Outlook for Korea's Economy in 2008
- reported by Samsung Economic Research Institute at Nov. 29, 2007
Summary
Despite volatile external conditions, the economy should be able to grow 5% in 2008. We see first-half growth at 5.2%, thanks to rising stocks and wages, which will boost consumption. In the second half, corporate investment will likely become the main driver, but with the economy slowing to 4.8%.
Global financial market turmoil, soaring oil prices and appreciation of the won will continue to produce strong headwinds. However, the economy is more resilient to high energy costs and unfavorable foreign currency rates. In addition, Korea , like other emerging markets, is less susceptible to US economic turmoil, the result of decoupling from the US market.
We expect Korea's 2008 current account balance will run a deficit of US$2.9 billion, ending 10 consecutive years of surplus. Exports are expected to exceed US$410.9 billion, posting another year of double-digit growth of 11.0%. Imports are forecast to go up by 12.8% reaching upwards of US$395.1 billion on the strength of increased imports of capital goods and consumer goods buoyed by domestic demand recovery. As imports increase faster than exports, the surplus scale of the 2008 trade balance is expected to slightly contract. Interest rates will likely rise to 6.0% on average and consumer prices should remain about 3.0%. The labor market should see about 20,000 more newly created jobs than in 2007.
The chief caveat is the extent of the economic slowdown in the US, Korea's No. 2 trading partner. The US Federal Reserve foresees modest growth of 1.9% in 2008. But if turmoil caused by the US subprime mortgage loans slows growth to less than 1%, the Korean economy will inevitably suffer a setback. Export growth would slow to a single-digit rate, and further consumption recovery based on the booming stock markets would be quashed. Consequently, the economic growth could fall below the 4.8% estimated for 2007.
With a new administration taking office in February, p olicy direction in 2008 should be focused on maintaining the current recovery trend. Korea is now a decade past the watershed financial crisis; a more positive and aggressive attitude is needed.
Deregulations and a more competitive mindset among corporate leaders are required to reach fuller potential.
1. Overall Trends
Korea's economic performance began accelerated after the first quarter of 2007, rising to 5.2% in the third quarter. Robust exports and facilities investment led the economy in the first half, while improved consumer spending was the main driver behind economic growth in the second half.
Exports of goods and services increased 11% year-on-year in the first half and decelerated to 9.2% year-on-year in the third quarter. A recovery in household consumer sentiment and a rise in household assets stemming primarily from Korea 's bullish stock market buoyed private consumption. It grew by 4.1% and 4.9% in the first half and in the third quarter, respectively.
Soaring oil prices, the weakening US dollar and global financial turmoil stemming from the US subprime mortgage woes posed growing threats to world economic growth. Those factors show no signs of receding quickly in 2008.
Supply disruptions still rule due to oil demand from developing countries like China and limits on production from oil-exporting countries. Amid the concern, the further weakened dollar prompts movement of speculative funds to real assets, such as oil. Oil-exporting countries raised the dollar-denominated oil prices to secure oil-related income due to their strengthened currencies; this also pushed up international oil prices. West Texas Intermediate crude flirted with US$100 per barrel on November 19 from the US$74.07 posted at the end of August. Dubai crude, which Korea depends upon, began 2007 in the mid-US$50 range per barrel. By mid-November, it was up to nearly US$86 per barrel.
The US housing industry is not expected to recover appreciably in 2008 and it is not known if financial institutions are finished taking write-downs worth billions of dollars. Flashing US economic indicators point to a 2008 slowdown and many on Wall Street are pricing in a recession. The rest of the world economies naturally would be buffeted by a US recession but they are less dependent on the US than before. Also, the length and breadth of any significant US pullback would have to be determined as 2008 progresses.
2. Economic Growth
The Korean economy is on a recovery track after years of underperformance. We believe the Korean economy grow 5% in 2008, slightly better than the 4.8% growth of 2007. Still, strong headwinds such as the liquidity crunch caused by the US subprime mortgage turmoil, skyrocketing oil prices, and unfavorable foreign exchange rates cannot be dismissed. Thus, 2008 will test the economy's resilience.
