South Korean Economic Outlook

Transcription

1 Economics Group Special Commentary Tim Quinlan, Senior Economist (704) Nick Bennenbroek, Currency Strategist (212) Shannon Seery, Economic Analyst (704) South Korean Economic Outlook The Bank of Korea (BoK) has kept its target lending rate on hold since June 2016, but there has been growing speculation that a rate hike could soon be in store. At its October policy meeting one member of the BoK s rate-setting committee dissented with a preference to raise rates. Then last week third quarter GDP came in at the fastest pace in three years. While we admit that third quarter growth was better than we were expecting, we do not think that rate hikes are imminent in South Korea. High levels of household debt imply headwinds for consumer spending, and a shrinking labor force diminishes the country s productive capacity. Those factors, combined with a mostly benign inflation backdrop, suggest to us that any rate hike will have to wait until In the meantime, a low base for inventory investment and an improving global economy represent the potential bright spots that may eventually compel the BoK to raise rates. Such bright spots will likely factor into the Korean won gradually appreciating against the U.S. dollar over the medium term. Figure 1 Figure 2 South Korean Official Bank Rate Percent 1 South Korean Real GDP Bars = Compound Annual Rate Line = Yr/Yr % Change 1 We do not think that rate hikes are imminent in South Korea Official Bank Rate: Compound Annual Growth: 5.8% Year-over-Year Percent Change: Source: Bloomberg LP, IHS Global Insight and Wells Fargo Securities As the old saying goes, a rising tide lifts all ships. That is an apt phrase to characterize the backdrop for a number of export-dependent economies. In figure 3 on the next page, we look at one common metric used to size up trade dependence which is exports as a share of overall GDP. A number of these more export-oriented countries have been posting improving GDP growth figures in recent quarters. In Malaysia, Thailand and South Korea, for example, the most recently published GDP report revealed an increase in the year-over-year rate of GDP growth relative to the prior quarter. Greater foreign exposure has contributed to faster rates of growth. Greater foreign exposure has contributed to faster rates of growth. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 Third quarter GDP in South Korea was particularly strong. Solid Q3 GDP in South Korea Third quarter GDP growth in South Korea was particularly strong. The annualized growth rate during the period was a torrid 5.8 percent with contributions from every major category except inventories, which exerted a drag of 2.8 percentage points. On a sequential basis, it was the fastest growth rate in seven years. On a year-ago basis, the 3.6 percent growth rate was the strongest since the first quarter of Because real exports of goods and services add up to 42 percent of GDP, growth in the rest of the world is particularly important for the South Korean economy. China is South Korea s most important export market; it receives roughly one quarter of all Korean exports. In that regard, the economic moderation of China since the beginning of the decade had exerted a slowing effect on the South Korean economy. However, growth in China has stabilized more recently and the global growth backdrop is improving and Korean exports are again on the rise. Figure 3 Figure Export Dependence Merchandise Exports as a Percentage of GDP Exports/GDP: 2012 Exports/GDP: 2016 *Japan's most recent data is South Korean Consumer Prices Year-over-Year Percent Change CPI: 1.8% Core CPI: Source: IHS Global Insight, The World Bank and Wells Fargo Securities That firming in the broader global economy manifested itself in a pronounced way in the third quarter GDP report. Looking at the GDP components on a quarter-over-quarter, nonannualized basis, net exports contributed substantially to headline growth. Exports increased 6.1 percent and imports were up a lesser 4.5 percent on the quarter, with both exports and imports reversing declines from the prior quarter. It would be an oversimplification, however, to characterize Korea s stronger growth in the third quarter as nothing more than an improving global economy. Consumer spending picked up for the sixth straight quarter rising 0.8 percent, non-annualized. Business fixed investment spending notched its seventh straight pick-up, though the pace of growth at just 1.1 percent perhaps reflects a bit of caution on the part of businesses. As mentioned earlier, a retrenchment in inventories weighed on Korean growth in the period. An argument could be made that inventories are now poised to be supportive of growth in the coming quarters. Businesses have drawn down stockpiles in six out of the past seven quarters which sets up a low base for this component to be additive to topline GDP in the near future. Even a slower pace of inventory correction would be additive to growth in the final quarter of the year. Are Objects in the Rearview Mirror Better Then They Appear? The most-recent move from the BoK was in cutting its primary lending rate a quarter of a percentage point to 1.25 percent. In the 17 months since, financial markets have attempted to dial-in precisely where the BoK is on the scale of neutrality, favoring a cut or an increase as the next move. Even prior to the recent GDP release, financial markets were beginning to price in the possibility that the BoK s policy bias was more hawkish than it was neutral. However, even with the surge in economic growth reported in the third quarter, fundamentals suggest lingering headwinds for the Korean economy, which underpins our expectation that the BoK will wait to raise its target lending rate until

