South Korea: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified industrial base
- Leader in high-end electronics
- Highly successful educational system
- High public R&D spending
- Increased Korean investment in China, Vietnam, and India
- Steel, textile and shipbuilding industry affected by Chinese competition
- Weight of commodities imports
- High level of household and small business indebtedness
- Aging population
- High youth unemployment despite successful education system
- Unpredictability of the North Korean regime
- Weight of chaebols in the economy
Although down slightly, growth is expected to remain robust in 2018 thanks to exports and budget support. The demand for semiconductors should continue to push exports, thus the secondary sector and South Korean industrial conglomerates (chaebols). The Olympic Winter Games in Pyeongchang, as well as an agreement on improving diplomatic relations with China, has the potential to boost tourism receipts. The contribution of exports could nevertheless be lower than in 2017 with the slowdown of activity in China. Stricter regulation on mortgages should weigh on investment in construction. In addition, despite the opportunities offered by the ICT sector, rising labor costs, especially if not accompanied by productivity gains, and corporate taxes could lead to a deceleration of private investment. Nonetheless, the more expansionary fiscal policy should promote growth. An increase in public employment, the minimum wage, and social spending is expected to support consumption that will remain constrained by the weight of household debt (155% of disposable income) and low employment growth, particularly among the youth.
Inflation is expected to stabilize around the central bank target (2%). This logic underpins the decision of the latter, in November 2017, to increase by 25 basis points its key interest rate, the first hike since 2011. The monetary policy is expected to remain accommodative in 2018, to avoid strangling the consumption of highly indebted households. Rising tensions with North Korea, which would erode consumer and business confidence, pose a risk to growth.
The Budget Surplus Persists Despite Stimulus
The budget surplus is expected to shrink as a result of the expansionary policy. The government’s payroll is expected to swell with the hiring of 9,500 additional civil servants. The increase in the minimum wage, various subsidies to reduce inequalities and financial support to SMEs will also weigh on spending. The growth of this spending in the social field will be partially offset by a decline in infrastructure spending. In order to respond to the North Korean threat, the defense budget is also rising. The maximum corporate tax rate, up from 22% to 25% will contribute to higher tax revenues. Public debt, which is lower than that of its OECD peers, is expected to remain stable and low risk. On the other hand, household debt, which continued to rise in 2017, is a source of concern.
In 2018, the current account surplus is expected to stabilize. The balance of goods is likely to remain in surplus, although export growth would be slightly lower than that of imports. The steadying of relations with China is expected to allow the flow of tourists to stabilize after having plummeted in 2017. The service deficit is not anticipated to widen in 2018 and could even be reduced thanks to the Winter Olympic Games. Negligible, the primary and secondary income balance should not weigh on the evolution of the current account.
Foreign exchange reserves will remain at a comfortable level, while the rise in the central bank’s key interest rate should help mitigate the risk of depreciation induced by capital flight, following the tightening of the Fed’s monetary policy.
Moon Jae-In Facing the North Korean Threat
Following the dismissal in March 2017 of Park Geun-Hye, embroiled in a corruption scandal, Moon Jae-in (Democratic Party) was elected President with an economic programme to stimulate growth, initiate social reform and reduce the influence of the chaebols. After nearly 10 years of a Conservative presidency, and despite the circumstances of the election, the transition was smooth. However, with only 40% of seats in the National Assembly, the President may encounter difficulties in passing some laws.
The aggressive attitude of North Korea, which was marked by new nuclear tests in 2017, will be the chief risk to political stability. Despite Moon Jae-in’s calls for dialogue, the threats of the Pyongyang regime against Seoul continue to fly. While visiting South Korea in November 2017, President Trump reaffirmed the bilateral security alliance between the United States and South Korea. The deployment of the US THAAD anti-ballistic missile defense system, completed in September 2017, illustrates the importance of this support and the worsening of the North Korean threat. Highly criticised by China, the installation of this system has been at the origin of a deterioration of diplomatic relations with the Middle Kingdom. However, even though China’s position on THAAD has not changed, they have been in the process of normalizing since the meeting between the Chinese and Korean Foreign Ministers at the end of October 2017. A few weeks later, South Korea’s refusal to conduct a military exercise alongside the United States and Japan appeared to be a sign of South Korea’s desire to improve relations with China.