1. Recent Trends
The Korean economy continued to recover strongly in the first half of 2010, growing 7.6% year-on-year. Global economic improvement lifted exports and facilities investment, especially in the IT and the automobile industries, propelling the strong rebound, which was accompanied by further gains in employment, particularly in the manufacturing sector. Still, enough uncertainties persist to prevent an all-clear signal. On the international front, the pace of recovery will very likely slow down due to worries over European sovereign debt risk, a probable tighter monetary policy in China and double-dip recession risk in the US, though chances of the latter are shrinking. Those worries have weakened consumer and business sentiment in Korea just as the effects of its fiscal stimulus to weather the global financial crisis are tapering off. Therefore the faster-than-expected recovery pace in the first half of 2010 is expected to slow down in the second half.
2. Global Economy in the Second Half and 2011
The global economy is projected to grow 4.4% in 2010 thanks to the fiscal stimulus of many countries. But in 2011, growth is forecast to slip to 3.6%. As for the developed world, their government-led growth will likely lose steam as effects from their economic stimulus wears off and the European fiscal crisis lingers. Therefore, advanced countries are forecast to grow only 1.6% in 2011, a sharp drop from 2.5% in 2010.
As for emerging countries, which have relatively sound economic momentum, growth is forecast at 5.7% for 2011, down from 6.4% in 2010. This is mainly because belt-tightening measures will contract their domestic economy. Their exports also will be dented by the expected slowdown in advanced economies.
The US economy is forecast to expand 1.9% in 2011, slowing an estimated 2.6% rate this year. With weak fundamentals in the private sector and concerns over a double-dip recession, President Barack Obama proposed a US$350 billion additional stimulus package recently to reignite the world's biggest economy.
The eurozone economy is expected to grow a mere 1.0% in 2011, down from 1.5% in 2010. Due to Southern Europe's sovereign debt risk and subsequent austerity measures, some countries in the eurozone will inevitably contract, which will likely crimp regional trade.
3. Korean Economy in the Second Half and 2011
The Korean economy sustained growth momentum in the first half of 2010 thanks to the semiconductor and auto industries, which led a rise in overall output. However, in July, production growth in both industries started to decline slightly. The downward trend is expected to continue, which will mean waning exports and investment by the two economic engines. Thus, Korea's economic growth will likely recede to 3.8% next year, down from 5.9% in 2010.
Driven by semiconductor and auto demand, global economic recovery and rising unit prices, exports in 2010 are expected to jump an estimated 25.4% compared to 2009. But in 2011, exports are forecast to rise only 8.5% due to softer global economic conditions and fiercer competition. In 2011, world economic growth will likely be modest due to sluggish US consumption, China's belt-tightening and Europe's sovereign debt overhang. Meanwhile, more leading global companies are expected to emerge from the shocks of the global financial crisis and stiffen battles for overseas market share.
Imports in 2011 also are expected to slow significantly, growing only 12.0%, compared to 31.6% in 2010, which has seen an increase in commodity prices and massive purchases of capital goods for investment. The projected year-on-year plunge in 2011 will be linked to the expected sluggishness of the export-led economy and stabilizing commodity prices.
Accordingly, trade surplus will likely shrink to US$18.2 billion for 2011 from US$30.5 billion this year. Also, the current account surplus is expected to decline sharply to US$15.2 billion in 2011 from US$22.7 billion this year as economic recovery and a slight appreciation of the won would widen the service account deficit to over US$20 billion for the two years.
Facilities investment is expected to jump 20.5% in 2010 but it will likely ebb in the second half as production capability has already been significantly reinforced thanks to expanded machinery investment. In tandem with this slow trend, facilities investment growth for 2011 is forecast to decline to 4.9%. As for the IT industry, the Facilities Investment Adjustment Pressure Index, a leading indicator of facilities investment, has been falling since the second quarter of 2010. Also, the automobile industry is expected to be more focused on overseas investment rather than spending at home as the domestic market will likely soften due to the base effect following a boom in 2010 and drop in new models. Considering that the two industries represent 55% of the manufacturing sector's facilities investment, an overall reduction in facilities investment is inevitable. The expected slowdown in export growth in 2011 also would be a drag on facilities investment.