Our estimate rests with the global decoupling from the US economy, which should mitigate the effects of a US downturn, and the ability of the Korean economy to accommodate high oil prices. The annual average price of Dubai crude is estimated to be US$74.1 per barrel, up from US$68.5 per barrel in 2007. Both the world and Korean economies have a higher level of immunity from the lofty oil prices. In particular, record-high oil prices will have a very limited effect on inflation risks and the overall economy because a stronger won more than offsets per-unit import prices.
The Korean economy should be at its strongest in the first half, especially the first quarter, as household assets bolstered by robust stock holdings encourages consumer spending. Year-on-year, we see first-half growth at 5.2%. Second half growth is estimated at 4.6% with a modest improvement in investment climate.
3. Private Consumption
In 2008, private consumption will post an annual growth of 4.5%, a little higher than 2007. Qualitatively improved employment and the bullish 2007 stock market will have a halo effect on private consumption in 2008. However, private consumption in 2008 may find it hard to surpass the mid -4% range: high oil prices will cause inflationary pressure and the shaky global credit markets would worsen consumer sentiment. In addition, any i nterest rate hikes could heighten the debt payment burden of households.
Private consumption grew an estimated annualized rate of 4.4% in 2007, slightly accelerating from the 4.2% in 2006. Private consumption steadily gained momentum in 2007, increasing from 4.1% in the first quarter to 4.2% in the second quarter and to 4.9% in the third quarter. Strong economic sentiment, the robust domestic stock markets and limited but improved flow of real income pushed the private consumption recovery, which will likely show 4.6% growth in the second half of 2007.
4. Fixed Investment
Facilit ies investment will likely rise at an annualized 7.1% in 2008, thanks to solid exports, stronger domestic demand and high capacity utilization rate. In the first half of the year it is expected to rise at a moderate rate of 6.3%, resulting from the base effect of strong performance in 2007. Increasing exports to developing nations are expected to buttress brisk exports and new car releases expand consumption of durable goods, both of which will lift manufacturing investment. In addition, private consumption is going to maintain growth momentum into the first half of 2008 from the second half of 2007, boosting non-manufacturing investment such as transportation, warehousing and communication service. Facilit ies investment will possibly soar 7.9% year-on-year in the second half of 2008 owing to investment inducement by high capacity utilization rate and a falling won-dollar exchange rate. Recently, the capacity utilization rate has risen significantly with sharply improv ed financial structure since the 1997 financial crisis, which will, in turn, serve as an incentive for facilit ies investment. A strengthening won will also contribute to facilit ies investment by lowering import prices of capital goods.
In 2008, construction investment is likely to increase at an annual 3.1% with residential construction shrinking, but non-residential construction and civil engineering works expanding.
In the first half, construction investment is expected to go up only 1.1% as a result of the base effect of the strong 2007 first half and disappointing investment for residential construction. Investment for public construction and civil engineering works will remain sluggish in the first half of 2008. The housing slump will continue as a new post-construction apartment sales system weighs down on house supply, and many new homes remain unsold in local areas where residential construction increased by 2006.
In the second half, construction investment will possibly rise 4.7% as public construction expands and non-residential construction grows over time following strong domestic demand. Construction by the public sector will increase, led by civil engineering works, due to more privately-funded projects and balanced national development projects.
Projects for balanced national development will begin in the first half of 2008 and produce tangible results into the second half. Moreover, investment for commercial construction is expected to fully recover into the second half.
5. Trade
External factors such as the weak US dollar make a slowdown in exports seemingly inevitable. However, Korea's export structure has become more tolerant of global weakness of the US dollar and can better withstand a cooling of the world economy. Thus, we believe exports will maintain double-digit growth at 11% in 2008, or about US$400 billion. Meanwhile, imports appear poised to rise about 12.8% to exceed exports. The narrowed trade surplus coupled with a decline in service account deficit will likely mean the current account will turn red in 2008, ending 10 years of surplus.
