Debt, strong won hamper recovery

Korea to remain attractive place for investment

By Kim Rahn

Debate over a full-scale economic recovery is heating up after the Bank of Korea (BOK) reported that the gross domestic product (GDP) grew 3.3 percent in the third quarter from the previous quarter, the highest in 21 months.

Most economists agree that the economy is back on track for a solid recovery but they are split over the pace of a rebound, expecting that growth will be slower than the government's forecast.

High household debt, the tapering of the U.S.' quantitative easing policy and a strong Korean won are cited as major downside risks that could derail a recovery. However, they expect that the country will continue to attract foreign capital thanks to strong fundamentals.

In order to have a grasp of how Asia's fourth-largest economy will unfold down the road, The Korea Times interviewed four economists from the Hyundai Research Institute (HRI), the Korea Institute of Finance (KIF), HSBC and Moody's Analytics.

China risk

HRI chief economist Han Sangwan said Korea's economy turned upward, hitting the bottom around the end of last year and at the beginning of this year.

However, he said that the speed of growth for next year will not meet the government's expectations, 3.9 percent. The institute earlier set GDP growth outlook at 3.8 percent.

"Next year, the growth will be driven by overseas demand that is likely to recover," Han said. "Companies also have small numbers of products in stock from the long-term economic slump. With exports expanding, they may expand inventory investment."

He said there are external downside factors but the impact of these might not be grave.

"The winding-up of U.S. monetary easing programs will be an indication of the country's economic recovery. If China's growth falls rapidly while the country undergoes social and economic structural reforms, this will have a negative effect on Korea. But we think the Chinese government will make an effort to prevent a ‘hard landing,'" he said.

Regarding the won-dollar exchange rate which has been falling, Han said it is possible for the rate to go below 1,000 won per dollar in a worst-case scenario.

"But the falling will not be as fast as now. Exporters may not be able to make profits if the rate drops to below 1,050 won," Han said.

He also expected foreign capital to keep coming into the country for as long as quantitative easing in the U.S. continues.

"The Korean market is regarded as a safe investment haven with strong fundamentals. The stock market is at the beginning stage of an upward tendency. Dollars will come for the time being, while improved economies in the U.S., Europe and Japan will propel the tendency next year."

Exports to drive growth

Park Sungwook, director at the KIF, said Korea's economy hit the bottom in the third quarter of 2012 and has been growing ever since.

"While growth this year has been led by government stimuli such as an extra budget, next year's growth will be driven by exports as the global economy will improve," Park said. "With export expansion, facility investment will also increase. With a similar growth pace to this year's, we expect the economy to grow 4 percent in 2014."

The institute expected facility investment will rise 7.5 percent, up from this year's estimate of 2.3 percent, and export will grow 6.7 percent, up from this year's 5.4 percent.

However, Park said the gap between sectors benefiting from the growth and those not benefiting might expand. "The gap can aggravate the imbalance of the Korean economy, such as the disparity between exports and domestic demand and between data and consumer sentiments."

He also said that the growth pace may not be as fast as during past expansion eras because of slower growth in emerging markets, gradual recovery in advanced nations, and Korea's low growth potential due to its aging society.

For the won-dollar exchange rate, Park forecast the year's average in 2014 at 1,074 won per dollar. "Continuous current account surplus will make the won strong, but the tapering of the U.S. stimulus and Japan's possible additional easing will make it weak. Overall, the won will gain slightly more than this year."

Household debt burden

Ronald Man, economist at HSBC, said that Korea is recovering but the recent growth has been led by exports dominated by chaebol.

"But small domestically-oriented companies are still struggling. The new government may feel the need to provide more fiscal support to smaller businesses over the coming year, especially to fulfill President Park Geun-hye's pledges made during her election campaign," he said.

HSBC expected growth in developed markets to be stronger next year and China to have quality growth, which will bring stronger demand for Korean goods. Its GDP growth outlook for 2014 is 3.2 percent.

But Man pointed out some risk factors, including household debt here and possible additional monetary easing by Japan.

"While household debt in Korea has shown signs of stabilization following a tightening of credit access by banks, concerns have shifted toward the distribution of debt. Leverage has been increasingly skewed toward the low- to middle-income group, who borrow to finance necessities rather than luxuries," he said.

He also warned that Japan may have additional monetary easing if the country's growth is not strong enough. "This will likely put appreciation pressure on the won against the yen. To respond, Korean companies may feel the need to cut its prices to maintain price competitiveness, which translate into lower profits. Taken together, this will weigh on Korea's economic recovery."

Man said that Korea will remain an attractive investment proposition next year because the country has solid economic fundamentals and allows investors to benefit from the gradually improving global trade cycle.

Policy mix works

Matthew Circosta, economist at Moody's Analytics, said Korea's growth pace has picked up markedly over the past six months following the government's fiscal stimulus measures, low interest rates, stabilization in house prices, and employment-boosting measures.

"One positive aspect of Korea's economy in recent quarters is the rise of services, including finance and insurance, retail, and healthcare, which has helped offset weakness in the export-oriented industrial sector," he said.

He added that the export-oriented country will be one of the biggest beneficiaries of a synchronized pickup in global demand. Moody's Analytics' growth forecast for Korea is 3.7 percent next year.

Circosta pointed out that high household debt, at around 75 percent of GDP, is still the biggest risk to household consumption, the wider economy and the financial system.

He also cited that the tapering down of U.S.' stimulus is an overseas downside risk. "Sustained volatility in Korean equity and bond markets as a result of uncertainty over U.S. fiscal and monetary policies could make consumers nervous about spending and businesses uncertain about investment and hiring."

He said the delay of the tapering down has put upward pressure on the Korean won and that this trend could continue through at least the early part of 2014. "Whenever U.S. policymakers begin to unwind their monetary stimulus, most likely around mid-2014, capital outflow will contribute to a weaker won. Overall, Moody's Analytics expects the Korean won to end 2014 at 1,100 won against the dollar."

Circosta also forecast Korea will enjoy solid investor demand as it has boosted foreign reserves and lowered external debt since the 1997 Asian financial crisis. "Korea is not immune to market disruptions but does appear less susceptible to capital outflows than other Asian economies."