2008 vs. 2011
Korean economy may avoid crisis but likely to face slower growth
By Kim Jae-kyoung
South Korea and its people have been through the severe trauma of economic crises following two financial disasters. They first went through the currency crisis during 1997-1998 when the country begged for bailout funds from the International Monetary Fund (IMF).
A decade later, Asia’s fourth largest economy was again exposed to a financial crisis in 2008, due to a massive outflow of foreign capital caused by the global credit crisis stemming from the U.S. subprime mortgage meltdown.
What is common in both crises is that the main trigger was foreign investors pulling money out of the country en masse. Policymakers and investors here now fret about another crisis whenever global investors show signs of scrambling for an exit.
With the situation in the Eurozone spinning out of control, there are renewed fears that the country will face another crisis. Growing concerns over the U.S. economy slipping back into another downturn has added to the fears
In September, foreign investors net-sold 1.31 trillion won on the Seoul bourse, including 971.6 billion won by European investors. The Korean won lost around 8 percent against the U.S. dollar since Sept. 9, the fastest depreciation among Asian currencies.
The markets bounced back last week with the benchmark KOSPI recovering to the 1,800 level and the won gaining ground on the dollar. However, no one believes that it is the sign of a big rally. For some, it is seen as a technical rebound prior to a bigger crash.
No crisis in 2011
Some pessimists argue that Korea is likely to undergo another crisis similar to the one that shook the country in 2008 if the fiscal crisis in Europe takes a turn for the worse. However, Korean policymakers and many economists are dismissing such concerns, claiming that Korea is now in a different situation from 2008 in many aspects.
“In 2008, the financial malaise caused by insolvent financial firms squeezed credit in the global market, which fast translated into the real economy,” Jeong Young-sik, a senior economist at Samsung Economic Research Institute (SERI), said.
“However, what’s happening now is different from the 2008 credit crisis. Although concerns are growing over insolvency of banks in Europe and the U.S. due to the debt crisis in Eurozone, there is no sign that a full-scale credit squeeze will hit the global market,” he added.
SERI came up with three possible scenarios regarding how the Europe debt crisis will unfold _ 1) orderly default or restructuring; 2) disorderly default; and 3) spread of default in the region.
Among them the institute said that the most likely scenario is the orderly default or restructuring under which Greece avoids defaults and other countries, including Italy and Spain, do not receive bailouts.
If this is the case, it is highly probable that Korea will head off a crisis for two main reasons. First, the country has seen improvements in key indicators measuring external stability, including ample foreign exchange reserves ($303.3 billion), lower short-term debt ratio (37.6 percent), a fall in banks’ short-term borrowing abroad and an improvement in loan-to-deposit ratios (97.8 percent).
“Things (in Korea) are not as bad as the currency markets indicate. The central bank (of Korea) has lots of firepower,” said The Economist, a British economic weekly, in its latest issue.
Second, Korea is on a much better footing than Western countries suffering from fiscal crisis. “Unlike the U.S. and European countries, Korea has more ammunition to fight. There is more room for the country to opt for fiscal and monetary policy tools in a more flexible manner,” FSC Chairman Kim Seok-dong said in a recent interview with Business Focus.
“Although G20 countries seek policy cooperation to address debt issues, they are running out of policy options. In this regard, the ongoing crisis is expected to give Korea a chance to create opportunities for further growth.”
Korea’s debt-to-GDP ratio stood at 32 percent, which is well below the U.S. (100 percent), Italy (121.1 percent), and Greece (165.6 percent). The Bank of Korea froze the key rate at 3.25 percent Thursday, which is compared to the U.S.’s 0 to 0.25 percent, Japan’s 0 to 1 percent and the European Central Bank’s 1.5 percent.
“Korea has a more open financial market than its neighbors. Therefore, it is more affected by global financial shocks. However, Korea has many strengths. The worst for Korea is if China gets into trouble,” Wharton School professor Mauro F. Guillen told Business Focus.
Is it really safe?
Taking only indicators into consideration, Korea is relatively immune to a financial crisis but market volatility is highly expected to persist in the domestic market as the debt crisis in Europe and the U.S. is likely to linger for a while.
If the fiscal crisis in Europe turns into a full-scale financial crisis, advanced economies, including the U.S., will face slower growth. If western economies, particularly the U.S. economy, continue to lose growth momentum, it is inevitable that emerging economies, including Korea, will see an outflow of foreign capital.
The issue here is there is a general lack of confidence in the markets and the Fed is trying to generate it, but it has fewer and fewer tools at its disposal.
“The problem is that there is not so much that the Fed could actually do in order to stimulate the economy. The real interest rates are already negative with deflation risks being much lower than last year,” Natixis U.S. economist Inna Mufteeva said.
“In this context another round of QE would have quite a limited impact on the economy with risks being on the upside (knowing that the Fed’s balance sheet is already around $3 trillion).”
Guillen said that the global economy has already fallen into stagnation.
“We have stagnation for now. What we do not know is if lax interest rate policies and quantitative easing will generate inflation. Right now, inflation is not a problem. I am hopeful it won’t be in the future unless the economy grows rapidly,” he said.
In its October report, Deutsche Bank suggests that in order to solve the root cause of the debt problem, the world should focus on breaking the so-called negative feedback loop, which refers to a vicious cycle of “bank sector sovereign exposure,” “bank funding pressure,” “contraction in lending (deleveraging),” and “recession.”
“The longer the delay re-stabilizing confidence with capital, the greater the chances of a deleveraging recession. Many banks are already deleveraging,” the bank said.
Preparation for worst case
Over the past month, the local financial markets have had a roller coaster ride. Following severe ups and downs, the Seoul bourse enjoyed sharp gains last week. However, the market doesn’t know whether there will be a big rally or a jumbo crash again.
The key reason for this is the sheer scale of what will happen if things go wrong abroad. In this regard, experts said that the government should prepare safety measures in a preemptive manner.
“In short term, the government needs to seek to sign a currency swap with the U.S. and the ECB. In the private sector, banks should diversify their funding sources to Asia and the Middle East from the U.S. and Europe,” said Jeong of Samsung said.
“In the long term, the nation should strengthen international cooperation to control sudden capital inflow and outflow, while establishing a financial system to cushion the blow from the outside,” he added.