EARLIER this month, when the Bank of Korea (BOK) revised downwards its economic growth estimates for the first quarter, some observers saw little reason for concern. Exports were continuing to do well, and after chalking up a remarkable nine straight quarters of positive growth, the economy in general seemed to be on a sound growth track.
A closer look at the first-quarter data, however, suggests that things may not be as rosy as they seem. The South Korean economy faces important structural problems, and if they are not handled carefully they could become increasingly important impediments to future growth.
The country’s gross domestic product grew a revised 1.3 per cent in the January-March period from the previous quarter, slightly lower than an earlier 1.4 per cent estimate. Even so, it was the highest quarterly gain in three quarters, according to BOK. Compared with a year earlier, the economy expanded by 4.2 per cent.
The problem with this rosy picture is that almost all the growth is coming from exports, while the domestic economy remains in the doldrums.
In recent months major South Korean chaebols, or conglomerates, such as Hyundai Motor and Samsung have gained against their Japanese rivals as a strong Japanese yen and a weak South Korean won have boosted sales. Exports, which are equal to almost half of GDP, gained 4.6 per cent in the first quarter compared to the previous three months. This was significantly better than an expected 3.3 per cent expansion, and has encouraged some observers to hail the resilience of the economy in the face of adversity.
However, private consumption, which accounts for about 60 per cent of GDP, is slowing. In the first quarter of the year, this indicator grew by only 2.8 per cent from last year, sliding from an average of 4.1 per cent last year. The problem has been developing for some time. Last year, Hyundai Motors’ foreign sales figures jumped by 18 per cent, while domestic sales declined by 6 per cent.
Further complicating the picture is the need to raise interest rates to combat inflation at a time when debt servicing is already eating into household incomes.
Consumer prices rose 4.1 per cent last month from a year earlier, the fifth straight month that inflation had exceeded the central bank’s 2 to 4 per cent target range. On June 10, the BOK responded by raising interest rates for the third time this year. The benchmark seven-day repurchase rate now stands at 3.25 per cent, up from 3 per cent, following increases in January and March.
Opinions on the wisdom of this latest move vary widely. Critics note that official statistics show that household debt has reached 146 per cent of income, exceeding levels in the US at the height of the sub-prime mortgage crisis. An editorial in the Joong An Daily on June 13 warned that further rate rises “could trigger insolvencies and throw cold water on the slowly improving real estate market”.
Others argue precisely the opposite. Mr Erik Lueth of the Royal Bank of Scotland told the Financial Times earlier this month that the high household debt should be “a key motivation” for raising rates in order to prevent the problem becoming worse. Household debt rose 9 per cent last year.
What everyone seems to agree on, however, is that disposable income has declined. Savings now stand at less than 3 per cent of income, down from 25 per cent in the early 1990s. The gap between the rich and the poor has also widened. In other words, the country has become increasingly prone to externally generated cyclical shocks, with little depth in domestic consumption to fall back on.
Many South Koreans blame the nation’s highly profitable chaebols for the problem, accusing them of squeezing the small and medium-sized enterprises from which they purchase components. Foreign competitors also point to what they see as official policies designed to favour the export-oriented chaebols by keeping the won cheap at the expense of domestic-oriented firms and household income. “This policy is unsustainable now that inflation and oil prices are moving higher,” says UBS economist Duncan Wooldridge. “Policy cannot favour exporters for ever.”
President Lee Myung Bak says he wants the chaebols to share their wealth with the rest of the economy, particularly the small- and medium- sized businesses that employ 90 per cent of the workforce. But the fact that he pardoned Samsung billionaire Lee Kun Hee in 2009 after the latter’s conviction on corruption charges, and followed this up in August last year by pardoning several other senior Samsung figures, has encouraged scepticism.
Since January, the government has imposed price controls and even tolerated a mild currency appreciation to help stem the rising cost of living. But the basic structural problems facing the economy have yet to be addressed in any systematic way.
If left unaddressed, these imbalances will eventually have a significant impact on macroeconomic growth.
Copyright © 2011 Singapore Press Holdings Ltd