According to the Bank of Korea (BOK)'s latest data, South Korea’s GDP rose by just 0.3% in Q3, the slowest quarterly growth seen in a year. At the same time, exports, which account for half of the country’s GDP, fell 5.7% year-on-year in October, the biggest drop in two years.
Furthermore, the South Korean won fell to the weakest level in 13 years, the country’s corporate debt is nearing a record high, and household debt rose to record levels and is the highest among major economies. The collective decline of these key indicators highlights the unprecedented slump in South Korea’s economy.
South Korea’s economy is mainly export-driven but this segment has been severely suppressed amid the ravaging Covid-19 pandemic as global supply chains are disrupted...
Declining profits as exports hit
South Korea is a typical economy controlled by plutocrats, or the chaebol (a group of massive, mostly family-run business conglomerates). The country’s top ten chaebols including Samsung, Hyundai Motor Company and SK Group account for about 70% of South Korea’s GDP, but the heyday of these industry giants seems to be ending.
Samsung’s Q3 net profit fell 23.6% year-on-year, while its operating profit declined for the first time in three years by 31.4% year-on-year. The struggling micro markets will inevitably drag down the macroeconomic indicators; hence, the International Monetary Fund (IMF) revised down its forecast for South Korea’s 2022 GDP from 2.5% to 2.3% in its latest World Economic Outlook report.
South Korea’s economy is mainly export-driven but this segment has been severely suppressed amid the ravaging Covid-19 pandemic as global supply chains are disrupted, and developed economies such as Europe and the US, which have close trade relations with South Korea, are showing signs of recession.
At the same time, the US Federal Reserve’s aggressive interest rate hikes this year have dealt a big blow to the won and pushed up import costs. The increased cost of imported raw materials is then passed on to export products, diminishing the country’s export competitiveness and widening its trade deficit. The latest data show that the country’s accumulated trade deficit has exceeded US$30 billion, the highest compared with the same period from previous years.
The BOK’s interest rate hikes are in part aimed at safeguarding the stability of the country’s currency market, but the won has continued to tumble.
Depreciating currency and rising inflation
The dire economic situation is aggravated by inflation, as the country’s consumer price index rose 5.6% year-on-year in September. In turn, the Engel coefficient, which measures the proportion of money spent on food in household expenses, reached its highest in 21 years at 12.86% in 2021.
The BOK raised its base rate by 25 basis points (bps) to 3.25% during November, the highest in ten years, and the ninth increase since August 2021 when the central bank began rolling back over a year of its accommodative policy. While the rate hikes seem to have eased inflation, the BOK expects imported inflation, mainly stemming from food and energy, to remain in the 5-6% range for quite some time.
The BOK’s interest rate hikes are in part aimed at safeguarding the stability of the country’s currency market, but the won has continued to tumble. So far, the currency has depreciated over 17% against the dollar this year, hitting a 13-year low and becoming Asia’s worst-performing currency apart from the Japanese yen.
As the won’s significant depreciation would also accelerate international capital withdrawal, the BOK has sold billions of its foreign exchange reserves this year to defend the exchange rate, reducing its reserves to US$414.01 billion in October, the biggest fall in nearly 14 years. Also, the country has sold nearly US$20 billion of its US Treasury bonds, cutting its holding to US$112.3 billion.
Tumbling stocks and rising debts
Adding to South Korea’s looming currency crisis is the tumbling stock market. Its benchmark Korea Composite Stock Price Index (KOSPI) plunged from a peak of 3,200 points in June 2021 to about 2,200 points in October 2022, a drop of 30%. Notably, foreign investors owned more than 30% of the total market capitalisation of the domestic stock market. The impetus to short sell amid the won’s depreciation is particularly strong among this group of investors, who accounted for about 70% of short selling by trade on KOSPI in August 2022.
At the same time, as of 2021, one out of an estimated four adults in South Korea is a stock owner. In fact, the country’s population of 51 million owned a whopping 60 million stock accounts. While most stock investors are in their 40s and 50s, 80% of South Korean youths aged between 20 and 30 also invest in stocks, funds, cryptocurrencies or other assets.
