Country Report South Korea
South Korea’s economic growth has slowed to around 2% in 2012, on the back of a weak global economic environment. However, domestic private consumption has limited the extent of the slowdown and a slight pickup is expected for this year. Presidential elections in 2012 passed smoothly, with Park Guen-hye winning the elections. Overall, the policy focus will be more balanced then before. The situation in North Korea has deteriorated following that country’s missile and nuclear tests and subsequent intensifying of UN sanctions. South Korea’s external liquidity position remains comfortable, helped by a vast amount of FX reserves. However, relatively strong dependence of the banking sector on external wholesale funding, which has decreased in recent years, remains a risk in case of shifting risk perception towards South Korea.
Introduction and update
South Korea’s economy performed weaker than expected last year and grew by around 2%, while near 3% growth had been estimated earlier. Private consumption was the main growth driver last year, while government expenditure also supported growth. However, these were insufficient to counter the weakening of the external sector on the back of a sluggish global environment, which also translated into very weak investment growth. Exports grew by a mere 3.2% in 2012, a sharp decrease from the 9.5% growth in 2011. Relatively weak domestic economic activity also led to an easing of inflation to 1.4% year-on-year in December last year. Authorities had been reluctant to lower interest rates to support growth, fearing resurfacing inflationary pressures. However, in July last year, year-on-year inflation fell below the central bank’s 2012 inflation target range of 3% ±1% (in 2013-2015, the Bank of Korea will maintain an narrower inflation target range of 2.5%-3.5%), policy interest rate were lowered to 2.75% in two 25bps steps in July and October. The budget balance has deteriorated on the back of weaker economic growth and registered a deficit of around 2% of GDP in 2012. In order to maintain the country’s sound fiscal position, the South Korea government is reluctant to employ public spending growth to support GDP growth. However, for this year the government will front-load on spending, planning to execute around 40% of the total 2013 budget in the first three months and around 70% in the first half of the year, with spending on welfare and education rising in particular. This should help to boost growth without leading to a strong deterioration of the budget balance – estimated at -2.6% of GDP in 2013 – while the external sector is hoped to pick up afterwards. In all, GDP growth is estimated at between 3% and 3.5% this year and around 4% in 2014.
The South Korean won appreciated steadily in the second half of last year, prompting Korean financial regulators to tighten rules on currency forward position for both local and foreign banks. This measure took effect in January and the won has depreciated since. Later this year, the won might start to appreciate again on the back of stronger GDP growth and the prospect of monetary policy tightening in late 2013. If the situation in North Korea would escalate, this would put potentially strong downward pressure on the won.
Park Guen-hye elected as South Korea’s first female president
On December 19th, 2012, Park Guen-hye won South Korea’s presidential elections. She will take office on February 25th and will be South Korea’s first female president. Park is the daughter of former President Park Chung-hee, who took power in a bloodless coup in 1961 and held the presidency until 1979, the year he was assassinated. Adding to her tragic family history, is the fact that her mother was killed 5 years earlier by a bullet meant for her father, after which she became her father’s first lady at age 22. Park, who took over as head of the Saenuri Party (formerly known as the Grand National Party) only last year, transformed that Party in rapid pace and led it to winning an unexpected majority in the parliamentary elections in April last year. The presidential campaigns revolved around improving the country’s welfare systems and around increasing “economic democratization”, a term implying a curbing of the excessive power of the country’s chaebols (family-run conglomerates) in order to allow small business to grow. By doing so, both she and her opponent, Moon Jae-in of the Democratic United Party, cleverly tapped into dissatisfaction among the public about widening income inequality. In the end, Park won 52% of the votes, as she was slightly more popular with the many voters over the age of 50 than her opponent. Park will focus on finding new sources of growth and enhancing welfare provision. However, in spite of her tough criticism on the chaebols, Park’s policies will overall remain more or less in line with those of her predecessor, including largely maintaining the strong position of chaebols in the country. This implies that South Korea will maintain its business friendly policies under her watch.
North Korea: Back to square one
Many had hoped for a wind of change in North Korea after Kim Jong-un took over as supreme leader of North Korea’s totalitarian regime, after his father, Kim Jong-il, died in December 2011. Backed by his uncle, Jang Sung-teak, the leadership transition had appeared to pass smoothly. In 2012, Kim Jong-un took over the most important official positions in the country, including the first secretary position of the Korean Workers Party (KWP) – he could not become the general secretary, as his father had been named general secretary for eternity -, standing member of the politburo, commander-in-chief of the Korean People’s Army (KPA) and Chairman of the KWP’s Central Military Commission.
However, in the second half of 2012, signs that Kim Jong-un was less successful at establishing control over the military, a vital step in cementing his overarching power within the country, started to surface. Top military positions were reshuffled, mostly aimed at putting close allies of Kim Jong-un in crucial positions. In this regard, General Kim Kyok-sik, a hard-liner who oversaw the 2010 shelling of a South Korean island, plays a pivotal role. He was named the defence minister of North Korea in November and was promoted to chief of the army’s general staff in December last year.
Since then, the situation has gone into a downward spiral. Right around the time Kim Kyok-sik was appointed, North Korea successful carried out a long-range missile test. The move was most likely an effort to enhance Kim Jong-un’s standing within the military KPA. The response of the international community’s was highly critical and the UN intensified sanctions against North Korea in January this year. In turn, North Korea threatened to perform a third nuclear test, and quickly afterwards, on February 12th, 2013, actually did so. The previous tests had been carried out in 2006 and 2009 and had led to a further isolation of North Korea and increased international sanctions. In fact, only China had continued to support the country, diplomatically and with food and energy aid. This time, China is far less supportive of North Korea, but is expected to maintain its aid to the country. Other countries reacted more forcefully, pointing to the threat North Korea poses to world peace now that it may be able to reach parts of the US and Europe, as well as most of Asia with a nuclear missile (assuming the country is able to place a nuclear device on one of its long-range missiles, which is not certain).
As a result, any hopes of an improvement of the situation in North Korea have diminished and the regime has placed itself in a position that it will have to play hardball with the international community once again. This is very unfortunate. The new South Korean president, for instance, was more open to dialogue with its northern neighbour than her predecessor and North Korea was even starting to attract some attention as a manufacturing location, as labor is very cheap in the country. Now, however, the situation is back to square one.
It remains unlikely that North Korea will go beyond tests and provocations and actually carry out an attack on South Korea or another country, as this would imply an act of suicide by the regime. However, it is likely that North Korea will continue on the path it has followed in the past, and continue to blackmail the international community with its nuclear capabilities to achieve more influence and improve its position. However, a risk that provocations, intentionally or unintentionally, escalate into something worse also remains present, which would have a significant negative effect on, among other things, international investor sentiments towards South Korea.