Korea’s economy

Korea was one of the OECD countries most severely affected by the global crisis, even though its financial sector had been relatively healthy. Indeed, the crisis has been quite a blow to an economy that had become one of the developed world’s star performers in recent years, with the financial market volatility and the steep drop in the exchange rate reminiscent of the 1998 Asian crisis.

The exchange rate also depreciated by 30% in trade-weighted terms between July 2008 and the end of February 2009, reflecting concerns about the size of Korea’s foreign debt as well as an outflow of foreign investment. This led to a sizeable drop in equity prices and reduced household wealth. Despite the weak exchange rate, exports plunged by more than 30% at an annual rate in the final quarter of 2008, causing a sharp contraction in output.

But the situation is improving. The Korean economy was one of the first among OECD countries to stabilise, recording slightly positive growth in the first quarter of 2009 thanks to a number of factors. First, the depreciation of the won strengthened Korea’s international competitiveness by making exports cheaper, helping it gain market share even in still-shrinking markets. Second, the Bank of Korea had acted swiftly by cutting its policy interest rate from 5.25% in August 2008 to a record low of 2% in February 2009, and this bolstered lending to small firms and households. Third, the fiscal stimulus that the government introduced from the second half of 2008 began to take effect. Both government spending on goods and services and construction investment, led by public infrastructure projects, recorded double-digit increases in the first quarter of 2009. In April 2009, a fresh boost came from a supplementary budget amounting to 1.7% of GDP, which provided support for the unemployed, low-income households and small and mediumsized enterprises.

Beyond fiscal and monetary stimulus, the authorities have implemented a number of additional measures to limit the impact of the global financial crisis on Korea. In late 2008, they arranged currency swap arrangements with major countries and guaranteed domestic banks’ foreign debt up to $100 billion, a move that helped ease concerns about Korea’s external debt. The won has rebounded since March, although it remains well below its July 2008 level.

The government has also moved pre-emptively to limit any negative effect on the financial system from the economic downturn. It has injected capital in seven banks and established a 40 trillion won (4% of GDP) fund to purchase non-performing loans.

All of these initiatives have already paid off, both in a stabilisation of output, and a strong bounce-back in business and consumer confidence, which now exceeds its September 2008 pre-crisis level. Financial-market conditions have also settled, thanks to a revival in corporate bond issuance and a rally in equity prices.

In sum, the Korean economy seems poised for recovery, but there are negative factors to deal with. There is still the impact from shrinking employment, for instance. Also, exports account for about half of the Korean economy. This means the outlook depends crucially on world trade, which is projected to recover only gradually.

For more detail on Korea’s economic performance, contact Randall.Jones@oecd.org

For latest economic projections on Korea, see OECD Economic Outlook No 85, June 2009, at www.oecd.org/eco/economic_outlook. See also, www.oecd.org/korea

Exports and production have bottomed out

Seasonally adjusted, 2005=100

Three-month moving average

Source: Bank of Korea, Korea National Statistical Office