Warning signals from the country’s bond and debt markets could send shockwaves through the international society. The IMF recently announced that the South Korean government’s debt-to-GDP ratio would reach 54.1% at the end of this year, an increase of 14 percentage points from five years ago, and 8.5 percentage points higher than the average of over 30 developed economies.
Following the increased interest rates, the country’s 10-year bond yield has risen sharply from about 2% at the beginning of the year to about 3.77% currently, hitting a maximum yield of about 4.65% at one point. The BOK estimates that for every 0.5 percentage point increase in interest rate, the annual interest burden increases by about 6.6 trillion won (US$4.8 billion).
More importantly, South Korea’s commercial paper collections have risen to their highest in 13 years, with 115.2% leverage on debt for non-financial companies.
Indeed, the final impact is a culmination of multiple factors. A greater pressure than repaying national debt is corporate credit debt. Recently, Gangwon Jungdo Development Corporation missed its 205 billion won debt payment and was declared bankrupt by the Korea Financial Telecommunications and Clearings Institute.
Many companies in South Korea issue asset-backed commercial papers — construction companies alone support such tools to the tune of 2.6 trillion won. More importantly, South Korea’s commercial paper collections have risen to their highest in 13 years, with 115.2% leverage on debt for non-financial companies. The figure was at 110% before the Asian financial crisis, and rose to 116% as it hit.
Notably, the latest figures show that current household debt in South Korea is at the highest level on record at 1.87 trillion won. According to the Institute of International Finance (IIF), household debt stands at 104.3% of GDP, which makes South Korea the highest-ranked of the world’s 36 major economies (with the Eurozone counted as one entity) for household debt relative to the national economic scale.
With rising debt servicing rates, falling property prices and a weak stock market, a nationwide debt storm is brewing in South Korea.
Data from the IIF also reveal that nearly three-quarters of South Korea’s household wealth is linked to real estate; among those with debt, young people aged 20 to 30 years old owed over ten trillion won. With rising debt servicing rates, falling property prices and a weak stock market, a nationwide debt storm is brewing in South Korea.
South Korea’s economy is known as the “canary in the coal mine”, referring to the early industrial era when canaries were sent into coal mines to detect high concentrations of poisonous gas. This vivid analogy shows that South Korea’s economy is especially sensitive to global changes. While it is true that the country’s current predicament is in the context of global tightening of currency policy, a downturn in the world economy, and geopolitical tensions, it is also being projected to many countries in various ways.
No lack of opportunities to recover
Notably, there is no lack of opportunities for South Korea to recover through domestic measures.
First, the BOK still has room to manoeuvre in its controls. Since the 2000s, South Korea’s interest rate peaked at 5.25%, which is still 2.0 percentage points higher than the current rate. While raising interest rates might lead to higher company costs and bond rates, it would also curb inflation, the biggest headwind to economic growth. Besides having the world’s ninth highest foreign exchange reserves, South Korea also has over US$1.7 trillion in overseas financial assets, with ample strength in its toolbox to resist the dominant dollar and protect its own currency.
Second, the robust South Korean economy still has room to expand. With a per capita GDP of US$34,800, South Korea is one of seven economies in the pantheon of the 30/50 club — countries with a population above 50 million and per capita GDP above US$30,000. Furthermore, it was officially recognised as a developed country by the United Nations Conference on Trade and Development a year ago, meaning that it is well-equipped to withstand pressure.
Meanwhile, South Korea’s industrial competitiveness is ranked top in the world, and manufacturing research and development and high-tech industry density ranked second, with tertiary sectors accounting for 61% of GDP. Also, its high industrial distribution provides a strong outlook for the economy.
Clearly, as long as there are no mishaps with the China and US economies, South Korea’s external trade will be able to withstand pressure.
Third, as the tenth largest economy in the world, South Korea’s foreign trade has sufficient strength. It has signed 18 free trade agreements with 58 countries including major economies such as the European Union, the US and China, and continues to push for economic cooperation with emerging markets.
The South Korean government recently announced a strategy of shifting away from bilateral relations with major economies and seeking multilateral economic cooperation. Notably, even amid shrinking global trade in the first three quarters of 2022, South Korea’s trade surplus with its top trade partners China and the US reached US$3.89 billion and US$21.19 billion respectively. Clearly, as long as there are no mishaps with the China and US economies, South Korea’s external trade will be able to withstand pressure.
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