Economics Korea: Moon s first days DBS Group Research 7 August 7 Moon is pursuing a set of policies pledged during the election A supplementary budget and minimum wage hike have boosted hopes for growth in 7-8 But corporate profitability, a slowdown in the property market, rising public debt and inflation remain risks to watch Relations with China and US have remained stable under the new government. North Korea remains a key source of uncertainty About days have passed since President Moon Jae-in took office. Domestic policies have been pushed forward in the direction of boosting incomes and reducing inequality, in line with campaign pledges. External / foreign relations have remained stable despite the uncertainties related to North Korea. Moon s approval rating has stayed high at about 8% according to Gallup surveys. Income-led domestic policies The centerpiece of Moon s domestic policies is to boost household incomes and reduce economic / social inequality. A KRW trn supplementary budget that focuses on jobs and social welfare was put forward immediately after his inauguration in June. The budget received parliamentary approval at end-july. A tax reform plan that involves tax hikes for large companies and high-income earners was announced in August. Key points include raising the corporate tax rate to 5% from % for companies with annual profits exceeding KRW bn, and raising the income tax rate to % from % for individuals with incomes over KRW 5mn per year. This bill will be submitted to the parliament for approval in September. Meanwhile, the government has also made decisions to hike wages. The minimum hourly wages will be raised by 6.% to KRW 7,5 from next year. This is in line with Moon s election pledge of raising minimum wages to more than KRW, by (5.6% YoY). Finally, the government has announced two rounds of property market cooling measures since June. During the latest round, Seoul and two other cities were designated as overheated speculative zones. Multiple-home owners in the selected areas will be required to pay an additional -ppt capital gains tax when selling homes (pending parliamentary approval). The loan-to-value ratio and debt-toincome ratio will also be lowered to %, from 6% and 5% respectively. Positive impact on consumption: The income-led policies are expected to spur consumption. The supplementary budget will directly create jobs in the public sector and improve the social safety net (e.g., subsidies for young job seekers and the elderly). The minimum wage hike, meanwhile, will benefit the low-income earners. Note that low-income households tend to have a relatively high propensity to Ma Tieying (65) 6878-8 matieying@dbs.com Refer to important disclosures at the end of this report.
Chart : Unit labor costs: manufacturing = Chart : Construction investment % ppt, YoY. Contribution to GDP growth.5..5. 9 -.5 8 5 5 -. Q Q Q Q Q Q5 Q6 Q7 consume. And consumption (private plus government) accounts for a dominant 6% of GDP. The government estimates the supplementary budget will lift GDP growth by. percentage points this year, and that the minimum wage hike will lift growth by an another.ppt in 8. Accordingly, the finance ministry now expects % GDP growth in 7 and 8. The Bank of Korea hasn t taken into account the impact of fiscal stimulus and currently projects GDP growth of.8% this year and.9% the next. Chances are high that the BOK will also upgrade forecast at October s meeting. Pressure on the corporate sector: Moon s policies mainly focus on household incomes / benefits. Some measures come at the expense of the corporate sector. Wage hikes, for instance, will add to companies costs. Small firms may not be able to fully pass on the wage costs to consumers, due to the concerns about competition and market shares. Note that total wages have increased by.% (YoY) on average during -6, while labor productivity was nearly stagnant. As a result, unit labor costs in the manufacturing sector have risen persistently over the past six years (Chart ). Without a catchup in productivity, faster wage growth ahead would mean more pressure on unit labor costs. Tax hikes and tighter regulations on chaebols also have negative implications for the corporate sector. These measures would dampen the incentives to invest among large companies, before unleashing opportunities for the SMEs. The top companies including Samsung, Hyundai and LG, whose annual profits well surpassed KRW bn in 6, will be affected by the proposed revision in corporate tax rates. Property market slowdown: A slowdown in the property market is another possible side-effect. The August round of property cooling measures is widely seen as the toughest since. Higher capital gains tax and stricter lending rules may help to curb the speculative demand in the property market, and thereby, stabilize housing prices. This may also help to rein in the excessive expansion in household debt, which has reached an all-time high equivalent to 96% of GDP. But economic growth may be affected. The construction sector has been an important growth driver in the past - years. In H7 alone, construction investment contributed.5ppt to GDP growth (Chart ). A slowdown in this sector could have a noticeable impact on the broader economy. Public debt expansion: A rise in public debt is also a concern. The 7 supplementary budget doesn t require debt issuances as it will be mainly funded by the excess revenues expected for this year (KRW 8.8trn). Indeed, the government has achieved above-target revenues for the first time over four years in 6 (.%).
