South Korea. Country Economic Forecast. Highlights. Forecast for Korea. 27 Jul 2015

Transcription

1 Country Economic Forecast Highlights Korea grew by just.3% on the quarter in Q, down from.8% in Q. The MERS virus outbreak in late May caused household spending to fall by.3% on the quarter in Q after three reasonable quarters. Farm output also fell sharply because of a drought. Household spending is expected to pick up in Q3 as the impact of MERS fades (no new cases have been reported for two weeks), while extra budget spending of.8trn won (around US$bn) has been proposed to boost the economy and counter the drag from MERS. We forecast improving consumer spending in H, growing by.7% in as a whole. The sharp weakness in Chinese import volumes seen in H is having major repercussions for Korea and other countries in the region. Exports to China accounted for about % of Korean GDP in 4. Goods export volumes edged higher in Q, but were still lower than a year earlier, while services export volumes fell sharply in Q on fears about MERS. There are some signs that the external background may now be stabilising but the recovery in regional trade will be gradual and exports are unlikely to boost Korean growth significantly in H. Earlier this month the Bank of Korea (BOK) cut its growth forecast to.8% but this seems high as GDP would have to rise by more than % per quarter in both Q3 and Q4. We do expect that expansionary monetary and fiscal policy will boost activity but we forecast quarterly GDP growth of.7% in Q3 and.9% in Q4, giving growth of.4% (down from.7% previously). Growth should then pick up to 3.% in 6 as the world trade background improves. But there are a number of uncertainties that could have repercussions for growth prospects. If the US Fed starts to raise interest rates in September, there is a risk of further downward pressure on the currency, while the stronger dollar might dent demand in other economies in the region and exacerbate existing market turmoil in China and Europe. Against this background the Korean authorities might be tempted to let the exchange rate weaken to bolster export prospects and also leave interest rates lower for longer. Reflecting these fears the trade-weighted won has fallen by over 5% since May. However, if the outlook turns more positive then the large external surplus may drive a KRW recovery. Forecast for Korea (Annual percentage changes unless specified) Domestic Demand Private Consumption Fixed Investment Stockbuilding (% of GDP) Government Consumption Exports of Goods and Services Imports of Goods and Services GDP Industrial Production Consumer Prices Current Balance (% of GDP) Government Budget (% of GDP) Current Account ($bn) Trade Balance ($bn) Short-Term Interest Rates (%) Exchange Rate (Per US$)

2 Forecast Overview Subdued exports & MERS dampen Q GDP The economy grew by less than we had expected in Q, with the.3% quarterly gain notably down from the.8% increase seen in Q. The outbreak of the MERS virus dragged household spending.3% lower on the quarter, offsetting the boost from record low interest rates and higher budget spending. Goods export volumes rose by.% quarter-on-quarter but were still down on a year earlier, while services export volumes fell sharply on the quarter (tourist arrivals fell by 4.3% year-on-year in June). Sluggish regional trade has also discouraged investment in machinery equipment, which edged up by just.4% on the quarter (after a.% gain in Q). But domestic activity to improve in H A total of 36 Koreans have died from MERS since the first case was discovered in late May but fears have dropped in recent weeks and, provided there is no fresh escalation, the virus should be much less of a drag on consumption in Q3. An.8trn won (about US$bn) extra budget has been proposed by the government and, once this has been agreed in parliament, it will be directed at low-income households and the tourism sector, aiming to cancel out the drag from MERS. We expect household spending to grow by.8% on the quarter in Q3 and.9% in Q4, helped by record-low interest rates and annual growth in household lending of % in recent months. However, the risks to our consumer spending forecast are probably to the downside. Household debts are high (over 5% of disposable income) and, even before MERS, spending had been modest, rising by.5% in Q4 and.6% in Q. & GDP growth seen rising to 3.% in 6 We have reduced our forecast for growth to.4% from.7% previously (and 3.5% at the start of the year). However, the fiscal and monetary stimulus will gradually boost activity. Indeed the one sector that made a robust contribution to Q growth was construction which gained.7% on the quarter, likely reflecting the housing market stimulus feeding through. In addition there are some tentative signs that the external background across the region may now be stabilising, although the likely recovery in regional trade will be very gradual and contribute little to boosting Korean growth in H. As a result, we expect the economy to grow by.7% on Korea: Quarterly contributions to GDP % quarterly contribution Private consumption Fixed investment Net exports Government consumption Stockbuilding Q3 Q4 Q Q 4 Source : Oxford Economics / Haver Analytics Korea: Consumption and investment % year Investment Korea: Exports US$bn (seasonally adjusted) Source: Haver Analytics Consumption Source: Oxford Economics / Haver Analytics F'cast

