Chinaflation worries poised to hit Korea

Ryu Woo-ik, left, South Korea’s ambassador to China, is seen in a convention participated in by policymakers and businessmen from both countries to discuss ways to improve economic cooperation and improve trade activity between the two nations, in Dalian, China, earlier this month. There are worries among policymakers here that Korea’s dependence on China to fuel its export-driven economy could make the country more vulnerable to the fallout of changing economic conditions there. / Korea Times file

By Cho Jin-seo

Growth and inflation in China are increasingly affecting the world economy, and the Korean government is to allocate more resources to prevent Beijing’s economic conditions from undermining Seoul’s policies.

Both the Ministry of Strategy and Finance and Bank of Korea are recently more alert to the risks connected to China’s growth as it has become the greatest threat to the domestic economy.

On Sunday, in a joint press release, economy-related government agencies announced that it is to commission a five-year, comprehensive research project on China’s economy and politics to the National Research Council for Economics, Humanities and Social Sciences. The council is a powerful control tower of 23 state research agencies and think tanks.

“This is to build a system to conduct research on China and to expand inter-agency studies on current affairs in China,” an official at the Ministry of Strategy and Finance said.

Such efforts seem belated to some. The Bank of Korea is already being criticized for missing its inflation target this year as the rise of commodity prices in China has pumped up prices in Korea as well in the second half of the year.

Bad weather was also a factor in the surge of the vegetable prices in 2010 but the central bank says the so-called Chinaflation will be a more fundamental problem for its monetary policy in 2011.

“China’s economy is so closely related to the Korean economy that 34 percent of Korea’s total imports came from the country,” said Lee Sang-woo, director general of the Bank of Korea’s research department as he forecast next year’s inflation would be around 3.5 percent. This would be the highest in three years. “It is inevitable that China’s inflation policy will be a variable in the Korean economy next year.”

Korea’s heavy dependence on international trade for domestic growth makes it difficult for the central bank and the government to plan ahead fiscal and monetary policies. As a nation with few resources and a limited domestic market, the economy depends on international trade more than any other developed country does. The proportion of trade to the nation’s gross domestic product is expected to have been 85 percent this year, according to the Ministry of Strategy and Finance, which is far higher than the United States (18.7 percent in 2009), Japan (22.3 percent), and even China (45 percent).

More than 20 percent of Korea’s trade is done with China, which is almost double the portion of trade with Japan, the second largest partner. And the importance of China keeps increasing. The problem is that as prices in China are rising, Korean manufacturing firms that import natural resources and parts from China as well as consumers who buy Chinese products and foods are negatively influenced.

This has prompted Kim Choong-soo, the governor of the Bank of Korea, to be unusually frank. “Wages and inflation in China are on an upward trend, which would eventually cause inflation in the domestic economy as a result of rising import prices,” said Kim Choong-soo, the governor of the Bank of Korea.

High inflation is deemed inevitable in China. KOTRA, the state trading agency of Korea, sees that the country will achieve a GDP growth of 9 percent. Year-on-year inflation was steadily rising from 3.1 percent in May to 5.1 percent in November. In order to tame inflation, the central bank of China raised its key interest rate over the last weekend, but many economists think that it will take at least a few months for the interest hike to take effect on prices of consumer goods.

Korea is not alone in watching what happens in China with wary eyes. Changes in the economic conditions in China can bring a “spillover effect” to other Asian nations, the International Monetary Fund (IMF) warned in its latest report.

“China’s role in processing trade also has implications for other Asian countries in the Asian supply chain, where Chinese final goods exported to the West require, for their production, substantial inputs from the rest of Asia,” it said. “Developments in China seem to have spillover effects on market confidence in other countries. And the list goes on.”

For the whole world, a 1 percentage point shock to China’s GDP growth is followed by a cumulative response in other countries’ growth of 0.2 percentage point after three years and 0.4 percentage point after five years, the IMF report claims, though it does not a provide country-specific analysis for Korea.