150710 south korea watch

South Korea Watch Growth subMersion

Group Economics Emerging Markets Arjen van Dijkhuizen +31 20 628 8052

10 July 2015 •

Economic slowdown has continued in recent months, with MERS outbreak hitting confidence and spending

•

Exports suffer from lower external demand, strong won

•

Authorities have reacted with fiscal stimulus and monetary easing, although Bank of Korea remained on hold in July

•

We leave 2015 growth forecast unchanged at 3% for now, following a reduction earlier this year

Economic growth continues its downward slide

terms in April and May by around 2.5% yoy. After having

South Korea managed to overcome the tapering tantrum in

accelerated in recent months, retail sales are likely to have

2013 relatively unscathed. Still, growth started to slow since

cooled recently due to the impact of MERS. Sales in

Q1-2014, falling to a two-year low of 2.5% yoy in Q1-2015.

department stores and discount chains were reported to have

According to the central bank, growth momentum has

contracted by 10% yoy in June. Services industries including

weakened further in Q2. The slowdown is quite broad-based.

tourism seem to have been particularly affected.

Private consumption suffers from high debt levels and falling growth in disposable income, with households savings surging

Export and import growth in negative territory

last year. Meanwhile, investment is hindered by slowing

% yoy

50

exports, hit by falling external demand and the strong won.

15 10

Manufacturing PMI points to further slowdown % yoy

25

8

65

6

60 55

4

50 2

45

0

40

-2

35 08

5

index

09

10

11

Economic growth (lhs)

12

13

14

15

Manufacturing PMI (rhs)

Source: Thomson Reuters Datastream

0

0 -5

-25 -10 -50

-15 08

09 10 11 Current account balance

12

13 Exports

14

15 Imports

Source: Thomson Reuters Datastream

Another stimulus package following a confidence shock South Korea’s public finances are relatively healthy, as the budget shows small surpluses and public debt is around 37% of GDP. This creates room for fiscal stimulus. Last year, the

MERS has hit confidence

government launched a stimulus package after the Sewol ferry

More recently, the outbreak of the Middle East Respiratory

incident hit confidence.The story repeats itself. Last June, the

Syndrome (MERS) disease – Korea reported its first case in

government presented a fresh stimulus package (equivalent to

May – seems to have affected both consumer and business

around 1.5% of GDP) in reaction to the MERS outbreak,

confidence. So far, 186 people have been infected and 35

consisting of a supplementary budget and additional spending

have died. Both the consumer and the business confidence

measures. Still, longer term contingent liabilities for the budget

index dropped sharply in June, after having slowly recovered

stem from expensive pension systems, as pension reforms

in previous months. MERS also seems to have given the

only proceed slowly.

Manufacturing PMI, which had already fallen from 51.1 in February to 47.8 in May, another blow. The index dropped to

Exports hit by lower external demand and strong won

46.1 in June, the lowest level since September 2012.

Despite attempts to diversify South Korea’s growth model, the country is still heavily reliant on exports. In 2014, exports of

Latest activity data do not bode well either

goods and services accounted for 52% of GDP. Korea’s

The latest activity data do not paint a very convincing picture

exports of electronics are sensitive to the global business

either. Industrial production has been contracting in annual

cycle. Export growth has fallen strongly in recent years,

2 South Korea Watch: Growth subMersion – 10 July 2015

reflecting lower external demand and currency appreciation.

After the June rate cut, BoK remains on hold in July

Exports to Japan, in particular, but also to the eurozone have

With inflation levels remaining far below the target zone of 2.5-

been on a declining trend for a few years now, while exports to

3.5%, the Bank of Korea (BoK) has continued with monetary

China have stagnated. The real effective appreciation of the

easing, despite its traditional cautiousness related to large

won is hurting external competitiveness. The won has

household debts. After two 25 bp policy rate cuts last year, the

strengthened by around 65% versus the yen since 2012 and

BoK cut rates twice this year as well, to a record low of 1.5%.

by around 60% versus the euro since 2009. Still, import growth

According to the BoK Governor, the June cut was a pre-

has fallen hand in hand with export growth, partly reflecting the

emptive move aimed at mitigating the fall-out from the MERS

weakness of domestic demand, resulting in even higher

outbreak. On its 9 July meeting, the BoK left the policy rate on

surpluses on the trade balance and the current account.

hold. Assuming headline inflation to rise gradually in the second half of this year, we expect the BoK to remain on hold.