3 the quarter in Q3 and by.9% in Q4. We forecast GDP growth will rise to 3.% in 6, supported by: Expansionary fiscal policy fiscal policy has been loosened to guard against the economy stagnating. We see higher public spending feeding through to more sectors during H and 6. Accommodative monetary policy last month s rate cut took the policy rate to a record-low.5%. However, the BOK is unlikely to cut again unless the economy falters significantly, as the annual growth in credit to households has already climbed to % in April and May from around 6% a year earlier. Consumer spending to build momentum gradually we expect the underlying trend in consumer spending to gain momentum steadily, growing by more than 3% a year in 6-7. Annual employment growth remained reasonable at.% in Q (although it has trended downwards in recent quarters), while low interest rates should also support activity. helped by strong global trade Stronger US and EU demand will boost exports weak sales to China and the rest of emerging Asia have been a major constraint on export performance so far this year but this drag is gradually expected to ease. In addition, growth in the US and the EU is forecast to strengthen further in 6. Overall, we expect world trade weighted by Korean export shares to grow by 4.6% in 6 and 5.6% in 7, after an estimated expansion of just.4% this year (the weakest performance since 9). Won has weakened in recent months but could easily strengthen if global outlook turns more positive the trade-weighted won has depreciated by more than 5% since May, reflecting concerns about Korea s high exposure to weaker China activity and the risk of turmoil in the Chinese stock market undermining global financial markets and further dampening regional trade. We also see the US Fed raising interest rates from September. The weakening in the KRW will provide some welcome relief for exporters but the won is still much less competitive than it was in. However, the large current account surplus and Korea s status as a regional safe haven means that the KRW could gradually appreciate over the medium term if the global outlook starts to turn a bit more positive. Korea: Government budget balance % of GDP F'cast % year Source: Oxford Economics Korea: Contributions to GDP growth GDP Net exports F'cast Source: Oxford Economics Korea: Exchange rates 5= less competitive more competitive Domestic demand v US$ v JPY v CNY Source : Oxford Economics / Haver Analytics 3

4 Risk Assessment The risks facing the Korean economy are expected to stay fairly stable over the medium term provided the global economy stages a steady recovery and China restrains North Korea from doing anything too reckless. CPI inflation is forecast to remain below the mid-point of the target range of.5-3.5%. The country s external position is also more solid than before the 8 global crisis, with a large current account surplus and a stable external debt ratio (with banks short-term debts considerably lower than in 8, albeit still sizeable). Our forecast for the oil price has been cut sharply over the medium term and this will bolster the current account surplus over the next few years. The economy has been supported by fiscal boosts in recent years but the scope for further sustained fiscal expansion is limited given the concern that one day the state might have to cope with the huge costs of unification if North Korea collapses. Emerging risks North Korea relations with the North are not quite as strained as in early 3 but the situation is still tense given the North s rocket and nuclear tests, its bellicose rhetoric and the uncertainty of dealing with a young and inexperienced leader who controls a huge army and stock of weapons. Financial strains while the economy grew at a reasonably robust pace in 3 and early 4, the expansion was quite narrow, led by the country s leading multinationals, while a large proportion of small and medium-sized firms continued to stagnate. As a result, many SMEs are still struggling to meet the heavy debt obligations they built up in the mid-s. Key risk scenarios Investment collapse in China the Korean economy has close trade and financial linkages with China. A standstill in Chinese investment would lead to lower trade flows and probably financial disruption; as a result, Korean growth could slow significantly in. US and EU upside surprise if oil prices were to drop further, to around US$45 per barrel next year, the strong fundamentals of the US economy would be reinforced, lifting global demand. With global growth reaching 4.% in 6 (against 3% in our baseline forecast), Korea would experience much stronger growth. Risk index (=no risk, =highest risk) World average Sovereign risk Trade credit risk Political risk Regulatory risk GDP growth CPI inflation Current account balance Government balance Government debt External debt - Risk warnings Risk scenarios Domestic activity still patchy despite substantial stimulus Inflation will stay well below target for some time Strong current account surplus a crisis buffer Uncertainty about N Korea limits fiscal flexibility Debt rising, but low relative to US, EU and Japan Banks have reduced external debt since the crisis Impact of scenarios on risk index Maximum impact of scenarios on risk index % year Investment collapse in China Disorderly Grexit Bond markets fright Orderly Grexit US disappoints US and EZ upside surprise Impact of scenarios on GDP growth Baseline Investment collapse in China Bond markets fright US and EZ upside surprise Source : Oxford Economics 4

