Weakness in exports has put the South Korean economy under stress. And though consumer finances are currently good, high household debt could curb further growth in consumer spending.
The South Korean economy is currently under stress due, in large part, to weakness of exports. Indeed exports declined every month so far in 2015. The US dollar value of exports was down 7.8 percent in May versus a year earlier.1 Moreover, the outlook for exports appears weak. New export orders have been declining, boding poorly for future growth of exports. This is important given that exports account for roughly half of GDP and have traditionally been an important source of growth for the Korean economy. In fact, for the past decade consumer spending has consistently grown more slowly than overall GDP.2 Instead, the economy has relied on the strength of exports to drive economic growth. Exports have driven the industrial sector. Notably, industrial inventories continue to rise relative to sales, thus boding poorly for future increases in production.
The weakness of exports is related to two important factors: First, the slowdown in China’s economy has had a negative impact on demand for Korean goods, second, the decline in the value of the Japanese yen has boosted the competitiveness of Japanese exports at the expense of those from Korea. Exports have an important impact on the willingness of Korean businesses to invest in new capacity. A weak export environment is likely to suppress business investment. On the other hand, if Korean companies perceive a permanent loss of competitiveness due to exchange rate movements, they may choose to invest in order to boost efficiency and drive more innovation.
Given the weakness of exports, the strength of the domestic side of the economy becomes of paramount importance. On this, there is some good news. A combination of lower oil prices, expansionary monetary policy, and increases in government spending are having a positive impact on consumer finances. Real personal income is increasing and it is leading to accelerated growth of retail spending. On the other hand, household debt is now about 150 percent of disposable income, a relatively high level. This is likely to be an impediment to further growth of consumer spending.
While it appears likely that growth in 2015 will be slower than in 2014, the outlook beyond will depend on a number of factors. First, the slowdown in China has already taken a toll on Korean exports and investment. What happens in China will influence the path of Korea’s economy. Korean manufacturers play a role in China’s export-oriented supply chain. They also supply China’s domestic market. The outlook for both remains somewhat uncertain.
If the price of oil remains low or moves even lower in the coming year, this will be especially beneficial to consumer spending—and vice versa.
Second, the price of oil will make an important difference as well. If the price of oil remains low or moves even lower in the coming year, this will be especially beneficial to consumer spending—and vice versa.
Third, Korea exports a great deal to Europe and the United States. The trajectory of both economies will play a role in the outlook for Korean exports and, consequently, Korean GDP.
On the other hand, the growth of the consumer sector will likely play a more modest role in the outlook for Korea. In recent years, consumer spending has grown more slowly than GDP. This is likely to continue, especially due to debt constraints on consumers. Nonetheless, a tight labor market with rising wages should be beneficial to the consumer sector.
On the positive side, government debt as a share of GDP is modest, and the budget is nearly in balance, thus providing ample room for more fiscal stimulus if needed. External debt is low and the country runs a current account surplus. The latter is important as it means less vulnerability to volatile capital flows. It also means greater ability to absorb the impact of rising debt should the government engage in more fiscal stimulus.
Monetary policy has been relatively easy in the past year, with the central bank having cut interest rates several times. The benchmark rate, at 1.75 percent, is now at an historic low. Further easing is unlikely in the short term unless the economy slows further. Inflation is under control, at a little more than 1.0 percent, so there is certainly no need for tightening anytime soon. Moreover, the currency, although having risen against the yen, remains relatively low valued. When the US Federal Reserve tightens policy later this year or early next year, it is likely that the US dollar will rise, putting downward pressure on the Korean won.