By Park Hyong-ki
The Korean economy is bracing for another impact as the U.S. Federal Reserve prepares for a possible rate hike this week.
Analysts say that the American central bank will most likely further increase its federal funds rate by a quarter percentage point when it convenes its policy meeting on March 14 and 15. It raised that much to between 0.50 and 0.75 percent last December.
This will put the Korean economy in a tighter spot. Hit by low private consumption on high unemployment and household debt, the Korean central bank is stuck between calls for a rate decrease in the face of low growth and an increase following that of the U.S.
There is more than 90 percent chance that the Fed will raise its key interest rate as the Fed indicated that the American economy is in a positive transition.
Fed Chair Janet Yellen recently hinted that it will “gradually increase the rate” in March if employment and inflation data meet its expectations.
So far, they are closely aligned with the Fed’s targets. Core inflation stands at 1.7 percent, which is near the Fed’s 2 percent target, and the U.S. unemployment rate stands at 4.8 percent. The U.S. usually tries to keep the joblessness at around 4 percent to bolster the world’s largest economy.
The Fed indicated last December that it has room for at least three more rate hikes in 2017 on the back of the rosy outlook.
“The US economy is enjoying multiple tailwinds at the outset of 2017 such as a sharp rebound in energy-sector capital spending, strength in the single-family housing market, a pickup in non-defense capital goods, strong momentum in employment growth and signs of rising price inflation,” said Nariman Behravesh, the chief economist at IHS Markit.
IHS forecast the U.S. to grow 2.3 percent this year, and expand further next year on the Trump administration’s fiscal stimulus.
On the contrary, the economic outlook for Korea looks dim.
The U.S. rate hikes, Trump’s protectionism and China’s economic retaliation over a Terminal High Altitude Area Defense (THAAD) battery will deal a blow to Asia’s fourth largest economy.
The U.S. rate hike in March will pressure the Bank of Korea (BOK) to follow suit to keep capital from exiting and disrupting the local market.
However, the trouble is that Korea’s household debt is extremely high at over 1,340 trillion won.
This makes the economy much too vulnerable to a rate hike here. The BOK noted that a 1 percentage point increase in borrowing rates would increase the debt repayment burden by an additional 9 trillion won.
Analysts say that it is unlikely the central bank will lower the rate at this point as it has indicated that it has used all available monetary resources at its disposal, including a rate cut to 1.25 percent last June.
It seemingly does not want to risk further fueling and worsening the debt.
But the BOK is expected to buy some time for a rate increase following the U.S.
“There is no reason for the central bank to point out risks when data show a rebound in exports and inflation. It may freeze the rate until the end of the first half of this year,” said Park Hyung-min, an analyst at Shinhan Investment.
Even though the BOK projected the economy to grow 2.5 percent this year, growing external uncertainties are weighing down Korea.
Analysts expect the economy to grow below the 2017 forecast.
In addition to the debt and unemployment, China’s THAAD retaliation is expected to hurt the Korean economy.
In the worse-case scenario, Korea’s gross domestic product could fall by 0.25 percent when its exports of consumer products to China decline about 20 percent.
Also, restriction of Chinese tourism to Korea will negatively affect the economy.
China accounted for almost half of total international tourist visits to Korea in 2016. About 8 million Chinese visited Korea last year, up about 35 percent from the previous year, according to IHS.
“Consumer and retail products, and tourism will inevitably suffer,” said Ahn Ki-tae, an analyst at NH Investment & Securities.
As an example, Japan’s exports to China dropped 13 percent in 2012 amid a dispute over the sovereignty of Senkaku Islands or Diaoyu Islands in the East China Sea. Japan’s automobiles and tourism suffered as a consequence. China banned exports of its rare earth minerals to Japan, the analyst noted.
“Korean manufacturing companies also have large-scale production facilities in China, making them vulnerable to economic retaliation by China,” said Rajiv Biswas, an economist at IHS.
The country’s exports to China amounted to $124 billion last year, accounting for about 25 percent of the total.
China is also one of the largest investors of Korea’s sovereign debt, holding state bonds worth 17.5 trillion won, or 18 percent of the total.
China is the third-biggest investor in the KOSPI. It has been unloading its Seoul shares since the latter half of last year.
In addition to the THAAD risk, Korea’s economy faces other challenges including the impeachment of President Park Geun-hye, shipping industry crisis and corporate debt restructuring.
Other external risk factors include the British exit from the European Union and the French presidential election, observers point out.
Also, China’s economy is expected to continue its deceleration this year as it focuses on innovation-led growth while seeking to reduce debt and restructure industries facing overcapacity. The world’s second largest economy is projected to grow 6.5 percent in 2017.