5 Long-Term Prospects Growth will ease but fundamentals strong Notwithstanding the patchy performance of the economy over the past couple of years, retains a number of fundamental long-term economic strengths: Links with China though Chinese growth will not be as rapid as in the past, Korea s strong trading relations with China will help maintain the outlook for exports of both consumer and capital goods. Diverse export products and markets Korea has strengths in a wide range of manufacturing products and a presence in many key growth markets but must invest and innovate to remain competitive. However, also faces a number of longerterm challenges: Unproductive service sector despite some limited progress recently, the service sector remains relatively undynamic and unable to utilise fully the country s high education standards. Ageing population the working-age population will start to shrink in 7, and fall steadily thereafter. This will be a factor pushing growth down to % by. Korea: Working age population % year Label Working age population (5-64 years) Source: United Nations / Haver Analytics Potential GDP and Its Components Average Percentage Growth Potential GDP* 3.6. Employment at NAIRU. -. Capital Stock Total Factor Productivity..3 *ln(potential GDP)=.65*ln(Employment at NAIRU) +.35*ln(Capital Stock)+ln(Total Factor Productivity) Long-Term Forecast for Korea (Average annual percentage change unless otherwise stated) GDP Consumption Investment Government Consumption Exports of Goods and Services Imports of Goods and Services Unemployment (%) Consumer Prices Current Balance (% of GDP) Exchange Rate (per $) General Government Balance (% of GDP) Short-term Interest Rates (%) Long-term Interest Rates (%) Working Population Labour Supply Participation Ratio Labour Productivity

6 Background Economic development On the basis of IMF PPP data, Korea s per capita income relative to that of the US has risen from about 8% in 98 to 6% in 3. Prior to the Asian economic and financial crisis of , GDP growth was particularly rapid, growing by about 9% pa between 98 and 996. This strong growth was led by the manufacturing sector and focused on exports, so encouraging the use of the latest manufacturing techniques. In addition, there was an emphasis on raising education standards and skill levels across the whole labour force. However, growth in the last few years running up to 997 was inflated by excessive foreign currency borrowing by companies and massive over-investment, particularly of construction. The crisis was not only a shattering blow in the short term but also had major long-term repercussions, prompting the corporate sector to be much more cautious with regard to investment; in the investment share of nominal GDP was 7% compared with 9% in and 38% in 99. In the ten years to average GDP growth was a more modest 3.6%. Structure of the economy Although Korea s ratio of goods exports to GDP (49% in ) is relatively modest by regional standards, the exports are crucial to the performance of the overall economy. In seven of the ten years from 3 to, net exports contributed more than.7% points to annual GDP growth. The export outlook is also critical in determining business investment. This sensitivity to the global trade cycle was clearly shown by the plunge in activity in the final few months of 8 in response to the eruption of the global financial crisis and its numerous repercussions. The reliance on exports is also shown by the fact that in each of the last five years consumer spending has grown more slowly than overall GDP. Indeed, it is not since the early s that consumer spending growth has noticeably exceeded GDP growth, and that was associated with a disastrous consumer credit boom. Although the ending of the latter led to temporary deleveraging in 3 and 4, households dependence on debt rose sharply in the years before the global financial crisis and this pattern has persisted during the recovery (partly due to subdued income growth), with the debt to disposable income ratio rising from 6% in 4 to 38% in 7 and 55% in. In the years prior to the global financial crisis, much of the growth in investment was concentrated in a handful of very large and very successful export-oriented companies, while investment by small- and medium-sized companies lagged far behind. This pattern of growth discouraged policymakers from making further efforts to ensure that the country s chaebol companies did not exert too much power over the whole economy for fear that such moves might dent investment and export growth. However, the presidential campaign of late was marked by calls for economic democratisation effectively the reduction of the economic and political power of the largest corporations. As a result, some reforms in this area in the next few years seem inevitable. In, agriculture (including fishing) accounted for just.7% of GDP (gross value added), compared with construction s 5.8% share (down from over % in the mid-99s), and manufacturing s 3.%, with the remaining 6.4% coming from services, mining and utilities. Balance of payments and structure of trade The country s goods export trade is overwhelmingly centred on manufactured products, although it has a much wider spread of export manufacturing sectors than many of its neighbours. In, merchandise exports totalled US$548bn. Of these exports, autos and auto parts accounted for 3.%, petroleum products.3%, semiconductors 9.%, general machinery 8.8%, petrochemicals 8.4%, ships 7.%, steel 6.7%, LCD devices 5.%, telecoms 4.% and textiles.8%. Meanwhile, exports of services totalled US$bn in, with US$4bn of that coming from credits for transportation services and US$4bn from travel. By contrast, the import structure is very skewed towards industrial materials, fuels and semi-manufactures (64% of total imports in, with 35% of the 6