Exports to Japan, eurozone impacted by won strength Outlook and main risks

Index, Jan. 2008 = 100, 12 months rolling

180

Earlier this year, we cut our 2015 growth forecast from 3.5% to 3%. Although downside risks to the outlook have risen further,

160

we keep our 2015 forecast unchanged right now. We expect 140

some acceleration of growth to 3.5% in 2016. This view is

120

based on several assumptions. First, we assume monetary easing and fiscal stimulus to support domestic demand.

100

Second, we expect export-oriented Korea to profit from improving global growth and trade. Third, we assume there will

80

be no sharp slowdown in China (Korea’s main export

60 08

09

10 China

11 US

12 Japan

13 14 Eurozone

15

destination), assuming the Chinese authorities will succeed in managing the fall-out from the latest stock market correction and keep Chinese growth close to their 7% target this year.

Source: Thomson Reuters Datastream

Still, current growth levels remain clearly below the levels seen

Despite recent uptick, inflation remains low Falling commodity prices and weak domestic demand have driven inflation down. Since late 2014, headline inflation has fallen below 1% yoy, dropping to a record low of 0.4% yoy in March/April. Spurred by higher food prices, inflation has risen a bit in recent months, reaching 0.7% yoy in June. Core inflation has remained more stable at around 2%. We expect headline inflation to gradually rise in the second half of this year (annual forecast: 1%), but to remain relatively low.

in the first part of this century, with growth averaging around 6% in the years between the Asia crisis and the global financial crisis. This underlines that Korea has to step-up structural reforms to leave its growth model less dependent on exports. Main risk to the outlook stems from disappointing growth in China and the advanced economies. We still think South Korea is relatively well-placed to manage potential contagion from a faster-than-expected Fed lift-off, given its strong fiscal and external fundamentals.

Key forecasts for the economy of South Korea

Inflation rebounds, BoK on hold in July

2012

2013

GDP (% yoy)

2.3

2.9

3.3

3.0

3.5

CPI inflation (% yoy)

2.2

1.3

1.3

1.0

2.0

Budget balance (% GDP)

1.3

1.0

0.5

0.5

1.0

3

Government debt (% GDP)

35

36

37

37

38

2

Current account (% GDP)

4.2

6.2

6.5

5.5

4.5

Gross fixed investment (% GDP)

29.6

29.3

29.1

31.9

31.9

Gross national savings (% GDP)

35.2

35.3

35.5

37.5

36.7

USD/KRW (eop)

1071

1055

1099

1130

1150

EUR/KRW (eop)

1390

1454

1330

1130

1323

% yoy

6 5 4

2014 2015e 2016e

1 0 08

09

10 CPI

11

12

Core CPI

Source: Thomson Reuters Datastream

13

14

15

Policy rate

Budget b alance, current acc. for 2015 and 2016 are rounded figures

Source: EIU, ABN AMRO Group Economics

3 South Korea Watch: Growth subMersion – 10 July 2015

All publications of ABN AMRO on macro-economics, commodities and sector developments can be found on: insights.abnamro.nl/en Follow Group Economics on Twitter: https://twitter.com/abnamroeconomen

This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics.The information in this document is strictly proprietary and is being supplied to you solely for your information. It may not (in whole or in part) be reproduced, distributed or passed to a third party or used for any other purposes than stated above. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer.

No reliance may be placed for any purposes whatsoever on the information, opinions, forecasts and assumptions contained in the document or on its completeness, accuracy or fairness. No representation or warranty, express or implied, is given by or on behalf of ABN AMRO, or any of its directors, officers, agents, affiliates, group companies, or employees as to the accuracy or completeness of the information contained in this document and no liability is accepted for any loss, arising, directly or indirectly, from any use of such information. The views and opinions expressed herein may be subject to change at any given time and ABN AMRO is under no obligation to update the information contained in this document after the date thereof.

Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks andany possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading this document, you consider investing in a product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether the relevant product –considering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO reserves the right to make amendments to this material. © Copyright 2015 ABN AMRO Bank N.V. and affiliated companies ("ABN AMRO").