Outlook for Korea's Economy in 2009

I. Current Trends

Economic conditions in the second half of 2008 have deteriorated rapidly. Sluggish domestic demand is leading the downturn with consumer prices already rising by more than 5%. The balance of international payments is also alarming with both the current account and the capital and financial accounts running deficits. In particular, the combination of poor economic performance and external uncertainty is causing steep fluctuations in stock prices, the won/dollar exchange rate and interest rates.

In the wake of an outflow of stock investments and the global liquidity squeeze, the won/dollar exchange rate has soared, fluctuating by 50 won-60 won per US dollar daily despite government measures taken. Market interest rates also have increased significantly. Even though the government has released measures such as a bond market stabilization fund, companies still face difficulty in raising funds as banks (which suffer from worsening financial health) reduce corporate loans. Meanwhile, stocks have tumbled below 1,000 due to the outflow of foreign capital following the shortage in global liquidity and accelerating global economic weakness reflected in dismal corporate earnings.

II. Forecasts

1. Economic Growth

The Korean economy has had two economic slumps since 2000. In 2001, Korea experienced 3.8% growth in the aftermath of the bubble burst in the global information technology sector. The main cause behind the downturn was sluggish exports, which declined as much as 13% due to weakening external conditions. In 2003, the Korean economy grew by only 3.1% mainly due to soaring household debt, which led to negative growth in consumption (-1.2%).

The external and domestic conditions for Korea in 2009 will be a combination of the 2001 and 2003 slumps. SERI forecasts 2009 economic growth at 3.2%, down 1.2 percentage points from our estimate for 2008. Highly fluctuating interest rates, a volatile domestic currency and wavering stock markets amid the global financial crisis will further dampen domestic demand. Exports, which have been a main driver for the nation's economic growth, will also decelerate to single-digit growth as consumers worldwide pull back discretionary spending. Overall, export contributions to economic growth will wither.

2. Private Consumption

Private consumption has significantly froze in 2008. After a rebound in the latter half of 2007, private consumption grew by only 2.9% during the first half of 2008, marking especially low growth of 1.1% in the third quarter. Among the factors that contributed to contracting consumption in 2008 were skyrocketing consumer prices, stagnant employment, tumbling values of financial assets and rising household debt. Except for consumer prices, on which pressure has recently been eased, most factors are hardly expected to improve soon. Thus, private consumption will likely grow by only 1.7% in 2009.

3. Fixed Investment

Facilities and construction investment will also continue to stagnate in 2009. Heightened expectations over the new government's policy lifted facilities investment significantly earlier in the year. However, the side effects of the global financial crisis, surging prices of oil and raw materials and a depreciation of the won derailed any follow through. Accordingly, facilities investment is expected to grow by only 2.3% in 2009 as sluggish exports will shrink investments in the manufacturing sector and financing difficulties for companies will likely have a negative impact on future investment.

In addition, construction investment is also suffering from a burgeoning inventory of unsold newly-built apartments amid a stagnant housing market. Despite deregulation and changes in real estate policy, it would be difficult to expect the housing market to improve soon. Construction investment is forecast to rise by a mere 1.3% in 2009 due to shrinking investments in the private sector. Yet, the sluggish construction sector will be somewhat complemented by the new government's development project of several new regional economic blocs.

4. External Trade

In 2009, major economic contraction in both industrialized and developing countries will cause Korea's export growth to plummet to 3.2%. Exports will drop due to the base effect of high export growth in most of 2008 and as export prices that have enjoyed high increases thus far slow due to price drops of raw materials and oil.

Under these circumstances, exports will contribute less to economic growth. Import growth will plunge more, however, to produce a turnaround in the trade balance to surplus in 2009. The current account, likewise, is expected to post a surplus of approximately US$2 billion.

5. Prices and Employment

The easing of inflation concerns that began in the second half of 2008 as oil prices plummeted is expected to continue in 2009. Any renewed worries would likely spring from internal factors, specifically public-service price hikes (scheduled for 2009) and labor demand for wage increases. Consumer prices in 2009 are forecast to rise 3.2%, 1.6 percentage points lower than expected consumer price growth of 4.8% in 2008.

During 2009, growth in domestic demand will continue to be lackluster, further gnawing into job creation. Temporary and daily workers will face particular difficulties as well as the self-employed. By industry, newly-hired workers will decrease in the manufacturing, construction, wholesale and lodging/restaurants industries while new jobs will show up mainly in certain service sectors such as in business support/individual/public services. The unemployment rate is expected to be 3.5%. 

6. Interest Rates

Similar to 2008, interest rates (in terms of the AA- corporate bond yield) in 2009 is expected be around 7.0%. The sluggish global economy and delayed recovery in domestic demand will hamper the demand for funds. Less worry over inflation, with global raw material prices stabilizing, will also put reduced pressure on interest rate increases. With the global credit squeeze worsening fundraising conditions, however, market rates will face upward pressure, limiting the decline.

As financial markets need more time to recover, the pursuit for safer assets will continue which will further widen the gap between the yields of government and corporate bonds.

With financial institutions facing worsening fundraising conditions, their lending capacity will weaken overall. To weather the global credit crisis, they will also strengthen risk management. Under these circumstances, small- and medium-sized enterprises with weak credit ratings or companies with high debt-to-equity ratios will have extreme difficulties in securing financing.

7. Foreign Exchange Rate

In 2009, the won/dollar exchange rate is forecast to be in the 1,040 won-plus range, lower than an expected 1,092 won average in 2008. Global financial woes are expected to moderate in the presence of both financial rescue packages and liquidity-boosting efforts made by countries across the globe. Foreign investors' net selling of Korean stocks, a cause for the weak won at present, will likely slow. Shrinking domestic demand will push down demand for imported goods and cause the current account to turn to surplus, which will cause the won to appreciate. Although the won will improve, volatility in the foreign exchange market is likely to continue. The repercussions from the global downturn will grind down equities at least through much of the first half of 2009. The volatile global financial market and the ailing global economy may force adjustments in futures hedging positions of shipbuilders and investment management companies that operate overseas funds, which would further affect the foreign exchange market.

III. Implications

Financial turmoil is spreading across the world and the quick spillover to the real economy is being amplified on an unprecedented scale due, in part, to a globalized world economy. In order to minimize the effects of the widespread financial crisis on the real economy, financial institutions should play the crucial role of financial intermediary. Also, the government should make efforts to prop up the struggling real estate market and offset the spread of financial trouble in real estate. By accelerating its plans to bolster domestic demand with tax cuts, deregulation and fiscal spending increases, the government should be able to help mitigate the impact of global headwinds to come in 2009.
- seriworld.org