7 total accounted for by crude oil and other fuels), whereas the import of finished goods is quite modest (reflecting the country s competitiveness in many manufacturing sectors and consumers preference to buy Korean goods in many cases). In addition, over 4% of imports are used as inputs for export manufacturing. Another significant development has been the country s ability to benefit from the rise and rise of China s economy. In, Korea s exports to China and Hong Kong represented 6.9% of all merchandise exports (sales to the US in that year were.8%) but in this combined share had risen to 3.5% (and that to the US shrunk to.7%). And while clearly a lot of the country s exports to China are used as components in exports to the US and EU, a significant share is dependent on Chinese domestic demand such as investment machinery, ships and cars. Adverse popular reaction to the sale of Korean companies to foreigners, together with a lack of liberalisation in the service sector, has led to generally quite low FDI inflows during the last decade, nearly US$5bn in and, significantly lower than annual FDI outflows of about US$bn. Policy Given the concern that North Korea could suddenly unravel, leaving the South with an enormous unification burden, the authorities have traditionally run a conservative fiscal policy. This meant that they had plenty of scope to initiate a large fiscal boost in response to the global crisis at the end of 8. Notwithstanding the latter, general government debt was only 35% of GDP in Q4. The central bank has followed an inflation targeting system since 998. In -, the Bank of Korea targeted 3% CPI inflation in a tolerance range of +/-% around this target. However, the target for 3-5 has been narrowed to 3% +/-.5%. Prior to the global crisis, the authorities intervened very heavily in the foreign exchange markets to limit the appreciation of the KRW (and so avoid the export sector becoming uncompetitive). However, the KRW fell very sharply against the US$ during 8 and has yet to recover fully its losses whereas the Chinese, Japanese and Taiwanese currencies are all stronger against the US$ than they were in 7, so the overall threat to Korea s competitiveness is relatively modest despite the ongoing strengthening of the KRW against the yen. Politics Economic development in in recent decades has not been undermined by the proximity to North Korea s military power. However, fear of uncontrolled change in North-South relations was a key factor behind President Kim Dae-Jung s sunshine policy towards the North, which started in and was continued by his centre-left successor, Roh Moo-hyun. Their emphasis was on trying to encourage the North to take small steps towards a more market-oriented economy, with the hope that these changes would gradually build a momentum of their own and would enmesh the North in a web of peaceful trade. This policy achieved little, with the North making only making very modest economic changes and instead focusing a large proportion of its resources on a nuclear programme, conducting its first nuclear weapons test in October 6. The North s nuclear programme increased the pressure on the international community to get more involved and some progress in the six-party nuclear talks (South and North Korea, the US, Russia, China and Japan) was achieved during 7 when a roadmap for the disabling of the North s core nuclear facilities was agreed. However, while some of the elements of this agreement have been carried out, the North s behaviour has remained hostile perhaps in response to the firmer line taken on North-South relations by the South s President Lee Myungbak of the centre-right GNP party. During 9- there was a marked escalation of cross-border and regional tension as Pyongyang tested long-range missiles, conducted a second nuclear weapons test, then (most probably) sank a n warship in March and shelled an island in the South in November. The death of the North s leader, Kim Jong-il, in December and his replacement by his inexperienced son, Kim Jong-un, has further ratcheted up the tension on the peninsula, although the South will continue to hope that China can exert some checks on the North. However, despite pressure from China, the North has conducted another nuclear weapons test. 7

