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Contribution What can we expect in post-pandemic Korea?
Alicia Garcia Herrero
By Lee Kyung-min
By Alicia Garcia Herrero
After a long fight against the COVID-19 pandemic, Korea has started to open up recently by making international travel possible albeit still difficult.
The Korean economy, though, has been recovering for the whole of 2021 thanks to both fiscal, but especially monetary stimuli (the latter being about 15 percent of GDP).
As if this were not enough, external demand has been very supportive thanks to the strong rebound of the global economy in 2021, led by China in the first quarter and followed by the U.S. and, more recently, Europe with, however, a slowdown in China since the peak in the first quarter.
Korea's growth rate this year is expected to reach 3.9 percent, which is quite positive given the still not fully open economy but, at least, with more limited mobility suppression than other countries in Asia, especially in ASEAN. The rather high domestic mobility maintained throughout the pandemic has been possible thanks to widespread contact tracing and testing measures.
More recently, the vaccination rate has reached 70 percent, which has allowed the country to treat COVID-19 as endemic, which is increasing cross-border mobility from very low levels but also supporting household consumption.
Going back to the monetary stance, the interest rate cut to 0.5 percent and the introduction of quantitative easing coupled with large fiscal stimuli, contributed to rapidly increasing debt levels. This is especially problematic as households have been increasing their borrowing, not just to purchases homes, but also to fund financial investments, in particular buying equities.
Such financial speculation, beyond the obvious economic recovery, was an important factor behind the Bank of Korea's (BOK) decision to raise its intervention rate by 25 basis points and another 25 basis points at the end of November.
Looking forward to 2022, we expect exports to lose steam for a number of reasons.
First of all, global demand will not be as strong as it is now as China's economy is clearly decelerating as is America's. Moreover, rate hikes should dent consumption, all the more so given the high household debt.
On the positive side, cross-border mobility should help the economy although it really hinges on when China opens its borders as most of the tourists coming to Korea are Chinese. Unfortunately, recent announcements by the Chinese authorities do not point to a change in their zero-case strategy in tackling COVID-19, which boils down to a still muted outlook for inbound tourism into Korea.
All in all, GDP growth should decelerate to 2.5 percent in 2022, which is still rather robust for Korea.
In that regard, the problem is not so much growth but inflation and geopolitics. On the former, fuel prices and other supply shocks such as fertilizer shortages, will likely push up food price pressure, causing the CPI to increase to 2.4 percent in 2022.
The fact that the central bank raised its rate another 25 basis points should help contain inflationary pressure. In fact, global factors also matter, such as the commodities price cycle, but also the increase in transportation costs related to abrupt changes in global supply chains, some of which relate to COVID-19, but also geopolitics.
Notwithstanding these risks, it is hard to expect more action from the BOK in 2022, perhaps no more than an additional 25 basis points, as the burden from high household debt and its impact on consumption cannot be underestimated. All in all, the bank could end the year with rates hovering at 1.25 percent.
Finally, President Moon Jae-in's single, five-year term is ending and a presidential election is scheduled for March 9, 2022. Fiscal spending increased under President Moon while interest rates were low.
Despite ruling on a pro-poor platform and raising the minimum wage, Korean asset prices, especially housing, increased rapidly, creating a sense of economic insecurity in the country. Against such a backdrop and given the push for common prosperity in China ― as well as hints at better income distribution by Japan's new Prime Minister Kishida ― President Moon might be inclined to introduce additional measures to improve income distribution before his mandate ends.
This could imply higher taxes for the wealthy or else more expenditure on welfare, with the latter possibly raising our growth outlook for 2022.
All in all, 2022 is a year of economic consolidation for Korea, a post-pandemic but also an election year in which many important issues, including the unequal impact of the pandemic and the ensuing acceleration of technological progress, will need to be tackled.
Growth should not be the major focus and hopefully not even inflation if the BOK manages to control inflationary pressure stemming from the commodities cycle and the reshuffling of the value chain. Still, big risks remain especially from the increasingly tense strategic competition between the U.S. and China and, obviously, North Korea.
The writer is the Chief Economist Asia Pacific at Natixis.