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InterviewsSeptember 1 2011

South Korea's shifting economic focus

With the second highest debt-to-disposable income ratio in the world, the South Korean economy might appear to be in trouble. But Choongsoo Kim, governor of the Bank of Korea, insists that the country’s financial system is not at risk, and suggests that balancing the focus between export and domestic demand will lead to sustainable economic growth.
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South Korea's shifting economic focus

Q: To what extent is South Korea affected by shocks in the global economy?

A: To answer this question, you have to look at how Korea is trading with the rest of the world. Until a decade ago, the US was the number one trading partner with Korea, and Japan and Europe were our other major trading partners. Now, however, the situation is quite different, as we have diversified. China has become our number one trading partner, number two is the Association of South-east Asian Nations, third is Japan, fourth is the EU, which is followed by the US and Latin America.

Even though China is our number one trading partner, I personally pay more attention to the economy of the US. Why? Since we are trading with countries whose economies are very much affected by the state of the US economy, we pay more attention to the indirect effects of trade rather than to its direct effects.

Second, we focus on Europe. We depend heavily on capital from abroad, and Europe is our number one foreign capital investor. This is perhaps different from most people’s expectations as they would probably think that the US or Japan would invest more.

We are also paying attention to countries such as Greece, not because of our trade with Portugal, Italy, Greece and Spain, but because of the indirect effects it has on capital flows between Europe and Korea.

Third, we pay attention to the economic state of China. Both Korea and China have the same policy concerns, as we both suffer from rising inflation. In China the Consumer Price Index (CPI) year-on-year growth was 6.5% in July 2011. And in Korea, in July 2011, we experienced CPI year-on-year growth of 4.7%. For both countries, the actual CPI rate is higher than the policy objectives and we have both made efforts to control rising inflation.

Q: How worried are you about the level of household debt in South Korea?

A: I am not worrying about it in the sense that it will evolve into a crisis immediately. The household debt problem is a serious policy concern, but it is to a certain extent manageable. Because this problem did not happen overnight, there is no panacea, and we may have to endure some difficult times to cope with it. The debt-to-disposable income ratio is about 150%, the second highest in the world after the UK. To explain why we are not overly concerned, we can look at the debt problem from two different perspectives.

One involves whether the financial system will be at risk because of it. Because the Korean government introduced strict regulations on lending, particularly on housing loans, the loan-to-value ratios are very restrictive, averaging only 47.1%, which is low enough to keep our financial institutions sound and prevent systemic risk.

The second perspective is the ability of households to pay back their debt. In the case of Korea, about 87% of household debt is held by people whose incomes are in the top 60% bracket. Therefore, people with low incomes – those most likely to struggle in meeting their obligations – do not have much household debt. In Korea, household debt is usually secured against collateral, which people on a lower income typically do not have when applying for mortgages.

From both these perspectives, therefore, we will not face such a serious problem. However, this does not mean that there is no problem at all. Nor do I pretend that there is a simple solution; this will take a long time to solve.

Q: Is your priority to focus on domestic demand or exports?

A: Until now, particularly in overcoming the global financial crisis, the exports sector has played a leading role, but I do not think such a pattern will continue. Policy attention must be paid to monitoring the balance between exports and domestic demand for several reasons.

One important reason is that, even though there has been growth in the export sector, employment does not necessarily follow, as employment is usually created by the domestic sector. Thus we have to pay attention to boosting domestic demand.

Another reason is that the trickling down effect of exports is not as strong as in the old days. There is no guarantee that small and medium-sized enterprises will benefit from the export sector. And so it is important to maintain the balance between exports and domestic demand; otherwise economic growth cannot be sustained.

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