Meanwhile, due to a delayed recovery in the housing market, private construction investment will likely continue to be tepid in 2010, growing at a mere 0.2%. Construction investment, however, will likely rise 1.4% in 2011 on the back of continued civil construction investment by the public sector and resumption of building construction. Although growth in construction investment will be limited due to a scaling down of government social infrastructure investment, civil construction investment by the public sector, especially large government projects (e.g., four rivers restoration project), will likely continue. Although construction of low-price apartments should lift sentiment in residential construction, a large backlog of unsold new apartments will likely remain a hurdle. Non-residential building construction will grow slightly thanks to improving leading indicators such as construction orders and the amount of land permitted for construction. But high office vacancy rate will likely e xert negative pressure.
4. Consumer Prices and Employment
Consumer prices are forecast to climb 3.0% year-on-year in the second half of 2010. Rising public utility charges are exerting inflationary pressure while grain prices remain high due to crop damage caused by abnormal climate and reduced exports by major grain producers. A possible La Nina weather phenomenon in the southern hemisphere in late 2010 and early 2011 also threatens to further damage global grain supplies.
In 2011, consumer prices are forecast to rise by 2.8% due to slower economic recovery and eased inflationary pressure coming from overseas. Demand-pull inflationary pressure will probably subside next year as consumer sentiment and private consumption eases. Appreciation of the won and downward stabilization of oil prices will also blunt inflationary pressure.
The job market clearly has improved in 2010. In the first eight months of the year, the number of employed increased 317,000 on monthly average from the same period a year ago. However, the hiring pace will likely slow in the second half. Job creation in the public sector will fall as the government's Hope and Work project, a government-led initiative to provide jobs to low-income households, ends, while manufacturing employment, which has led recent job creation, will fall as export and facilities investment slow, suggesting lower job creation capacity in 2011.
5. Interest Rates and Won/dollar Exchange Rate
Market rates, in terms of AA- corporate bond yields, are projected at 4.8% in the second half of 2010, similar to the first half's 4.9%. Higher consumer inflation in the second half will produce upward pressure on interest rates, while risk aversion from the uncertain outlook in the global economy and foreign investors' steady bond purchases will exert downward pressure.
In 2011, market rates are projected at 5.1% on average, slightly up from 4.9% in 2010. With additional rate hikes in 2011, interest rates are projected to inch up. Any interest rate hike is likely to take place within a limited range, because inflation is contained so far. Furthermore, aggressive interest rate hikes in fear of an economic slowdown are unlikely. Moreover, as major economies such as the US, the EU and Japan delay their stimulus exit strategies and maintain low interest rates, foreign investors who try to capitalize on the difference in interest rates in and out of Korea are expected to continue purchasing Korean bonds.
The won/dollar exchange rate is expected to decline slightly in the fourth quarter of 2010 and in 2011. In 2011, the average rate is predicted to fall to 1,110.0, down from 1,158.0 in 2010. Probable factors pushing up the won's value are a weak dollar, gradual appreciation of the yuan, the won being undervalued and Korea's current account surplus. The US Federal Reserve is maintaining a loose monetary policy to accommodate the fragile US economy and the government prefers a weak dollar to bolster export competitiveness. Yet any drastic appreciation of the won is unlikely. The government's possible promotion of additional measures to raise foreign exchange market soundness and risks on Korean peninsula will limit the won from strengthening too sharply. Externally, concerns of slowdown in US and Chinese economy and Europe's sovereign debt crisis will limit the won's strength.
6. Policy Suggestions
As the Korean economy snaps back quickly after being battered by the global financial crisis, it is forecast to grow 5.9% this year and 3.8% - close to Korea's potential growth rate - in 2011. However, it is too early to say that the Korean economy has completely put the global financial crisis behind it. The Korean economy saw its long-term growth rate slump after the 1997 Asian financial crisis. The prospect of Korea's economy being thrown into the same situation in the face of another financial crisis is not altogether unlikely. Korea, whose average economic growth was 4.4% over the period from 1998 to 2008, is predicted to see 3.3% average growth in the period from 2009 to 2011. The government's stimulus that has spearheaded the economic recovery is being scaled back. Furthermore, there is considerable uncertainty whether growth momentum in the private sector will replace the government's contribution to the economy.
Thus, an exit strategy that includes fiscal prudence and interest rate hikes should be approached cautiously. After enjoying a strong rebound compared to other nations, Korea now is under rising pressure to pre-empt inflation by increasing its benchmark interest rate, which was at a record low 2.0% for 17 months before it was raised to 2.25% in July this year. However, rate hikes could magnify interest burdens if the Korean economy slows down as anticipated. Therefore, any departure from the monetary easing policy should be carried out in stages.
-seriworld.org