Is Korea’s recovery sustainable?

Growth in the Korean economy pulled back sharply in the second half of 2011 with four key factors weighing on spending and sentiment - exports, inflation, household debt and financial markets. However, there are now encouraging signs in those areas.

Consumer price growth has fallen below 3 percent, household loans have slowed, financial markets are calmer and industrial production and retail sales have reversed their slide. Buttressing the domestic improvement are signs of the U.S. economy turning the corner to an upward slope and financial system firewalls around the euro zone sovereign debt crisis. All of this is helping renew optimism about the domestic economy.

Is the brighter mood warranted? In particular, what kind of impact will the instability factors of 2011 have on this year’s economy, and what are the policy implications for sustainable growth? The outlook is positive but not spectacular.

Korea’s exports contracted sharply to 3 percent on-year growth in the first quarter. The global economy is likely to slow further due to lingering worries in Europe and moderating expansion in China, Korea’s largest export market. Other factors include the retreat of the Japanese yen from record highs and diminishing advantages for Korean exporters as Japan recovers from its 2011 natural disasters. In addition, there will be intensifying competition for businesses in higher-growth emerging economies.

The consumer inflation rate eased to below 3 percent in March for the first time in 19 months, and is likely to stabilize aided by the base effects of the 2011 inflation spike and government welfare policies. These include support for childcare costs and free school meals, which will help arrest inflationary pressure. Nevertheless, the absolute level of living costs is unlikely to decline significantly.

The prices of agricultural and oil products will remain vulnerable to the impact of external and domestic supply shocks. Possible increases in public utility fees, not to mention high housing rents and individual service prices, will exert pressure as well. The perceived level of inflation will be higher than actual inflation, dampening consumer sentiment.

Since the global financial crisis erupted, household debt has steadily increased despite weaker sentiment. Still, the risk of default on household debt remains low. Debt payment capability has improved, with net financial assets and asset-to-debt ratio rising. One risk is the multiple loans that households hold. If borrowing conditions at non-banks worsen, it would inevitably jeopardize the ability to service bank loans. The structural vulnerability, coupled with government efforts to curb further growth in loans and increased efforts by households to repay their existing loans, will continue to suppress consumption.

Financial markets are stabilizing faster than expected entering 2012. Ample global liquidity and the retreat of European debt woes, along with relatively favorable fundamentals in the Korean economy, inflow of foreign capital and unabated current account surplus, will be positive influences. However, the cooling of the Chinese economy, continued concerns about the euro zone, rising tension in the Middle East and geopolitical risks on the Korean Peninsula can also reignite financial market volatility.

With the four instability factors gradually softening, the economy is expected to see a moderate recovery with the leading index of macroeconomic indicators improving. Private sector recovery remains weak, making a swift comeback for the economy unlikely.

Exports will inevitably slow, while private consumption is also unlikely to make rapid gains. Financial markets should be more stable but will unlikely be a big boost to the real economy.

Given a moderate recovery, the government will have less urgent need for active economic stimulus measures - but government efforts will be needed to boost private sector resilience and sustain stable expansion.

by Shin Chang-mock

* The writer is a research fellow at the economic policy department at the Samsung Economic Research Institute. For more SERI reports, please visit www.seriworld.org.