By Kim Tong-hyung

The D-word is getting serious play from pundits and government officials here as they debate whether Korea faces a perfect storm in which all parts of the economy go down together.

The catastrophic vortex of unemployment, decaying family finances and a freefalling housing market has been made worse by dismal global conditions that threaten to decimate exports and shatter the country’s fragile recovery. This heady mix of negatives has market watchers concerned whether the economy is being sucked into deflation.

The worries are shared by policymakers too. The Bank of Korea (BOK)’s surprise decision last week to cut interest rates by 0.25 percentage points to 3 percent, after a 13-month holding streak, showed that rate-setters see the specter of deflation rising as inflation falls.

BOK maintains an inflation target band of 2 to 4 percent, and while headline inflation appears to be stabilizing below 3 percent, costs of imports dropped sharply by 3.5 percent just last month, threatening the lower ceiling of the band. The bank lowered its gross domestic product (GDP) growth forecast for the year from 3.5 percent to 3 percent the very next day and admitted that things have been worse than feared.

Officials at the Ministry of Strategy and Finance are also scrambling to design measures to jolt economic activity and avoid a downward economic spiral, but options are limited after they dramatically front-loaded the annual budget to give the economy an early-year spark. Finance Minister Bahk Jae-wan, who continues to display an inability to talk without making baseball analogies, admits he can make only ``small ball’’ adjustments and not game-altering swings.

``We don’t consider the current situation as deflation. However, the recovery has lost some of its vibrancy due to the decline in global trade and it’s vital for the government to breathe new energy in economic activity,’’ said a senior government official, after the finance ministry unveiled 8.5 trillion won (about $7.45 billion) in fiscal spending during the second half of this year.

``We aren’t considering a supplementary budget that could only have temporary effect. We have to prepare and build ourselves for the long run and we are discussing what are the right steps to do that.’’

To put it simply, deflation is the opposite of inflation, describing a state where the general level of prices fall consistently over an extensive period of time.

While falling prices might sound nice to consumers, the truth is that deflation is bad for everyone involved because it triggers a cycle of decreased spending and increased unemployment. People will stop buying goods and services waiting for them to get cheaper, which brings more deflation as well as corporate collapses and job losses. The most dramatic example of deflation remains the Great Depression of 1929.

Deflation is even more dangerous for a country like Korea where people owe as much money as the whole economy generates in a year, as household incomes will continue to shrink but debts will not.

Consumer price inflation has been stabilizing at the 2 percent range, but skeptics wonder whether this could be an indicator that deflation is at the door, given that investment and consumption remain in a slump despite eased price pressures.

Korea’s GDP grew by just 0.8 percent in the Jan.-March period from the preceding quarter and market observers expect the second-quarter numbers to be significantly worse due to the sharp pullback in exports and low levels of consumer spending.
Companies listed on the Korea Composite Stock Price Index (KOSPI) suffered a combined 130 trillion won loss in stock valuation over just the past three months.

The housing sector continues to be in a deep freeze, with the transitions of apartments in June dropping by nearly 33 percent from the same month of last year, which wasn’t exactly a bright period for the market.

BOK puts household debt at around 911 trillion won based on data from savings institutions and other financial services providers. When this is combined with borrowing by self-employed people, the total surpasses 1.1 quadrillion won, compared to the 1.2 quadrillion won the economy made last year.

``I think the concerns are somewhat exaggerated as it will take a more significant mix of negatives to ever approach a situation that could be called as deflation,’’ said Lim Hee-jeong, an economist from the Hyundai Research Institute.

``That said, there is no arguing that household finances are in an extremely precarious state. The fall in the value of assets to which the debts are tied, like houses, may further erode the level of consumer spending and push families to the brink of implosion.’’

Oh Jeung-keun, a Korea University economist, said the government should provide bolder gestures to keep deflation worries at bay.

``The concerns for deflation are growing owing to falling property prices. The measures announced by the government are not enough to inspire confidence. We need more measures to boost property market activity and the BOK may have to slash interest rates a few more times.’’