Korea's Goldilocks economy

By John Burton

Despite talk of debt problems among mid-sized chaebol and households, Korea is currently enjoying what could be described as a Goldilocks economy: neither too hot that it causes inflation nor too cold that it results in a recession.

Once known for its volatile economic swings, Korea is boringly calm nowadays. Growth is slow but steady ― and improving. Gross domestic product grew by 1.5 percent since mid-2012 before accelerating to 2.3 percent in the second quarter of this year.

Indeed, Korea is now regarded as a safe haven by foreign investors. While money was being pulled out of other emerging markets by foreign investors this summer on worries that the U.S. was starting to ease its policy of easy money, foreign funds were flowing into the Korean stock market.

Investors have been attracted by the market's low valuations, but also the belief that Korean exports will grow as the global economy gradually recovers from the global financial crisis five years ago.

Korea has other strengths when compared to countries awash in government debt, including those of the U.S., Japan and many European countries. It enjoys a healthy current account surplus, which reached a 15-year high in August, boosted by a flood of free-spending Chinese tourists. Central government debt is only 35 percent of GDP, while the fiscal deficit is likely to be only 1.8 percent of GDP this year.

Credit growth relative to nominal GDP has been brought under control, ending the profligate bank lending that caused Korea to suffer damaging debt crises in the past. Borrowing to buy homes has been a main source of increased household debt. But the government has reined in the heated housing market over the last few years by imposing strict loan-to-value ratios on mortgages.

But the good macro-economic news hides troubling news on the micro level. The overall profitability of the top 20 chaebol has been worsening over the past four years, with only four chaebol reporting improving profit margins ― Samsung Group, Hyundai Motor Group, Lotte Group and Booyoung. The average profit margin ratio for all listed Korean companies has also been dropping, with a third of the top 20 percent of listed companies having missed revenue forecasts this year. The low profitability of most Korean companies is a worry if the economy should stumble or if the U.S. starts to tighten its monetary policy, resulting in weaker global demand.

There are even concerns that Korea has become too dependent on Samsung Electronics, which now makes up nearly a fifth of the value of the KOSPI index. There is talk of the "Nokia syndrome," referring to the Finnish telecoms group that once accounted for a large share of its country's market capitalization, but whose fortunes have since declined with a resulting impact on Finland's economic growth.

Samsung Electronics is now flushed with cash, but investors are worried about the company's strategy based on fears that smartphones are becoming a commoditized product. Samsung enjoys a profit margin of more than 20 percent on its smartphones, which accounts for a large share of the company's total earnings. But increasing competition in the smartphone sector could threaten future profit growth.

Moreover, Samsung is under growing pressure from foreign investors to increase its dividend payments instead of reserving its large cash pile for future capital investments, such as building new factories for its semiconductor business, another money-spinner for the company. Investor unhappiness over Samsung's dividend policy has meant that the company has underperformed the KOSPI index this year.

A main reason why Korean companies do not enjoy better profitability is that domestic demand is constrained by the high household debt and an aging population.

Fixing the household debt problems remains a challenge. Property prices have stagnated over the last few years or even fallen in some parts of the country, including Seoul. Easing some of the government's restrictions on mortgage lending would revive the market, allowing those with debts to sell their property at a profit and pay off their loans. But relaxing controls on mortgages could also trigger another property boom, potentially increasing the debt burden for buyers.

Nonetheless, the government's strong financial position will be able to keep things in balance for at least a while. It can easily resort to stimulus spending if the economy is in danger of slowing. Moreover, it can maintain its current low interest policy of 2.5 percent since the inflation rate is at its lowest in 14 years. Even worries about a rising won affecting exports appear to be exaggerated.

So like Goldilocks, Korea will be able to eat its porridge "just right" in the belief that the bears will not be arriving anytime soon.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at john.burton@insightcomms.com.

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