What we learned about Korea's economy during pandemic

By Park Chong-hoon

The government and the Bank of Korea (BOK) have made vital policy changes aimed at withdrawing the liquidity that they released during the COVID-19 pandemic. The central bank has raised its base rate by 25 basis points, earlier than any other Asian economy, and the government tightened macro-prudential policy in order to control household debt. We believe that these efforts reflect a desire to normalize the economic cycle disrupted by the pandemic.

COVID-19 has affected Korea's economy adversely for a year-and-a-half already, and we now have enough data to gauge its overall economic impact. The pandemic has had a varying impact across different national economies. Korea's experience has been specific to its economic characteristics, and it is interesting to see how COVID-19 has affected Korea's short-term economic cycle.

We think that the country has overcome the COVID-19 crisis better than many other economies, posting a faster recovery than expected. A year ago, few, if any, predicted that the Korean economy would grow by more than 4 percent in 2021. Economists predicting a V-shaped recovery had difficulty defending their argument, given the fact that the pandemic looked likely to be prolonged.

Furthermore, even if the crisis were to come to an end, most economists still expected consumer sentiment to take a long time to return to normal. COVID-19 was the first large-scale pandemic to occur in 100 years, after all.

However, a year later, consumer sentiment in Korea has rebounded too much higher levels than before the pandemic, and its recovery rate has been accelerating. Consumer sentiment started 2020 at 104.8, dropped to 73.3 in April 2020 and resurged to 110.3 in June 2021.

We believe that Korea's rapid recovery from the pandemic was largely because it is a manufacturing-oriented export economy. The country's exports were resilient throughout the pandemic, powered by growth in major, traditionally strong industries such as petrochemicals, automobiles, steel and semiconductors. The resilience of Korea's exports confirmed the importance of the economy's robust manufacturing capabilities.

It is also noteworthy that the unemployment rate did not rise during the pandemic, staying at 4 percent even at the peak of the crisis. Unemployment peaked in January 2021 as people returned mostly to normal activities following the reopening of businesses.

We attribute Korea's low unemployment rate during the pandemic to the following factors. First, many people, especially in the services sector, voluntarily left the job market so as to "wait out" the COVID crisis, while firms maintained employment levels backed by government subsidies.

Second, because employment was maintained, consumption remained steady, which supported the subsequent economic rebound and jobs growth. So, while Korea's "inflexible" job market has seemed a hurdle to increasing productivity and long-term growth, this very quality might have helped its economy through the pandemic crisis.

We acknowledge that supportive fiscal and monetary policies have played a significant role in this rapid recovery. Fiscal policy, executed through supplementary budgets, propped up the social safety net, and the government-led increase in consumption in turn helped domestic consumption. Meanwhile, the Bank of Korea's rate cut allowed companies to increase investment during the pandemic; facility investments have grown by an average 9 percent for the last six quarters.

However, not all the liquidity released to help the economic recovery was used to positive ends. The additional liquidity injected during the pandemic contributed to a rise in real estate and asset prices, as consumers took out loans at low interest rates and invested in assets, rather than using the funds for consumption. We believe that this speculative trend needs to be brought under control in an appropriate manner; otherwise, it could develop into an asset bubble more quickly than expected.

We also note that while the expansion of liquidity does not always increase inflation, it does make higher inflation more likely. Some economies that provided liquidity through quantitative easing (QE) following the global financial crisis in 2008 did not experience inflation. However, in the long run, liquidity has been found to lead to higher asset prices and costs, and therefore higher inflation.

Because of Korea's experience with the 1997 Asian financial crisis, there remain concerns that the foreign exchange market and foreign capital outflow could be factors in the course of future economic crises. However, despite the fact that the Korean won appreciated during the pandemic and foreign investors have sold stock valued at over 28 trillion won on the KOSPI to date in 2021, the financial markets in Korea did not falter.

We believe that the country's solid foreign reserves, continuing its current account surplus, and profits from overseas assets prevented a repeat of the Asian financial crisis, and we think that this resilience will be sustained going forward.

The Bank of Korea is now working towards normalizing monetary policy to control rising household debt, by controlling the liquidity released into the market. Given the large scale of liquidity released to fight the pandemic's impact, we would warn investors to expect a similar level of pain during normalization.

Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI).