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By Park Chong-hoon
South Korea's economy faces various challenges, such as rising inflation, falling real wages, a persistent trade deficit and a weakening real estate market, but the overriding concern for the market is Korea's declining exports to its key trading partner, China.
Korea's economic recovery in the second half of the year will be closely tied to China's post-reopening rebound, according to market economists and the Bank of Korea. So far, the expected positive effects of China's growth on Korea's exports and tourism have been limited, likely due to geopolitical tensions between the two countries and Korea's efforts to strengthen ties with the U.S. and Japan, potentially excluding China from its supply chain network in the process.
While concerns about the weak impact of China's post-reopening rebound on Korea are valid, we think the current weak economic link with China is likely influenced largely by the business cycle and structural trends rather than geopolitical tensions between the countries. The slowdown in Korea's exports to China, which mainly comprise inputs for China's manufacturing, is partially attributable to the decline in China's own exports to the U.S. and EU, and to a cyclical downturn in the IT sector. We think Korea can still benefit from China's recovery ― even if less than expected ― given the fundamental synergies between the two economies. As such, the current elevated market pessimism on the China issue is not warranted, in our view.
First, it is important to recognize that Korea is not alone in facing an economic slowdown. Globally, economies, including Korea, are facing challenges as a result of liquidity tightening by global central banks in an effort to correct record-low interest rates, which were eased during the pandemic. Ample liquidity and constrained production drove up inflation to concerning levels, prompting global central banks to hike interest rates to alleviate inflation, thus leading to a decline in asset prices worldwide.
Second, after reopening, China's growth is driven more by domestic demand ― particularly in services consumption and investment ― than the external sector. Consumption has rebounded rapidly, especially in face-to-face sectors such as restaurant services and retail cosmetics, while investment continues to grow on increased government support. On the other hand, its exports have been relatively sluggish, with the improvement in March and April likely driven by the fulfillment of backlog orders and temporary reopening effects.
This adds to our view that the slowdown in Korea's exports to China is due less to geopolitical tensions and more to global recessionary effects and the IT sector downturn. Korea exports a majority of its semiconductor production to China, which uses it to produce high-tech and electronic products for exports. As mentioned earlier, a key underlying reason for the drop in China's semiconductor imports from Korea is the slowdown in China's own exports to the U.S. and Europe.
Third, contrary to market fears, we think China will not resort to economic retaliation for its geopolitical differences with Korea, considering China's still-heavy reliance on exports and its trade links with the U.S., Japan and Korea. Rather, China and Korea can benefit mutually from fostering their economic relationship. China remains Korea's major strategic trading partner despite Korea's efforts to strengthen ties with the U.S. and Japan. Moreover, Korean companies' recent collaborations with China's battery material companies highlight the countries' ongoing economic cooperation in this strategic sector.
We think it is time to tone down the pessimism about Korea's economy, as business sentiment has a crucial impact on corporate strategic direction and decision-making, and excessive pessimism runs the risk of becoming a self-fulfilling prophecy. Korea's current economic slump is likely driven chiefly by the business cycle, rather than fundamental or geopolitical factors. Its external economic challenges and the domestic real estate downturn are primarily a result of rate hikes aimed at curbing inflation, in our view. Expectations of future rate cuts should support sentiment and ease the decline in real estate prices, easing concerns about financial stability.
In the medium to long term, Korea needs to address the issue of its weakening trade with China as a result of China's changing economic model and slowing growth rate. It can do this by diversifying exports to other markets and reducing its dependence on China, continuing to foster economic cooperation with other countries and capitalizing on industry collaboration opportunities with China.
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).
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