South Korea’s economy has bounced back strongly from the pandemic slump, thanks largely to its dominance of the semiconductor space. Yet with a presidential election on the horizon and further interest increases forecast, there is still some uncertainty as to future growth potential. Kimberley Long reports.
South Korea showed strong gross domestic product (GDP) results at the end of 2021. The fourth quarter saw 1.1% growth, taking the full year GDP growth to 4%, marking the fastest rise in 11 years. Exports grew by 4.3% during the quarter, but imports also grew by a comparable level, meaning a weak lift in net trade income. Meanwhile, private consumption grew by 1.7%, while construction investment increased 2.9%. The service sector grew by a comparatively low 1.3%.
The results are creating some optimism for continued expansion. Overall, the Bank of Korea (BOK) is forecasting the economy to grow by 3% during 2022. There are, however, issues to be worked out, not least from the Covid-19 pandemic, to ensure the economy reaches this target.
Alex Holmes, Asia economist at Capital Economics, says: “Exports have been really strong and are now about 8.5% above pre-pandemic levels. Meanwhile, government spending is around 10.5% higher. Investment is about 2.3% above, so lagging behind its pre-pandemic trend somewhat. The main weak spot of the economy is private consumption, which is still below pre-crisis levels. Despite Covid-19 restrictions being rolled back, people are still avoiding entertainment, recreation and hospitality venues.”
Semiconductor dominance
The manufacturing space has proven resilient for South Korea. The global shift towards working from home during the pandemic was an unexpected boon. The move led to an increased demand for all forms of computing technology, which has put pressure on the supply chains for component parts. With South Korea being the world’s biggest manufacturer of semiconductors, the country is racing to keep ahead.
Jeremy Zook, director of sovereigns at Fitch Ratings, says: “We expect demand on semiconductors to remain high as there is such a shift towards digitisation globally. There is a lot of pent-up demand and back orders in the sector too, which need to be met. We do expect export growth to taper off, but the exports themselves should remain resilient and around current levels.”
“The semiconductor industry represents around 7% of GDP — a large part of the economy,” Mr Holmes explains. “The government has tried to bolster the semiconductor industry. Last year it announced measures to support growth of the sector against the backdrop of supply shortages and growing competition from China.”
These measures took the form of Won510tn ($425.9bn) investments through 2030, led by manufacturers Samsung Electronics and SK Hynix, to create what South Korean president Moon Jae-in called a ‘semiconductor powerhouse’. The finance ministry announced it would raise the tax deduction ratio for semiconductor research and development investments from 30% to 40% to spur innovation and growth.
The dominance of the semiconductor sector has overshadowed South Korea’s other manufacturing sectors. Jeong Woo Park, chief economist for South Korea at Nomura Securities, says South Korea used to have strong petroleum, shipbuilding and chemicals industries, but they are all being impacted by structural changes.
“The auto industry is very important due to its huge labour force and the impact on so many small companies,” he says. “But this industry is also undergoing structural changes as more people move towards buying electric vehicles. Although the companies are taking steps towards these changes, I am cautious about how well prepared they are.”
However, there are plans to help encourage other aspects of the manufacturing sector. Shahana Mukherjee, economist at Moody’s Analytics, says: “Given the robust global demand and the strong outlook for this sector, we expect significant investment in this sector to continue in 2022, supported by a greater focus on developing new-energy vehicles and biohealth technology — part of the ‘Big Three’ industries. The government has expanded its support to these sectors by substantially increasing the budget allocated to them for the current financial year, and will likely provide more incentives to encourage investment.”
Given the robust global demand and the strong outlook for the [manufacturing] sector, we expect significant investment in this sector to continue in 2022
Slow domestic growth
The area of the economy which remains stubbornly low is domestic consumption. Ongoing social distancing measures to curb the spread of Covid-19 have impacted the service sector. At the time of writing, restrictions included a 21:00 curfew for restaurants and a limit of six people at private gatherings. The prime minister Kim Boo-kyum (in South Korea, the prime minister is the principal executive assistant to the president) extended the measures for two weeks amid concerns that the spread of the Omicron variant may have been amplified by the Lunar New Year celebrations. However, the country has high vaccination rates, with around 86% of the population fully vaccinated, and 54% having received a booster shot.
Chong Hoon Park, head of economic research for South Korea and Japan at Standard Chartered, says there is a need to see an uptick in activity in the hard-hit service sector for there to be a possibility of growth: “If activity levels continue at their current rate, the first-quarter [2022] results are going to be quite low. We hope this will improve as we move into spring.”
In part, recovery depends on whether consumers decide to spend the funds they have accrued over the past two years. “During the pandemic, there has been a huge rise in precautionary savings,” Mr Holmes says. “The savings ratio has started to drop back a bit, but it has not unwound its spike yet. As life returns to normal again, people should start to spend these funds, which would boost the economy.”
The move from the government from measures to stop the spread of coronavirus towards a focus on minimising the disruption caused by the virus may help with boosting domestic consumption. Steps towards normalisation had been taken at the beginning of November 2021, but were quickly reversed with the arrival of the Omicron variant, which has seen Covid-19 cases in the country rise to more than 50,000 per day.
However, any increase in spending may be muted. Mr Holmes says: “Consumer spending is likely to be impacted by rising interest rates — South Korea’s high level of household debt means consumption is sensitive to any change in borrowing costs.”
