South Korea: Risk Assessment
Business Climate Rating1
Slightly faster growth in 2014
In 2013, the activity bounced back, supported by export growth, especially to the US and the EU. This trend should be sustained this year in a context of world growth acceleration. Nevertheless, Korea is exposed to a Chinese slowdown. Exports to China account for ¼ of Korean exports and mainly concern semiconductors and components for mobile phones and cars. Strengthening the economy is at the heart of the government’s program, and loose monetary policy is combined with fiscal stimulus. Moreover, the government intends to design a reform of the labor market and a support mechanism for SMEs, to encourage research and entrepreneurship, and to increase social transfers. This program follows the April 2013 stimulus which consisted in measures to support the construction sector and the SMEs. Hence, Korean activity has been sustained by the improvement in the construction sector. However, private consumption remains sluggish - penalized by the decrease in consumers’ confidence. The Sewol sinking in April 2014 caused the death of nearly 300 people and impacted consumers’ behavior. Growth in retail sales has strongly diminished, coming to only 1% in May 2014 year on year. Furthermore, the high level of household indebtedness (166.5% of disposable income in 2012) weights on consumption. This phenomenon is reinforced by the slowdown in growth of disposable income.
As far as prices are concerned, inflation is currently under the central bank’s target, allowing monetary policy to remain accommodating.
Finally, the South Korean economy will continue to be a two-speed one, with dynamic industrial conglomerates - the chaebols– co-existing with a low-productivity services sector. And there are still important issues regarding corruption and the transparency of the chaebols, characterised by family control and hereditary succession.
Financial situation under control
The 2014 budget, the first since Park Geun-hye came to power, provides for a significant rise in spending associated with improving the social security system and supporting the local authorities. Spending will therefore rise and we will see a slight deterioration in the fiscal deficit. Public debt levels will remain sustainable and well below those observed in other OECD countries. Nevertheless, the debt held by state-owned enterprise needs to be monitored: it reached 30.9% of GDP in 2012. The new government team is planning to increase public service charges to help bring down the debt of state-owned enterprises.
Regarding the external accounts, export growth combined with a slowdown in imports will positively impact the current account, which will display a positive balance. In this context, reserves will remain at a satisfactory level, making the country resistant to sudden stop in capital flows. Meanwhile the won has not been overly affected by the US Federal Reserve’s announcement of the possible end to Quantative Easing III in summer 2013 and continue to progress against the yen and the dollar. This is explained by the robustness of the country’s current account surplus and capital controls introduced in 2012. Finally, high household debt levels are a risk for the banking sector.
Risks of heightened tensions with North Korea
Park Geun-hye arrival in power has resulted in a relative easing in relations between the two Koreas. The new South Korean president differs from his predecessor in her wish to enter into dialogue with Kim Jong-un, the new North Korean leader. However, tensions are likely to persist, in particular over North Korean nuclear ambitions. North Korea fired missiles into the sea off the east of the Korea peninsula in March and April 2014. Recurrent threats made by North Korea demonstrate the instability of relations between the two countries.
Regarding domestic politics, new social unrest is to be predicted, especially because of the precarious status of many workers. Moreover, the President has been strongly criticized for his management of the Sewol sinking. A new government is soon to be approved by the Parliament, as the Prime minister resigned after the sinking. Despite the party’s short victory in the local elections of June 2014 and despite the critics addressed to the President, the country’s stability shouldn’t be reconsidered.
- Diversified industrial base
- Leader in quality electronics
- Excellent education system
- High public spending on R&D
- Growing Korean investment in China, Vietnam and India
- Steel, textiles and naval industry affected by Chinese competition
- High import content of raw materials
- High-indebtedness of households and small businesses
- Aging population
- Problems regarding transparency of the chaebols, characterised by family control and hereditary succession
- Unpredictability of North Korea’s regime