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Country Report South Korea

Country Report

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Economic growth has accelerated last year, and is expected to rise to 3.4% this year. In the face of tapering, South Korea is confronted with an uncertain external environment. However, so far the impact has been limited. 

Strengths (+) and weaknesses (-)

(+) Well developed and diversified economy

South Korea’s economy is the 15th-largest in the World with a relatively high GDP per capita. It has a strong, diversified and internationally highly competitive industrial and manufacturing base. 

(+) Strong democratic institutions

Underpinned by a mature and stable democratic system, South Korea has strong institutions. Especially the rule of law, regulatory quality and government effectiveness are solid.

(-) Export dependency

South Korea’s economy is very open (import + exports amount to 114% of GDP) and heavily dependent on exports. As a result, it is vulnerable to external shocks.

(-) Relations with North Korea

The Korean War ended in 1953 without a formal peace-treaty and the countries are thus still officially at war. As a result of highly erratic and at times aggressive behaviour of North Korea, tensions flare up from time to time. 

Key developments

1. Annual growth is accelerating.

South Korea’s economic growth is accelerating following a relatively weak 2012. On the back of a solid second half of 2013 - real GDP growth was 3.3% and 3.9% in 13Q3 and 13Q4 respectively –growth rose to 2.7% last year, up from 2% in 2012. Economic support measures implemented by the government early last year, which boosted investment and consumption growth, were part of the reason for the growth acceleration. Even though export growth strengthened in 2013 compared to 2012, the net contribution to growth of the external sector was smaller – but still positive - as import growth accelerated as well. This year, while government consumption growth will slow, support measures for the real estate sector are expected to remain in place. This will continue to support investment growth. Furthermore, low unemployment will underpin private consumption growth. Export growth is currently estimated to accelerate further, but this will be highly dependent on economic developments in China and the US, as well as the value of the Korean won. In all, real GDP growth is expected to strengthen to 3.4% in 2014.

Figure 1: Growth accelerating gradually
Figure 1: Growth accelerating graduallySource: EIU
Figure 2: Won slightly affected by tapering
Figure 2: Won slightly affected by taperingSource: Ecowin

2. Tapering and the South Korean economy

News about the (further) reduction of quantitative easing in the US (tapering) had a short-lived weakening effect on the South Korean currency: the won. Subsequently, the won recovered relatively swiftly and, overall, it actually strengthened against the USD in 2013 (see figure 2), contrary to the currencies of many other emerging markets. South Korea’s well developed and diversified economy, the country’s large and sizeable trade and current account surpluses and a vast amount of FX reserves make that the country is among the strongest and thus safest emerging markets. The overall impact of tapering on the South Korean economy is difficult to gauge. A deterioration of investor sentiment towards emerging markets in general could have an impact on financial flows into South Korea despite its status as a safe country. Exports to emerging markets could also be affected, as many have seen their currencies weaken. On the other hand, further tapering would imply a strengthening of the US economy, which would imply a positive impact on demand for South Korea’s exports from the US, South Korea’s second-biggest export destination. Faced with an uncertain external economic landscape, South Korean authorities are adopting a wait-and-see approach for now - interest rates were kept stable despite the expectation of rising inflation this year, for instance – but have promised to take action to calm markets if needed.

3. North Korean regime intrigues are cause for concern

In the past six months, the relationship between South Korea and North Korea has remained more or less stable. However, domestic political developments inside North Korea have been worrisome. In particular, the execution of Jang Song-thaek, Kim Jong-un’s (North Korea’s president) uncle who had been installed as Jong-un’s mentor by his father – Kim Jong-il - is, of concern. Jang was removed from his position and put on trial for a very long list of offences in an exceptionally public manner and - a few days later - executed as a traitor. The real motives behind this unexpected move remain unclear. Such purges, although usually less public, are not uncommon in North Korea. However, given Jang’s strong position and many supporters within the government, it will have disturbed the balance of power between the army, the party and the cabinet in the country. It will remain to be seen of Kim Jong-un will be able to manage these interests as well as his father did. Political uncertainty will rise while the balance is being restored. This raises the risk of acts of aggression towards South Korea or threats against the international community occurring. Perhaps during the annual joint US-South Korean military exercises from end-February to April, when tensions between the two countries often flare up.

4. Relation with Japan deteriorate, but intensify with other countries

A trade spat broke out between Japan and South Korea, as Korea refused to lift a ban for Japanese products – even extending the ban to fish - from the areas around Fukushima, where a nuclear disaster took place in 2011, to the frustration of the Japanese government. In addition, South Korea’s president, Park Geun-hye, is not keen on close diplomatic ties with Japan as she sees Japan as failing to take responsibility for its wartime actions. In all, the relationship between South Korea and Japan, which are important trade partners, remains sour. South Korea has signed a new defence pact with the US, which is believed to allow for a pre-emptive strike on North Korea in case of an imminent attack, but details are unclear. Furthermore, a free trade deal was signed with Australia. The deal was labelled “cows for cars” by Australian unions, as it allowed for increased imports of Australian beef into South Korea while South Korean car manufacturers were given concessions in Australia. South Korea, furthermore, stated that it will prioritize on a free-trade agreement with China while it maintains its cautious stance towards the Trans Pacific Partnership agreement between the US and 12 other countries, which so far does not include China. 

Factsheet of South Korea
Factsheet of South KoreaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

South Korea is a high-income country with a strong industrial base. South Korea is the 15th largest economy in the world and a member of the G20 and the OECD. Since South Korea has adopted an outward-looking strategy in the second-half of the 20th century, in which growth and development were supported by labour-intensive manufactured exports, the country industrialized rapidly. The industrial sector still remains the backbone of the South Korean economy. From the 1990s onwards, South Korea’s manufacturing sector expanded into other, more high-tech areas such as microelectronics and microbiology. The importance of the export sector to the South Korean economy does, however, increase the country’s vulnerability to external developments. As a result of continued focus on business friendly policies, the country is ranked 8th out of 183 countries on the ease of doing business index.

A constitutional change in 1987 laid the foundation for the current stable multi-party democracy. South Korea’s political and business environment is dominated by close personal relationships and a strong influence of chaebols (large business conglomerates). The downside of this is economic nationalism and corruption. Since fighting between North and South Korea ceased in 1953 without a formal peace-treaty, the tense and uneasy relationship between the two nations remains an important downside risk. Tensions flare up from time to time, usually due to provocations initiated by the North Korean regime. 

Economic indicators of South Korea
Economic indicators of South KoreaSource: EIU
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