Chart : Net fiscal balance (scenarios) % of GDP. -. Chart : Housing rents & CPI inflation % YoY Housing rents CPI 6 -. -. -. Spending growth Nominal GDP ) 6.%.5% ) 6.% 5.% ) 6.% 5.5% 5 7F 9F F 8 - -8 Jan- Jan- Jan-7 Jan- Jan- Jan-6 Tax collections in H7 also appear strong. Assuming a higher realization ratio of % this year, total revenues will exceed the budget target by KRW 8.trn, roughly enough to cover the supplementary budget. But debt financing is likely to be required next year. The 8 general budget, according to the preliminary requests from government offices, will take total expenditures to a record high of KRW.5trn (6% YoY). The basic principle set by the finance ministry is to manage the growth of fiscal spending faster than that of nominal GDP in the next five years. Under various assumptions, we reckon that the net fiscal deficit will widen to KRW 5-7trn (.5-.5% of GDP) in, compared to some KRW trn this year (Chart ). Selective tax hikes on large companies and high-income earners won t be enough to cover the shortfall. The current proposal of tax reforms will only generate additional revenues worth KRW 5.5trn per year. Additional financing will be required and an expansion in public debt appears inevitable. Rise in inflation and interest rates: Inflation risks brought by the new government s new policies are non-negligible. Fiscal policy expansion could easily boost inflation given the economy is already growing close to its potential rate of % and the output gap is nearly closed. Wage hikes will add to inflation risks as companies may pass some of these costs onto consumers. The scheduled 6% hike in minimum wages for next year will be the biggest since. The hike is expected to affect.6mn workers and thus boost total wages by -%. Assuming a passthrough rate of %, CPI inflation would rise by some.5ppt in 8. Property cooling measures may help to stabilize housing prices / rentals but the impact on inflation should be limited. Only housing rentals are captured in the CPI statistics and the share is a small 9%. Note also that housing rents have never declined over the past decade, save for the tightening period in 5 and the global financial crisis in 8/9 (Chart ). The BOK currently forecasts inflation to rise to.9% this and next year. There is a risk that actual inflation exceeds the BOK s % target in 8, which could trigger rate hikes. Bond yields will also face upward pressures as inflation / inflation expectations increase. External relations External relations with major countries have remained stable under the new government. Ties with China were supported by Moon s efforts to slow the deployment of THAAD since taking office. On the other hand, the president made the
Chart 5: Tourist arrivals: China thou, persons, 9 8 7 6 5 Jan- Jan- Jan- Jan-6 Chart 6: Bilateral trade with the US USD bn 8 7 6 5 Trade surplus Exports to US Imports from US Jan- Jan- Jan-5 Jan-7 first overseas visit to Washington, reassuring the US about cooperating on key political / economic issues. Korea s tourism sector, which has been hit most badly by Beijing s retaliation measures on THAAD, has showed some signs of stabilization. The number of Chinese tourists visiting Korea stayed stable at 5k per month in May-June, after plunging by 6% at the start of this year (Chart 5). Admittedly, the US still insists on renegotiating a bilateral free trade agreement with Korea, and keeps the KRW on the watch list for unfair currency practices. That said, the Korea-US trade surplus has narrowed noticeably this year thanks to greater Korean imports (Chart 6). Should Moon s income-led policies successfully boost domestic demand, Korea s external surplus would narrow further, helping to sooth trade tensions with the US. Issues related to North Korea remain. Moon favors a soft line towards the North and calls for diplomatic approaches to defuse recent tensions. But Pyongyang s continued missile tests have resulted in new sanctions imposed by the United Nations. Given the higher-than-usual tensions between North Korea and the US, developments on the Korean peninsula need to be watched more closely than usual. Sources: All data are sourced from CEIC, Bloomberg. Transformations and forecasts are from DBS Group Research.
Recent Research IN: strong rupee raises questions 7 Aug 7 Rates: global rates roundup Aug 7 FX: USD is becoming oversold Aug 7 CN: has go global gone into reverse? Jul 7 ID: playing catching up Jul 7 CNH: bond connect tracker 7 Jul 7 TW: a temporary pause Jul 7 FX: steady ECB, stable EUR Jul 7 VN: stability is key 6 Jun 7 IN: GST set for kick-off Jun 7 TH: the deleveraging drag Jun 7 US: a mulish consistency Jun 7 SGS: carry environment Jun 7 IN: window opens for a rate cut 9 Jun 7 CN: more monetary flexibility 9 Jun 7 PH: to lead hikes in ASEAN 5 Jun 7 JP: BOJ s exit will take time Jun 7 Qtrly: Economics-Markets-Strategy Q7 8 Jun 7 Global: on sentiment, cycles and 6-year Jun 7 track records EZ: ECB not ready yet May 7 CN: reality check 6 May 7 IN: RBI on the defensive 6 May 7 KR: after the election May 7 US: unwinding QE May 7 FX: USD s hopes Trumpled May 7 IN: time for an upgrade? 8 Apr 7 Rates: global rates roundup 5 Apr 7 TW: Trump and Taiwan, revisited Apr 7 ID: stronger rupiah a boost Apr 7 CNH: room to loosen controls Apr 7 IN: watching state finances Apr 7 SGD: neutral for a long time to come 7 Apr 7 SGS: FX tailwind at the limit 7 Apr 7 IN: structural tailwinds to add to cyclical Mar 7 upswing KR: is optimism justified? 9 Mar 7 IN: monetary policy on cruise control 7 Mar 7 TH: narrower C/A surplus a plus Mar 7 SG: ensuring fiscal sustainability Mar 7 Qtrly: Economics-Markets-Strategy Q7 9 Mar 7 Asia: Trump and the state of US-Asia trade 7 Mar 7 CN: the rise and rise (and rise) of the RMB Feb 7 ID: next move is a rate hike Feb 7 SG budget: building the future economy Feb 7 CN: what to watch for as PBoC tightens Feb 7 SG: upgraded Feb 7 TW: Trump s policies and Taiwan 5 Feb 7 Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts and tables are CEIC and Bloomberg unless otherwise specified. DBS Bank Ltd., Marina Blvd, Marina Bay Financial Center Tower, Singapore 898. Tel: 65-6878-8888. Company Registration No. 9686E. 5