6. Consumer Prices
Consumer prices will likely rise 3.1% in the first half of 2008 and ease to 2.9% in the latter half for an annual increase of 3.0%. Surging prices of crude oil and grain in the second half of 2007 will likely lead to higher prices of petroleum products and food and beverages during the first half of 2008.
The prices of international raw materials are expected to fall somewhat in the latter half, but this will be offset by the inflationary gap (real GDP growth rate surpassing the potential growth rate) that is expected to be seen in 2008 for the third straight year (2006-2008), as well as imports from China. Given Korea's heavy reliance on Chinese imports of Chinese consumer goods and raw materials, the rapid rise in Chinese inflation will inevitably affect Korean domestic prices.
7. Employment
Recent labor market indicators exhibit no significant signs of improvement over the next six months. The unemployment rate in the first half of 2008 will likely be 3.3%, which is the estimate rate for all of 2007. However, the second half unemployment rate should drop to 3.1% as the labor market catches up to improving economic conditions. Therefore, the unemployment rate for 2008 is put at 3.2%, just below the estimated 3.3% for 2007. That will mean 310,000 new jobs in 2008 versus an estimated 290,000 for 2007.
Among the bright spots in the labor market has been a higher concentration of newly created jobs in the service sector, which is being looked upon as a growth engine to take the pressure off exports. Also, the number of people giving up on job-seeking is decreasing and the proportion of non-temporary employees in the national workforce is rising.
8. Interest Rates
Influenced by the monetary authorities' austerity measures and flow of short-term funds, interest rates are forecast to rise slightly to 6.0% on average in 2008. The Bank of Korea is expected to maintain its rate tightening policy to adjust liquidity in the market, which has greatly increased since the second half of 2006. In the meantime, banks are likely to issue more certificates of deposit (CD) and bonds to raise funds to make up for significant outflow from their short-term deposits into the stock market.
Interest rates will go up in the first half of 2008, but will decline to a stabilized level in the second half. In the first half, efforts to absorb liquidity will drive up short-term interest rates in particular. The second half should see market interest rates stabilize due to slower US economic growth and lower global interest rates.
Volatility in the global financial market will likely continue, heightening attention to safe assets. In Korea , investments in safe assets such as government bonds began to rise in the second half of 2007.
9. Foreign Exchange Rate
The US dollar is likely to stay weak in 2008 as a steady stream of US subprime mortgage woes come up for downward adjustment of interest rates . That will raise the danger of more foreclosures that will add to a glut in unsold homes and souring bank balance sheets.
The won will strengthen against the greenback as the dollar remains weak. However, there will be few domestic factors that could likely to affect the won's appreciation next year. Consequently, the appreciation level of the won will be lower than those of other major currencies. The won will likely to appreciate by around 2 % to the dollar in 2008.
Major global currencies are expected to appreciate by 4-7% against the greenback in 2008. The euro will stay strong as oil producing countries and Asian countries diversify their foreign currency holdings into euro away from the dollar. But its appreciation pace will slow from 2007. The Japanese yen should gain value as the yen-carry trade unwinds. Meanwhile, China is being put under a renewed pressure to allow the yuan to appreciate. The US is particular ly keen to see the yuan appreciate, while the Chinese government is likely to become increasingly aware of the rising inflation. The yuan is thus believed to appreciate at a faster pace next year.
10. Comment
With a new administration taking office in February, the economic policy challenge will be to maintain the current recovery trend in the face of significant external challenges. Any ripple effects from the credit stress in the US will need to be monitored closely. Financial authorities again will need to preemptively cope with any changes in major economies' policies, and exchange rate policy will need to focus on reducing volatility.
Now that Korea is a decade past the watershed 1997 financial crisis, the nation will need to build on the agonizing period of restructuring and move into the next decade with a less defensive mood and more aggressive and positive attitude.
The focus should be shifted slightly from stability to growth. To this end, the government should create a dynamic environment by lifting regulations actively, and businesses should concentrate on upgrading their competitiveness and discarding their conservative stewardship of recent years. A real commitment to new growth engines needs to be made and actively promoted to reach fuller potential.
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