A voter in Bundang, Gyeonggi Province, puts his ballot paper in a ballot box April 27 when the by-elections in 38 electoral districts were held. The poll in the Bundang Second District was the most closely watched, as the affluent area was referred to as a conservative stronghold. However, main opposition Democratic Party (DP) leader Sohn Hak-kyu was elected to represent the district. / Korea Times file

Won likely to get stronger to tame inflation

By Jung Sung-ki

South Korean voters, angry at rising food and oil prices as well as swelling household debt, turned against the ruling Grand National Party (GNP) in the April 27 by-elections, which was perceived as a mid-term evaluation of the Lee Myung-bak administration’s performance ahead of next year’s general elections in April and the subsequent presidential election in December.

Economists say the results of the elections, in which the conservative GNP won only one of the three key posts up for grabs, will have an influence on the direction of the government’s economic policy for the remainder of President Lee’s term.

Certainly, Lee’s office will focus more on favoring consumers or middle- and low-income families, rather than large firms, banks or producers, said Kwon Young-sun, an economist at Nomura International in Hong Kong, as bread-and-butter issues are swing factors in the politics and elections.

Such a shift is expected to reduce uncertainty on the incumbent government’s economic policy, which had been on a zigzag course, according to analysts.

“The outcome of the April 27 elections does not endanger the GNP’s overwhelming parliamentary majority,” Kwon said in a report. “However, we expect the results to alter Korean economic policy – moving more towards favoring consumers or middle- and low-income families.”

Despite the defeat in the latest elections, the GNP holds 171 seats of the 299-member National Assembly. The main opposition Democratic Party has 87 seats.

But the implications of the defeat in the most closely watched poll in Bundang, south of Seoul, are significant since the region was referred to as a conservative stronghold, according to election watchers.

“Before the general election in April next year, we expect politicians and policymakers to focus more on limiting inflation, increasing household savings/incomes, creating jobs and stabilizing the housing market, rather than simply increasing aggregated domestic product,” Kwon noted.

That said, income redistribution and price stability will top the political and policy agenda instead of the high GDP growth, he added.

The Korean economy recovered strongly in 2009-2010, supported by an undervalued currency, fiscal stimulus, financial supports and lower interest rates. But the inevitable side-effects are high inflation, a domestic debt overhang and income equality.

The portion of wages to national income fell to 59.2 percent in 2010 from 60.9 percent in 2009, whereas the corporate profit share rose, according to Nomura and the Bank of Korea (BOK). The corporate savings rate rose to a record high 20.2 percent in 2010, but the household net savings rate fell to 3.9 percent from 4.1 percent a year ago.

Large firms are sitting on cash reserves as they have shunned plowing back earnings surplus into fresh investment, while the household sector suffered from snowballing debt burden and lower real incomes.

Household debt in Korea rose 8.9 percent to 937.3 trillion won ($870 billion) at the end of last year, versus a 7.3 percent increase in 2009. Its ratio to disposable income stood at 146 percent, the highest in the OECD after Britain.

“Internally and externally, we are having a hard time now on how to overcome inflationary pressure,” Strategy and Finance Minister Yoon Jeung-hyun told reporters May 3. “The inflation risks are from supply shocks, not from the demand side as usual. How to deal with inflationary pressures is our first task.”

Stronger won

A former finance official, who requested not to be identified, anticipated a policy shift to a stronger Korean won to help limit inflation.

“The outcome of the April 27 elections show that the middle- and low-income families in the country are angry about the government’s economic policy,” the official said. “Despite economic growth fueled by solid exports, consumer prices have been soaring. That is, the undervalued won has supported exporters at the expense of consumers.”

“In this context, the government will support gains in the won to an extent, though not a greater extent, for the remaining tenure of President Lee,” said the official.

He was worried about the risk of any massive withdrawal of foreign investor funds from the country’s stock and bond markets.

“We should be prepared to counter a possible crash of stock prices after a massive outflow of foreign investors sometime later this year,” the official said. “Without the ‘safety pin’ of the won appreciation, foreign funds could be withdrawn from the country suddenly.”

The won’s rise has gathered pace since March, adding urgency to the government’s risk-reduction efforts. The currency rose only 2.6 percent against the U.S. dollar for the whole of last year despite robust exports that led the sharp 6.2 percent growth, the fastest in eight years.

Korean authorities have allowed the won to rise nearly 6 percent against the dollar so far this year as they look to temper imported inflation.

The won has recently lost some ground, as the U.S. Federal Reserve’s reassurance of loose monetary policy dented the dollar and boosted demand for higher-yielding emerging-market assets. The local currency closed at 1,083.20 won Friday.

Finance officials are concerned that while gains in the won may help to limit inflation, the government may counter excessive volatility in the currency and speculation on additional won gains could potentially destabilize the local economy.

“We respect the market functions but then if there is extreme volatility in the market, then we will have smooth operations to ensure the market will function in a stable manner for prudential purposes,” Yoon said. “There is still a lot of liquidity flowing in from advanced economies where there are low interest rates. That kind of foreign capital volatility can seriously affect our markets.”

Inconsistent policy

In the wake of the defeat in the general elections, the ruling camp is making efforts to reduce uncertainty on economic policies, which had been blamed for the lack of consistency.

CEO-turned-President Lee, elected on the pledge to put more emphasis on the growth than redistribution, has changed its stance and laid out policies against larger enterprises.

A case in point is the so-called extended profit sharing between larger businesses and their subcontractors. Under the scheme, larger corporations shall share part of their profits with their subcontractors.

Conglomerates and conservative economists called the proposal “radical” or “leftish” in violation of market economy principles.

Last month, Kwak Seung-jun, head of the Presidential Council for Future and Vision, said the national pension and other public funds should exercise their shareholder rights more actively to keep big conglomerates like Samsung Electronics in check and improve corporate governance.

Larger businesses led by the Federation of Korean Industries, balked at the remarks, claiming the exercise of shareholder rights by large public funds would seriously undermine the independence of private firms.

“Initially, the Lee administration helped make big business bigger despite complaints from small- and medium-sized companies,” the former finance ministry official said. “And the government has changed its stance abruptly and it is now raising the issue of corporate governance, which big businesses argue have been improved further than before. As such, the government has been getting lost, undermining predictability on the economic policy and business environment.”