adding, “The nation’s real estate market, supported by solid demand, will see no price plunge for the time being.” The Korea Development Bank (KDB) Research Institute has suggested that the government is feeling uneasy about inflation and an asset bubble and therefore won’t drop its strict monetary policy for the moment.

Strong Yen

The Japanese economy was mired in the strong yen and Sendai Earthquake last year. De-growth continued from Q4 in 2010 to Q2 in 2011, with only a slightly positive growth allowed the following quarter. It was Korea that benefitted the most from the circumstances.

The buzzword in the Japanese economy this year is going to be the rise of the yen. Since the bankruptcy of Lehman Brothers in 2008, its value against the US dollar has soared over 30%, staying at no less than 75 yen per dollar for five consecutive months since July 2011. The Japanese government intervened in the foreign exchange market between October and e November with funds amounting to nine trillion yen, or US$115.55 billion. Although the strong yen is likely to remain for now, there appears to be no signs of another steep appreciation. The government recently announced that it would continue stepping into the forex market.

Emerging Economies Losing Growth Vitality

Nowadays, keen attention is being paid to what impact economic contraction in advanced nations will have on their emerging counterparts. Many domestic experts are answering that developing nations’ growth will continue, with the pace slowing a bit. “Emerging economies’ average growth rate will turn downward amid weak exports and financial austerity, but it will decline not abruptly but gradually, preventing the world economy from plummeting,” SERI commented.

Of the newly industrializing regions, Southeast Asia, India and Brazil are expected to be relatively freer from the global shock. The Korea Institute for International Economic Policy (KIEP) said that major Southeast Asian countries would be able to increase their year-on-year growth rates in 2012. According to a recent analysis of foreign research centers such as Global Insight, Brazil, India, Russia, Latin American and Middle East nations are likely to grow this year as much as or slightly less than they did in 2011. Nonetheless, the trade volumes of BRICs countries may fall significantly depending on the situations in Europe and the US as more than 50% of their exports are destined for there.

Politics Coming Back

According to consulting firm Roland Berger, elections are being held in 59 countries this year. Presidential elections are scheduled in Russia (March), Spain (March), France (April), Mexico (July), India (July) and the United States (November), with general elections in Greece (February), France (June) and Mexico (July). China’s Community Party leadership changes hands in October, while general and parliamentary elections take place in Korea in the same month (December), the first time this has occurred in two decades.

Such uncertainties have the possibility of significantly affecting the global economy. In the US, intensifying political confrontation between the ruling and opposition parties may hamper economic stimulation, with the re-election of President Barack Obama not fully assured. In Europe, belt-tightening programs may undergo some alterations, with even the breakup of the EU possible depending on election results. “Even though the role of the government matters in regards to addressing global issues, available policy measures are quite restricted and the exertion of political leadership is limited in countries facing elections,” said KIEP. Korea is no exception. In a recent poll by the Korea Employers Federation (KEF), 64% of 252 Korean CEOs responded that the elections would have a negative rather than positive influence on its economy.

Precarious Foreign Exchange Market

In 2011 alone, foreign investors net-sold stocks worth eight trillion won in the Korean market over misgivings about the crisis in Europe. Any additional outflow by European investors in particular could shake the Korean capital as well as forex market to the ground. Currently, approximately 50% of total foreign funds are estimated to be European bank loans or bond investments in Korea.

The stability of the country’s foreign exchange market has risen substantially thanks to rising forex reserves, bank-sector soundness and capital movement regulations. However, the danger of a massive fund outflow lingers on. The LG Economic Research Institute (LGERI) warned that credit risks in the private finance sectors of Europe and the US leading to a capital crunch could cause the value of the Korean won to plunge. The same thing may also happen in the bond market.

SERI agreed to it by mentioning European banks’ recapitalization deadline is set at the end of June. POSRI pointed out that the won-dollar exchange rate would surge to 1,500 or so in the event of such rapid capital movement. Meanwhile, a BOK official analyzed the opposite, with the low interest rate policy of advanced economies channeling liquidity toward emerging nations.

Oil and Raw Material Prices Remain Steady

In spite of across the board predictions of a slowdown, petroleum and raw material prices do not appear to be nose diving. With global oil demand falling, contrary to supply amid the strong dollar, prices are likely to decline gradually. SERI predicted that international oil prices would fall 9.5% from a year ago to end at US$95 in 2012. POSRI estimated the figure to be 7%, while LGERI expects the price to reach US$105. The US Energy Information Administration (EIA) said demand from OECD member countries would decrease 0.07%, while demand from others would increase 3.35% during the same period.

When it comes to raw material prices, a downward movement is expected in the first half, before rising demand from emerging blocs somewhat offset the drop in prices in the latter half. Many speculative funds in the market appear to be moving to profit-taking, contributing to the falling demand.

Companies Hesitant about Investment

With the situation as it is, corporate investment appears to be remaining in the doldrums. The Korean government predicts this year’s domestic facility investment growth will stop at 3.3% on the grounds of barely increasing exports and lowering corporate profitability. Private economic research centers have arrived at similar analyses.

It appears that things look much bleaker for enterprises. In a poll by the KEF, 42% of respondents answered that they would continue retrenchment this year, with 31% saying they were aiming to keep the status quo this year. The majority of those polled felt that the current global crisis is 95% as severe as that of four years earlier.

The Korea Chamber of Commerce & Industry surveyed 1,000 Korean corporations in mid-December regarding equipment investments for 2012. According to the result, investment is expected to grow 4.1%, which is two percentage points lower than predicted in the same poll the year before. The Federation of Korean Industries announced that 15 and 14 out of 22 large Korean business groups were anticipating worsening exports and worsening financing conditions during 2012, respectively.

Household debt Approaching Tipping Point

Meanwhile, also in December, the Hyundai Research Institute conducted a survey on its Web site asking what will menace the domestic economy in 2012. 380 people participated, with the European fiscal crisis, contrary to many expectations, ranking not first but second by receiving 99 votes. It was none other than the household debt issue that was selected by more than one-third of respondents. Third place went to the emergence of political populism prior to elections (58 votes).

BOK statistical data shows that total household liabilities amounted to 900 trillion won as of 3Q 2011, and its ratio to GDP 80%, just five percentage points short of the critical level suggested by the Bank for International Settlements (BIS). Furthermore, many Korean households are deemed to have very weak debt repayment capabilities. The default rate ran to 0.72% at the end of the first half of 2011, the highest since the 2008 crisis. A large portion of mortgage loans are short-term that need to be paid back within three years. 90% of these are floating rate-based ones, meaning the non-performing loan ratio could skyrocket as the principal payment period approaches and interest rates hike. At the same time, higher-rate non-banking sector loans are on the rise, aggravating the situation. If the real estate market fails to make a significant rebound and external financial conditions continue to exacerbate, a combined recession may rear its head, affecting the real economy and local financial institutions alike.