South Korea: Risk Assessment
Business Climate Rating1
Stable growth in 2012 but below potential
The economy slowed in 2011 because of the international trade slowdown, the end of the restocking process and the tightening of economic policies, which particularly affected the heavily indebted households and SMEs. Growth is expected to remain stable in 2012 and investment is expected to perform well, particularly in electronics and automotives, due to the high rate of production capacity utilisation. Nevertheless, the construction sector is expected to continue to slow, with SMEs in the sector being especially weak. Private consumption, the main driver of growth, will benefit from the fall in inflation and will support retail sales. However, households remain significantly indebted (at 125% of their disposable income). Exports - which represent nearly 50% of GDP - will remain at a satisfactory level, particularly those to China, South Korea's main trading partner. However, the structure of South Korea's economy will continue to be a two-speed one with dynamic conglomerates - the chaebols - co-existing with a low-productivity service sector. Moreover, the issues of corruption and the transparency of the chaebols, characterised by family control and hereditary succession, remain important.
Solid financial position
As to public finances, the fiscal surplus is expected to grow further in 2012 due to the tightening of fiscal policy. Public debt will thus remain sustainable. As regards external accounts, the current account surplus fell in 2011 due to the decline in exports to Europe and the production line disruption caused by the tsunami in Japan. The surplus is likely to remain stable in 2012, with the slowdown in exports to the eurozone offset by increased sales to dynamic Asian emerging countries. In this context, foreign exchange reserves will remain at satisfactory levels, making the country able to withstand sudden capital flight.
The banking sector was affected by deposit runs from eight mutual savings banks in 2011. These savings banks were mainly exposed to the construction sector. The authorities reacted by suspending the operations of these banks and protecting deposits. They then created an asset management company in charge of restructuring the non-performing loans. Despite this crisis, the systemic banking risk is still contained, as is shown by the satisfying capitalisation ratio, the low level of non performing loans and the reduction of the banks' short-term external debt. However, the quality of the loans granted to SMEs, which account for 45% of the banks' portfolios, needs watching. Finally, in view of the significant volatility of portfolio investment flows, the authorities have strengthened capital controls. Besides macro-prudential regulations intended to limit risk-taking by South Korean banks tempted to engage in short-term borrowing on international markets (for purposes of investing massively in the won futures market), the authorities have introduced a tax on investments by non-residents in the domestic bond market.
Risks of heightened tension with North Korea
After the artillery attack by North Korea on the South Korean island of Yeonpyeong in November 2010, disputes sharply worsened in the Korean peninsula. Moreover the death of Kim Jong Il and the ascendancy of his son, Kim Jong Un, open up an uncertain transition period. In this context, tensions could remain intense in 2012. Resumption of the six-nation negotiations on the North Korea's nuclear programme seems highly unlikely at this juncture.
Although criticised for his handling of relations with North Korea, President Lee Myung-bak is credited with effective management of the economic crisis and will likely remain in power in Seoul through December 2012. Despite gains made by the Democratic Party in the April 2012 legislative elections, the Saenuri Party (in power since 2008) succeeded in keeping a parliamentary majority. This sets the stage for the presidential election in December and the voting in of a new incumbent with Lee Myung-bak barred from running again. Although economic policy continuity is expected to remain on track, this electoral year will nonetheless be marked by increased welfare spending to counter the growth of inequality that has become more pronounced these past ten years.
- Diversified industrial base
- Leader in quality electronics
- Effective educational system
- High public spending on R&D
- Increased South Korean investment in China, Vietnam and India
- Iron, steel and textile industries affected by Chinese competition
- Scale of raw materials imports
- Over-indebtedness of households and small companies
- Aging of the population
- Transparency problems of chaebols characterised by family control and hereditary succession
- Unpredictability of the North Korean regime