Happy New Year?

• Published Dec 30, 2015 4:03 PM KST
• Updated Dec 30, 2015 4:03 PM KST

By John Burton

Korea is entering the New Year with two key questions hanging over the economy. One is what will be the impact of the recent rise in U.S. interest rates? The other is what will be the impact of China’s economic slowdown?

The rise in U.S. interest rates poses a significant threat to countries, such as Turkey and Brazil, with large amounts of U.S. dollar-denominated government debt. They could experience a sovereign credit crisis similar to that Korea suffered in 1997.

Fortunately, Korea learned from that experience of nearly 20 years ago. Since then, it has sharply reduced its exposure to borrowing from overseas. It maintains a strong current account surplus and high foreign currency reserves. Its financial position is now seen as stronger than China and even some European countries that have higher credit ratings. In a sign of increased confidence in Korea, Moody’s recently raised the country’s sovereign credit rating.

However, the situation is different on the micro-economic level. Some Korean companies have high exposure to U.S. dollar debt and could be threatened with a credit squeeze if U.S. rates continue to rise amid a slowdown in global trade.

U.S. interest rate policy is also influential in setting monetary policies elsewhere, including Korea. If the U.S. Federal Reserve continues to hike interest rates next year, it could ultimately force the Bank of Korea to do the same. That would have a big effect on Korean households, which have some of the highest household debt among advanced nations.

Much of household debt is related to mortgages. Most Koreans have variable-rate mortgages rather than fixed-rate ones, which means that when interest rates increase they have to pay more money to the banks. The decision by the government last year to ease existing rules on mortgage loans to boost the depressed housing market resulted in a sharp increase in household debt.

The government claims that the household debt situation is not serious since most of it is concentrated among high-income households and their assets are more than double their liabilities. But the high levels of household debt still have a negative effect on economic growth. Families caught in debt traps have less money to spend, which depresses demand when the government wants the domestic economy to play a greater role in driving growth. In addition, spending tends to decline as people grow older, a particular concern for Korea with its rapidly aging population.

While people may soon spend less at home, the export-dependent Korean economy is also confronting the challenge of falling demand from China. If there is a severe economic slowdown in China, this would place Korea in a particularly vulnerable position. Korea’s trade with China accounts for a quarter of its total trade. Another quarter of Korea’s exports go to other Asian emerging markets, which would also be hit hard by China’s economic woes.

Korean industries, including chemicals, machinery, and cars, are already starting to feel the effects of slowing Chinese demand. Moreover, Korea is at risk of China weakening its currency to boost exports in an effort to revive growth. This would increase competition between Korean and Chinese products in foreign markets and might result in Korea depreciating the won as well.

Although lower commodity prices are benefiting the Korean economy, this will not fully counter the impact of a troubled Chinese economy or a slowdown in global trade generally.

The twin threats of rising interest rates and a Chinese economic slowdown should force the government to continue pursuing structural reforms, including reducing state corporate debt; reforming the labor market, the financial system and education; and easing regulations.

But whether the government can maintain momentum in this regard remains uncertain. President Park Geun-hye is entering her lame duck period, with attention of lawmakers now focusing on parliamentary elections next April followed by the presidential election at the end of 2017.

The main challenge for the Park administration in its last two years will be trying to strike the right balance between the country’s strong financial position and the challenges of potentially crippling household debt and a weak Chinese economy.

Seeing whether the government will be able to meet this test, should make the coming year an interesting one. Happy New Year!

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 johnburtonft@yahoo.com.