3 Inflation, measured by the Consumer Price Index (CPI), continues to linger around the BoK s target rate of 2 percent. The core measurement of CPI, which excludes the volatile components of groceries and energy, has moderately decreased, currently standing at just 1.3 percent. The stillsubdued inflation figures add to our doubts of an imminent rate hike, though we do expect inflation to gradually pick up throughout our forecast period. Despite heightened geopolitical risks, consumer confidence remains elevated, which should sustain modest gains in personal consumption. The threat, however, is that household debt in South Korea has doubled since Against those rising debt obligations and the associated financing cost, we remain cautious on the outlook for the consumer. High levels of household borrowing could constrain future consumption if individuals take on too much debt to finance with future wages and salaries a key consideration for the BoK as it balances the low interest rate environment to stimulate growth, without encouraging an excessive rise in consumer borrowing. In this regard, policymakers at the BoK have a similar problem to their counterparts at the Reserve Bank of Australia. Figure 5 Figure South Korean Household Debt Total Household Debt as a Percentage of Disposable Income Household Debt/Disposable Income: South Korean Working Age Population Population Aged as a Percentage of Total Population 7 Household debt in South Korea has doubled since Working-Age Population/Total Population: % 69% Source: Bloomberg LP, IHS Global Insight and Wells Fargo Securities South Korea has also experienced a slowing in its productive capacity as growth in its working-age population has slowed in recent years. The pace of population aging in South Korea is projected to be one of the fastest among its international counterparts, highlighting potential risks to the productivity of its labor force moving forward. As the elderly population grows as a percentage of total population, the labor market becomes constrained due to disproportions, hindering the availability of qualified workers. Although the unemployment rate hit a seven-year high of 4.0 percent earlier this year, it has been trending lower in recent months and currently stands at 3.7 percent through September. Effects of South Korea s shrinking labor force have the potential to produce downside risks of a secular like stagnation. The changing labor force paired with an uptick in personal consumption needs to be matched with a rise in personal income in order to keep an encouraging pace of growth. This is no easy task. With the slowing of the working-age population impacting the productive capacity of the economy, there is little room for growth concerning wages and salaries. Without an increase in output, it will be difficult to see any translation to an increase in income. Further, without an increase in income, personal consumption is likely to slow; if it does not, household debt will continue to soar. There has been discussion for policy reform to aid the high levels of debt that South Korea is experiencing. Talks concerning an increase in the minimum wage produce the potential to uplift a portion of wages in the hopes of spurring further personal consumption. But, again, an increase in output, or production, is needed to see a robust increase in income. The pace of population aging in South Korea is projected to be one of the fastest among its international counterparts. 3

4 An improving global growth environment should be an overall positive force on the won. Moderate Gains in the Won We expect moderate gains in the Korean won over time. An improving global growth environment should be an overall positive force for the won. However, even with the recent firming in Korean economic growth and an overall bias to tighten monetary policy, actual BoK rate hikes still appear to be some way off. Geopolitical tensions on the Korean peninsula may at times influence the value of the won, although in the absence of a significant escalation we doubt those tensions will have a lasting impact on the Korean currency. Finally we would note, that for two of Korea s key trading partners China and Japan we are also expecting only moderate gains in those currencies, a factor we believe argues for moderate gains in the Korean won as well. Figure 7 1,000 South Korean Exchange Rate KRW per USD (Inverted Axis) KRW per USD: 1, ,000 1,050 1,050 1,100 1,100 1,150 1,150 1,200 1,200 1,250 1,250 1, ,300 Source: Bloomberg LP and Wells Fargo Securities On Hold for Now We expect the BoK to leave its target lending rate unchanged at its November policy meeting. Despite the solid GDP report for the third quarter and notwithstanding the dissent at the October meeting, we do not think conditions currently warrant a rate hike. The headwinds of elevated consumer debt and a fast-aging population are not going away any time soon. That said, continued firming in the global economy, as well as a rebuilding of inventories should push the South Korean economy to continue to grow. If that proves sustainable, the BoK may eventually adopt a more hawkish bias in On that basis, we see scope for modest improvements in the Korean won over the next 12 months. 4

5 Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) (212) John E. Silvia, Ph.D. Chief Economist (704) Mark Vitner Senior Economist (704) Jay H. Bryson, Ph.D. Global Economist (704) Sam Bullard Senior Economist (704) Nick Bennenbroek Currency Strategist (212) Eugenio J. Alemán, Ph.D. Senior Economist (704) Azhar Iqbal Econometrician (704) Tim Quinlan Senior Economist (704) Eric Viloria, CFA Currency Strategist (212) Sarah House Economist (704) Michael A. Brown Economist (704) Jamie Feik Economist (704) Erik Nelson Currency Strategist (212) Michael Pugliese Economic Analyst (704) E. Harry Pershing Economic Analyst (704) Hank Carmichael Economic Analyst (704) Ariana Vaisey Economic Analyst (704) Abigail Kinnaman Economic Analyst (704) Shannon Seery Economic Analyst (704) Donna LaFleur Executive Assistant (704) Dawne Howes Administrative Assistant (704) Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Clearing Services, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. Wells Fargo Securities, LLC. and Wells Fargo Bank, N.A. are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2017 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE