[wallstreetturmoil] Korea Bracing for US Recession

Economic Crisis Around Corner Before Financial Crisis Is Over

By Kim Jae-kyoung
Staff Reporter

The Korean economy is facing a bumpy road ahead as the U.S. economy heads toward a hard landing and a recession with the fallout from the Wall Street crisis starting to creep into the economy.

If the U.S. slips into a recession ― two consecutive quarters of negative growth ― it will lead to a global recession, battering the Korean economy, which is relying on exports.

Experts said that Washington's $700 billion bailout plan to buy banks' toxic assets clogging the U.S. financial system will widen its fiscal deficit and dampen consumer and business sentiment.

Since Korea is vulnerable to shockwaves from the United States, a hard landing there will ripple through the Korean economy through multiple channels ― volatile markets, reduced exports, lower profits and sluggish foreign direct investment.

``If the U.S. economy sinks into a recession, it will deal a fatal blow to the Korean economy. It will slash exports, worsening the balance of international payments,'' a senior Bank of Korea (BOK) economist said, asking not to be named.

The nation's robust exports growth was mainly thanks to an increase in shipments to emerging market economies. A U.S. recession will lead to a slowdown in these economies, hurting exports and widening the current account deficit.

``The widening shortfall in the current account combined with growing uncertainties in the market could intensify dollar shortages here, deepening market volatility,'' he added. ``In the worst-case scenario, foreign investors could scramble for an exit en masse to secure liquidity, which would be catastrophe for Korea.''

The nation's exports grew 12.5 percent for the first 20 days of September, a setback from the 22.1 percent expansion during the January-August period. The growth rate stood at 18.7 percent in August and 36 percent in July.

As a result, the shortfall in the trade account reached $6.19 billion for the first 20 days of this month, compared with a $12.3 billion trade deficit between January and August. With the massive capital outflow, the local currency market remained volatile this month, with the Korean won losing around 6 percent in value against the dollar.

Global economists said that Korea, just like many other economies, will be affected by the problems in the U.S.

``In Korea, there are upward pressures on prices, and growth is slowing down. Real estate prices cannot go up, and credit has tightened,'' Mauro F. Guillen, director of the Lauder Institute at the Wharton School of Business, told The Korea Times.

`` If the U.S. economy does not start growing again, the Korean economy will have trouble,'' he added.

Many argue that parallels drawn with the Great Depression are overblown but they agree that the U.S. economy will undergo a longer-than-expected recession on the back of the fall of consumer and business confidence.

``I think the next story will be what is happening to main street. I do think that the investment bank bubble-bursting is only the start. We will now see the collapse of consumer spending and corporate profitability,'' said Richard Dobbs, a director in McKinsey & Company's Seoul office.

In the last weekly report under Lehman Brothers banner, the now-defunct investment bank said that the escalation of strains in capital markets points to a deeper and more prolonged slowdown in growth.

``The financial events are affecting a wide range of financial variables that drive real activity,'' the report said. ``Most important has been the damage to business and consumer psychology.''

U.S. private consumption has been falling in response to a toxic cocktail of bankruptcies, job losses, falling home prices and a long stream of financial sector bailouts

Lehman forecast that the U.S. economy will slip into recession by the year-end, with the GDP expected to contract by 0.5 percent quarter-on-quarter both in the fourth quarter of this year and the first quarter of next year.

Private consumption is expected to shrink by 1 percent in the fourth quarter and 0.7 percent in the first quarter, while the unemployment rate is forecast to peak at 6.7 percent in the second quarter of 2009.

In his latest research note, Andy Xie, an independent economist and former Morgan Stanley Asia chief economist said that while the financial crisis is far from over, the economic crisis is just around the corner.

``The U.S. is heading for a hard landing. A significant part of the U.S. consumption is kept afloat by the credit bubble. As the bubble collapses, the credit for consumption dries up, the U.S economy will likely contract by 2 to 5 percent,'' he said.

Europe and Japan are already slipping into recession due to sluggish exports caused by the U.S. credit crisis. The Eurozone saw its GDP growth contract by 0.2 percent in the second quarter, while the Japanese economy shrank by 3 percent.

``Their (Europe and Japan) weakness will feed back into the U.S. It has benefited from strong exports in the first half of 2008. The export support vanishes just as its credit crisis hits its consumers. The downward spiral is just beginning,'' Xie said.

kjk@koreatimes.co.kr