8 Data & Forecasts Key Indicators: Korea Percentage changes on a year earlier unless otherwise stated Industrial Unemploy- CPI Equipment Exports Imports Trade Wholesale & production ment Investment US$ US$ balance retail sales (s.adj.) s.adj. % (US$ mn) volume Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Financial Indicators: Korea Percentage changes on a year earlier unless otherwise stated 3mth int. Money Exchange Exchange Exchange Share Reserves Imports rate Supply rate rate rate price Cover % (M) Won/ avg. Won/$ avg. Won/Yen avg. US$ Bn Months Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

9 SOUTH KOREA TABLE SUMMARY ITEMS Annual Percentage Changes, Unless Otherwise Specified CONSUMERS TOTAL TOTAL REAL INDUSTRIAL UNEMPLOY- AVERAGE WHOLE COMPETIT- PRODUCER CONSUMER EXPENDITURE FINAL FIXED GDP PRODUCTION MENT RATE EARNINGS ECONOMY IVENESS PRICES PRICES EXPENDITURE INVESTMENT (%) PRODUCT- (8=) IVITY (C) (TFE) (IF) (GDP) (IP) (UP) (ER) (GDP/ET) (WCR) (PPI) (CPI) YEARS BEGINNING Q I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV COPYRIGHT (C), OXFORD ECONOMICS SOUTH KOREA TABLE SUMMARY ITEMS TRADE CURRENT CURRENT GOVERNMENT GOVERNMENT SHORT-TERM LONG-TERM REAL REAL EXCHANGE EXCHANGE BALANCE ACCOUNT ACCOUNT FINANCIAL FINANCIAL INTEREST INTEREST SHORT-TERM LONG-TERM RATE PER RATE PER (WON BN) (WON BN) (% OF GDP) BALANCE BALANCE RATE RATE INTEREST INTEREST US YEN (WON BN) (% OF GDP) RATE RATE DOLLAR (BVI) (BCU) (BCU* (GB) (GB* (RSH) (RLG) (Note ) (Note ) (RXD) (RXYEN) /GDP!) /GDP!) YEARS BEGINNING Q I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV Note : REAL INTEREST RATES = Nominal interest rate (RSH or RLG) - % change in CPI COPYRIGHT (C), OXFORD ECONOMICS 9

10 Long-Term Forecast for Korea Annual percentage changes unless otherwise specified GDP Consumption Investment Government Consumption Exports of Goods and Services Imports of Goods and Services Unemployment (%) Consumer Prices Current Balance (% of GDP) Exchange Rate (per $) General Government Balance (% of GDP) Short-term Interest Rates (%) Long-term Interest Rates (%) Working Population Labour Supply Participation Ratio (%) Labour productivity Employment Output gap (% of potential GDP)

11 Key Facts Politics Head of state: President PARK Geun-hye Head of government: Prime Minister HWANG Kyo-ahn Political system: Democracy Date of next presidential election: December 7 Date of next legislative election: April 6 Currency: n won (KRW), floating exchange rate Long-term economic & social development * GDP per capita (US$) Inflation (%) Population (mn) Urban population (% of total) Life expectancy (years) Source : Oxford Economics & World Bank Structure of GDP by output * 4 or latest 4 available year Agriculture.3% Source : CIA Factbook Industry 38.% Location: Eastern Asia, southern half of the Korean Peninsula Services 59.4% bordering the Sea of Japan and the Yellow Sea (CIA Factbook) Source : World Bank Long-term sovereign credit ratings & outlook Corruption perceptions index 4 Foreign currency Local currency Score Fitch AA- (Stable) AA (Stable) Developed economies (average) 75. Moody's Aa3 (Positive) Aa3 (Positive) Emerging economies (average) 37.8 S&P A+ (Positive) AA- (Stable) 55. Structural economic indicators * Current account (US$ billion) Trade balance (US$ billion) FDI (US$ billion) Govt budget (% of GDP) Govt debt (% of GDP) Long-term interest rate Source: Transparency International Scoring system = highly clean, = highly corrupt Composition of goods & services exports, 3 Other goods exports.3% Transportation 5.4% Oil production ( bpd) Oil consumption ( bpd) Source : Oxford Economics / World Bank / EIA Destination of goods' exports (3) China 6.% United States.% European Union (8) 8.8% Japan 6.% Hong Kong, China 5.% Source : WTO Source : WTO Manufactures 7.6% Fuels and mining products 9.7% Travel.% Other commercial services 9.% Agricultural products.8%