The threat from within

Investors’ expectations that the U.S. Federal Reserve will start winding down quantitative easing in September are rocking stock and capital markets of emerging and developing economies. Foreign funds that rushed into emerging markets due to easy liquidity in the United States are ebbing fast, wrecking havoc on currency and stock prices. Some analysts worry about a currency crisis in emerging markets.

Korean markets have so far remained relatively free of turmoil. Interest and foreign exchange rates are stable and stock prices are recovering. Some capital that exited from emerging markets is funnelling into our market, thanks to Korea’s reputation and sufficient foreign exchange reserves, current-account surpluses and a lower share of short-term foreign debt. External data that can signal dangers of a currency crisis all indicate fundamentals of the Korean economy have sharply strengthened from the past years. The looming dangers in other emerging markets are not expected to reach Korea and, in fact, could make the local market stand out among emerging economies.

Just because Korea is in no immediate threat of an external crisis, it cannot expect the economy to pick up on its own and join the ranks of advanced economies. Bigger dangers are brewing. The economy has been hampered by a slowdown for two years in a row. The economy, for the first time in nine quarters, grew beyond 0 percent in the second quarter from a previous three-month period, but annual growth of more than 3 percent is unlikely this year. The economy muddles along on exports with capital investment and consumption remains stubbornly sluggish.

Weak consumer spending due to the prolonged slowdown and mounting household debt dampen prospects for an economic recovery led by domestic demand. According to Statistics Korea, household spending fell 0.4 percent in the second quarter, a decline for the fourth consecutive quarter. Household debt increased to 980 trillion won ($880.1 billion) in the same quarter. Debt stifles spending and slows the economy, which leads to more debt, continuing the vicious cycle.

The Korean economy may look healthy, but on the inside it is suffering a chronic weakness of structural slowdown. It can fend off external threats for now, but it must combat the weaknesses within. The government should come up with a breakthrough to push the economy out of its slump. The economy won’t have the resilience to fight external dangers if it doesn’t recover through strong domestic demand.