Ms Mukherjee says there is a sense of urgency from the BOK’s board to tackle inflation pressures over the uncertainties the ongoing pandemic is placing on domestic recovery. “January’s headline inflation remained uncomfortably high at 3.6%, while core inflation gained pace,” she says. “With energy prices staying high, the pandemic-related uncertainty to global growth yet to settle and geopolitical developments likely to sustain the near-term volatility in oil prices, the potential for cost pressures and inflation to remain at over 3% in the coming months is high. We see this as one of the main drivers that could lead to further rate hikes in 2022.”
Rising interest rates
The BOK announced it was increasing the benchmark policy rate back to pre-pandemic levels of 1.25% in January 2022. The rise was the third in six months, after a hike in August 2021 made it the first Asian economy to increase rates since the start of the pandemic. Rising inflation spurred the BOK into action, with consumer inflation for the whole of 2021 reaching 2.5%.
Ms Mukherjee says the move signals the BOK’s “intent to tame inflation pressures and the build-up of financial imbalances in the interest of long-term financial stability. The rate increases are also indicative of policy-makers’ confidence in the strength of the economic recovery.”
Nomura Securities’ Mr Park adds: “The BOK committee members have said they are worried about high inflation in South Korea. This has been driven by high oil prices, but it is spilling over into other products.”
An area that has been causing concern for some time is the housing market. Prices rose by 11.98% between January and September 2021, marking the biggest price rise in 15 years. As a result, the number of residential property transactions dropped by 62% during December 2021. At 53,774, this was the lowest number of transactions since 2008, following the global financial crisis.
“The housing market has been running hot for some time, but there are some signs that it has started to tail off in the December 2021 data,” says Mr Holmes. “It is hard to tell if this is just down to the increase in interest rates. Household loan growth has also slowed a bit, but it is too early to tell if this is a trend.”
Opinion is split on what the BOK will do next. Mr Holmes says the BOK is expected to make three more 25 basis point (bps) rate hikes this year, taking the policy rate to 2% by the end of 2022. Meanwhile, Mr Zook says Fitch expects two more 25bps hikes this year, but for it to be held at this level during 2023.
“While the BOK is reducing the level of accommodation in the economy, it doesn’t necessarily want to get to a point where monetary policy is considered tight. We estimate a neutral rate at around 1.75% to 2%,” Mr Zook adds.
However, Nomura Securities’ Mr Park says they hold the non-consensus view on monetary policy: “The BOK will likely focus more on growth as the new government also will want to boost the domestic economy. So, in line with the new government’s economic policy (construction is one of the main area which the government can boost through its fiscal measures), I expect the BOK to keep interest rates at the current level of 1.25%.”
The responses of the government and the central bank have been pulling in different directions for some months.
Standard Chartered’s Mr Park says: “The BOK has been very hawkish since August 2021. On the other hand, the government has been really expansionary, adding around Won50tn to the budget to boost the economy in 2021. But they collected more than Won603tn in tax. Even though they were expansionary, it was financed by the tax revenues.”
He does not believe that policy can diverge much further: “The BOK is very concerned with inflation in the first half of 2021, but it will be more concerned with growth toward the second half of the year. In the second half of 2022 it is likely that monetary and fiscal policy are aligned to support the growth.”
Presidential election
The next steps for the economy lie in the outcome of the presidential election, scheduled to be held on March 9, 2022. The election will see current president and leader of the Democratic Party of Korea (DPK) step down after completing his five-year term. This election will see Lee Jae-myung of the DPK go up against Yoon Suk-yeol of the current opposition party, the conservative People Power Party. The polls have been tight throughout the campaign, which has been dogged by scandal and the unpopularity of the two main candidates.
Despite this, the elections have not caused an economic hit. “At present, it is hard to pick out the impact the elections are having on sentiment amid the impact of Covid,” Mr Holmes says. “But it is fair to say the elections will be consequential for the economy. The opposition party is likely to rein in the loose fiscal policy of recent years. Under President Moon, government spending as a percentage of GDP has gone from 18% in 2017 to 28% in the 2020 budget.”
Standard Chartered’s Mr Park says the winner will influence the country’s geopolitical stance. He says: “If the opposition party wins the presidential election, I think there will be some conflict between South Korea and China, as South Korea is more inclined towards the US and could create discomfort with China. I think it is unlikely, but we can rule out the situation with North Korea’s aggressiveness that can also have an impact on the financial markets and the foreign outflow.”
There are issues closer to home that the new president will have to deal with. Nomura Securities’ Mr Park foresees a rise in fiscal spending, regardless of the winner, due to the country’s ageing population. Figures from Statistics Korea show that in 2021, people aged over 65 made up 16.5% of the population. The issue is a long-term one for the country, as, coupled with the declining birth rate, the report suggested the over-65s could account for 43.9% of the population by 2050.
Responding to the continued high prices in the housing market may also be an important policy. Nomura Securities’ Mr Park believes there could be an intervention. “The current government is aiming to stabilise the housing market to gain political support. The opposition party does not like using rate policy for the housing market and think the government should increase housing supply.”
However, drastic changes to South Korea’s economic plans are unlikely, regardless of the outcome of the election. “We think the election result won’t affect the South Korean economy, as the country has a strong tradition where economic policy has been driven by government technocrats,” Standard Chartered’s Mr Park adds.
