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Contribution Korea's challenges and tailwinds
Dave Chia, economist at Moody's Analytics / Courtesy of Moody's Analytics
By Lee Kyung-min
By Dave Chia
Korea is one of the better performing economies in the Asia-Pacific region this year. Exports will be the best remedy for the pandemic-scarred economy, while hefty household debt coupled with a heated real estate market will be key challenges.
Like other economies, Korea has battled with a series of stop-start social distancing measures to combat repeated waves of COVID-19. Nevertheless, it was one of the few where output surpassed pre-pandemic levels in the March quarter of 2021. Second-quarter GDP growth lost some steam, and the third quarter will likely remain soft. We forecast GDP growth to notch 4.2 percent in 2021 and 3.3 percent in 2022. This is slightly more optimistic than the Bank of Korea's respective 4 percent and 3 percent forecasts for those years.
The Korean economy has a few troubles. Number one is rising household debt. This stands at 104 percent of GDP, according to the Institute of International Finance (IIF). Over the past decade, surging property prices and credit card spending have fueled household debt. This is a problem not just for households, but also for the broader economy given the systemic importance of households.
The appetite for cheap credit has been strong thanks to the sustained low interest rate environment. After more than a year at a record-low 0.5 percent, the central bank lifted the policy rate to 0.75 percent in August. In the second quarter, household debt climbed 6 percent from 2020, faster than in any other country, according to data from the IIF. Mortgages constitute over half of total credits to households. Growing household debt is inextricably linked to the heated housing market, making owning a home a distant dream for lower- and middle-income families
In recent years, a series of macroprudential tools such as mortgage loan caps and higher property sales taxes haven't tamed the heated market. Data from the Korea Appraisal Board shows that average property prices in Seoul have increased more than 70 percent in four years. There's no reason to think these cooling measures will bring boiling prices to a simmer in the near term. Often circumvented by speculators, the measures are an extra burden for lower- and middle-income-class households and first-time home buyers.
Korea was the first major Asian economy to lift interest rates in 2021. The 25-basis-point increase is too small to address the country's high household debt and property affordability problems, which is why another rate hike of the same magnitude is expected before the end of the year. Nonetheless, even if interest rates get back to where they were before the pandemic (the policy rate was 1.25 percent in December 2019), the problem of household debt and inflated housing prices would not be adequately addressed. Regulations specifically targeted at speculators are needed. With demand for housing consistently outstripping supply, an increase in new housing construction is also necessary.
Korea's strong export position is a bright spot in the economy. The nation is well-positioned to continue capitalizing on the global chip shortage and growing demand for electric vehicles. Automobiles and semiconductors accounted for more than 25 percent of Korea's total exports in August and have done so for the past 18 months. The percentage will likely increase to over 30 percent in the next three years.
The outlook for semiconductor and automobile exports in the near term is strong. The government has designated these industries as key export drivers and is providing financial incentives to support capacity, research and development. We expect Korea's export performance to be robust through 2024 thanks to the combination of buoyant external demand and the targeted government incentives for key sectors.
Domestic demand is forecast to enjoy a sustained recovery from early 2022 as rising vaccination rates pave the way for aggressive movement controls to be a feature of the past. Korea's proposed record 604.4 trillion budget for 2022, an 8.3 percent increase from the original 2021 budget, will include measures to boost domestic demand and aid job recovery in vulnerable sectors. Even though these fiscal measures are necessary, there's a trade-off involved relating to national debt, which has been rising. The country's national debt-to-GDP is expected to increase to more than 50 percent in 2022, up 10 percentage points from five years ago. Fiscal consolidation will likely take place in 2023 to save future generations from an excessive national debt burden.
Korea's economic growth stands to benefit from its advantageous position as a major exporter of sought-after semiconductors and automobiles. Even though the country continues to be at the mercy of the Delta variant, strong fiscal support alongside increasing vaccinations are expected to fuel recovery in consumption through 2022. Nonetheless, Korea's high household debt and heated real estate market remain as long-term downside risks that could cloud the otherwise upbeat economic outlook.
The writer is an economist at Moody's Analytics. Please note that this analysis has been authored by Moody's Analytics, which operates independently of the Moody's Investors Service credit rating agency.