After growth, Korea struggles with an exit

[News Analysis] Experts say the stimulus package - though it helped boost the GDP growth rate - did not translate into improving the fundamental employment situation.

Sept 29,2010
This month marks the second anniversary since the world was sucked into one of the worst economic meltdowns since the Great Depression.

For Korea, since losing over 3 percent of its GDP to the crisis, the economy has excelled compared to other major economies, largely buoyed by the government’s decisive response.

This is significant, since Korea’s economy has been, and is still, heavily dependent on the global economy.

Immediately after the U.S. financial market seized up with the collapse of Lehman Brothers and the subprime mortgage market, Korean corporations followed their global peers into a downward spiral.

In 2008, Korea’s GDP, stock market index and exports all took a nosedive.

Korea’s economy in the last three months of 2008 fell 3.3 percent from the previous year. The economic contraction continued until the second quarter of 2009.

Mirroring the overall economy, the floor fell out of the stock market, as it collapsed to the 900-point mark from over 1,800 earlier in the year.

Exports, which had been enjoying a double-digit expansion every year since 2003, saw the growth of outbound shipments slow to 9.9 percent in the last three months of 2008. Exports dropped 20 percent the following year.

A fast response

Responding to the crisis, the government quickly created an emergency economic team.

The Korean government was one of the first in the world to introduce a stimulus package. The package included infrastructure development projects in an effort to create jobs.

To help soften the negative impact of the recession on the job market, the government promoted so-called “job-sharing” programs, which encouraged employers to reduce workers’ hours in lieu of laying them off.

The same year, Seoul implemented a scheme to get recent university graduates into workplaces as interns. According to the scheme, corporations were responsible for only half of the interns’ wages, while the central government picked up the tab on the other half.

As a result, Korea was able to report positive growth of 1 percent on-year in the third quarter of last year. Since then, the Korean economy has seen strong growth, which surged to 8.1 percent in the first three months of this year and 7.2 percent in the following quarter.

This is the fastest recovery among OECD countries.

Is Korea ready for a exit strategy?

Some experts say that Korea is already late in the game compared to other countries such as China.

Additionally, they say extending the current loose monetary policy will likely harm the economy further down the road.

Ahn Soon-kwon, a macroeconomic researcher at the Korea Economic Research Institute, in a recent report insisted that actual profits gained from maintaining a low interest rate are less than the general perception.

Ahn said the average household loses more from lower deposit interest rates than they gain from less interest payments on loans.

But more critical is the possibility that the restructuring of insolvent companies will not be executed properly if loose monetary policy continues for an extended period.

If that were to happen, he said, the nation’s economy would be in jeopardy.

Ahn said that now is the time to normalize interest rates.

The government’s budget plan hinted that Seoul might be heading for an exit strategy.

Next year’s revenue is forecasted to be higher, while spending has been cut, particularly in government-financed infrastructure projects.

But experts are not interpreting the move as part of an exit plan.

Bae Min-geun at LG Economic Research Institute said that the government’s plan to reduce fiscal spending is hard to interpret as a full-scale retrenchment policy.

Rather, it is a move to improve the government’s fiscal soundness, which has been rapidly deteriorating because of increased spending since the onset of the global downturn.

Confusing signals

Minister of Strategy and Finance Yoon Jeung-hyun has repeatedly opposed the possibility of raising interest rates, citing instability in the global market.

In fact, according to a recent Bloomberg report, several central banks are considering extending stimulus measures adopted during the 2008 crisis or could introduce new stimulus plans, as the global economic atmosphere looses its upbeat momentum. Such central banks include the U.K. and Switzerland.

The Korean central bank, on the contrary, has been at odds with the finance minister over exit planning.

BOK Governor Kim Choong-soo since July has been citing rising inflation pressure, as real GDP is rapidly narrowing the gap with potential growth trends.

The unexpectedly fast economic recovery has been raising cost pressures on consumer products as demand continues to expand.

He added that inflation pressure will only increase once public utility bills go up later this year.

The market took his comments as a signal of an exit strategy. Kim even admitted that the current interest rate level was abnormal.

Earlier this month, Kim said the central bank was taking steps to normalize policy rates even though he unexpectedly froze the basis rate.

The BOK governor insisted that by raising the rate in July, he signaled that the central bank intended to normalize the economy.

“But, it is not appropriate to give details on when that timing will be,” Kim stressed.

Undoubtedly, Korea is in a dilemma.

If the government initiates retrenchment policies by raising the benchmark interest rate, it could cause economic growth to slow down.

On the other hand, if the government continues to expand fiscal spending, the deficit will continue to increase and the economy will suffer from inflation down the road.

This is a scenario that southern Europe knows all too well.

Large-scale stimulus packages - and doubts on the countries’ ability to make payments - drastically reduced their sovereign debt ratings.

But the Korean government claims its fiscal soundness is in the safe zone.

Can Korea withstand another blow similar in scale to the 2008 global crisis?

Although the possibility of another tsunami-like economic crisis is unlikely, economists are rising red flags on issues they say demand immediate attention.

The first is growing household debt that has resulted from extended loose monetary policy.

Household debt levels are similar to those that were amassed by high-spending consumers in the United States and the U.K.

In the third quarter of 2008, Korea’s total household debt was 638 trillion won ($556 billion). However, as of the second quarter of this year, household debt amounted to 711 trillion won.

The 80 trillion won gain is largely attributable to low interest rates, which were at historic lows between February 2009 and July 2010.

Rising household debt may be a problem - but what’s more troubling is rising loan delinquency.

According to the Financial Supervisory Service, the household loan delinquency rate was 0.78 percent, which is the highest delinquency rate since May 2009.

Particularly, delinquencies on mortgage loans have been rising for five straight months to 0.64 percent - the highest in 15 months.

This is not limited to households loans.

Companies, particularly small and midsize firms, have also seen a similar increase in late debt payments. Small- and mid-size companies could suffer the most if the central bank raises the policy rate, as they would then be forced to deal with even higher debt payments.

Another problem is the job market.

After two years, despite government efforts, job prospects for the younger generation have fallen rapidly.

Experts say the stimulus package, though it helped boost the growth rate, did not translate into improving the fundamental employment situation.

With the government’s emergency internship program ending this year, the youth unemployment rate is expected to rise - though that for the general population is expected to fall.

The unemployment rate of those between 15 and 29 years old was 6.1 percent in September 2008. But the rate was 8.5 percent as of July this year.

Two years have passed, but Korea is not yet out of the woods.

By Lee Ho-jeong [ojlee82@joongang.co.kr]

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