Korea Pointing the Way Downward - August 9, 2006
By Stephen S. Poloz, Senior Vice-President, Financing Products Group, Export Development CanadaThe South Korean economy is often seen as a global bellwether. Accordingly, signs of a slowdown in Korean economic growth should be taken seriously by businesses sensitive to the global business cycle.
Korea’s economy slowed to 0.8% growth in the second quarter of the year, down from 1.2% in the first quarter, which was down from 1.6% per quarter during the second half of 2005. Compared to a year ago, the economy is growing at a rate of 5.3%, but it is clear that momentum has eased considerably. To illustrate, even if the economy doesn’t slow any further for the remainder of the year, annual growth will slide to just 3.5% by year end.
The slowdown is being led by household spending, and is most evident in construction activity, which is in full contraction. The reasons? First, interest rates have been hiked by a full percentage point since last October in order to pre-empt the emergence of inflationary pressures. The economy is in good shape, with unemployment around 3.5% and inflation at about 2.5%, but the authorities are concerned that higher oil prices will create an inflation problem down the road.
Indeed, Korea is one of the largest importers of oil in the world. The import bill accounted for 6.5% of Korea’s GDP in 2005, more than double its level just two years earlier. The total oil bill rose by more than 20% in 2005, and will be even higher again in 2006. This is forcing consumers to spend less on other goods and services, and is the second reason for the slowdown.
Meanwhile, Korea’s exports remain strong, up 19% in June compared to year-ago levels. While this offers some comfort that the economy is not falling into recession, export growth is much slower than the rates of 30-40% seen just 12-24 months ago. Exports to China, which were growing at a rate in excess of 50% during 2004 and into 2005, have slowed to a pace of 12% in the first half of 2006. Assuming China’s efforts to slow its economy further succeed – and indications are that the authorities are absolutely determined to bring this about – then Korea’s exports will slow even further. China represents more than 20% of Korea’s foreign sales.
Korea’s unique position as a major exporter to both the U.S. and China and a major importer of oil mean that all of the big forces acting on the world economy are hitting it head-on. This has been true for past fluctuations in the world economy, too. During the global slowdown of 1997-99, Korea was naturally one of the leaders, since the Asian crisis was a key ingredient of the downshift. Similarly, Korea’s recovery in 1999-2000 preceded global recovery by a couple of quarters. But Korea’s slowdown in 2000-01 also preceded the global moderation, and its recovery in 2002-03 was also a leading indicator for the world. Accordingly, its new slowdown is very likely a harbinger of slower growth at the global level, once again.
The bottom line? There is little reason to expect anything more than a moderation of growth in Korea, and therefore in the world more generally. But the balance of risks has clearly shifted to the downside, and Korea should be monitored for hints about how low growth might go.
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