RaboResearch - Economic Research

Country Report South Korea

Country Report


South Korea flag
The South Korean government is trying to raise growth both in the short- and long-term. Meanwhile, the external vulnerability of the country and of its banking sector in particular, has decreased. Relations with North Korea remain uncertain and difficult.

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.

(-) 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, while a collapse of North Korea could result in very high fiscal costs for South Korea

(-) High household debt and dependence on external demand

Domestic demand growth has been low in recent years on the back of a weak housing market. This leaves the country dependent on its huge export sector. 

Key developments

1. Government tries to boost weak domestic demand

While economic growth in 2014 as a whole is likely to be above the levels of previous years, some stimulus measures have been taken recently to strengthen domestic demand. The South Korean economy grew by 3.6% y-o-y and 0.6% q-o-q in the second quarter after growing 3.9% y-o-y and 0.9% q-o-q in the first. While growth in 2014 is likely to surpass economic growth of the past three years, domestic demand has remained relatively weak. This seems partially related to the fall of consumer confidence following the tragic sinking of ferry Sewol. However, the weakness of the housing market also plays a role. In response, the government has recently introduced a USD 40bn (equal to about 3% of GDP) stimulus package, which mainly consists of liquidity support by policy banks). In addition, the central bank lowered its policy rate by 25 basis points to 2.25%, the lowest level since 2010. The government also quite controversially eased South Korea’s macro-prudential regulations, by lifting the loan-to-value ratio for mortgages to 70% and the debt-to-income ratio to 60%. While this still leaves those ratios relatively stringent by international standards, relying on a renewed surge in household credit to boost demand might be risky, given that household debt is already relatively high in South Korea.

2. Government also tries to raise long-term growth

Meanwhile, the government is also trying to boost South Korea’s long-term growth rate. While South Korea’s growth rate has been above those seen in most western countries, the structural growth rate seems to have slowed down somewhat. What is more, due to the rapid ageing of South Korea’s population, the country has one of the lowest birth rates in the world. The working age population is expected to start to decline in 2018, which is likely to result in a further fall of the structural growth rate. In February, President Park Geun-hye launched the 474 plan, which aims to raise the potential growth rate to 4%, the employment rate to 70% and income per capita to USD 40,000. While there is room to raise the labour participation of women, the 70% target looks ambitious. Furthermore, to boost growth the low productivity of the services sector will have to be raised. This would also help to reduce the dual nature of the economy, with its dynamic export sector and a slower growing and much less productive domestic sector. Nevertheless, the competitiveness of the export sector and the fact that total factor productivity growth has remained substantial in recent years, suggest that the overall medium-term growth prospects are not unfavourable.

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Bank’s foreign assets & liabilities
Figure 2: Bank’s foreign assets & liabilitiesSource: Macrobond

3. External vulnerability decreases

The external vulnerability of South Korea as a whole and of its banking sector in particular has continued to decrease. As South Korea has continued to post high current account surpluses (the 2013 surplus was a record USD 70.7bn or 5.4% of GDP), the country’s net international investment position (NIIP) has improved. In the first quarter of 2014, the negative NIIP was just 0.3% of GDP, down from 17.5% of GDP in late 2007. The net foreign asset position of the banking sector has improved significantly in recent years. Predominantly thanks to an increase of foreign assets, net foreign liabilities were USD 44bn in the second quarter of 2014, down from USD 133bn in the first quarter of 2008. In the second quarter, the net short-term foreign assets of the banking sector even exceeded the net short-term foreign debt (see figure 1). South Korea’s vulnerability to a sudden stop of foreign finance, which caused the 1997 crisis and led to some financial markets tension in 2008 again, has thus fallen strongly. This was also demonstrated last year, when South Korea was hardly affected by the tightening of financial conditions when financial markets started to anticipate tapering by the US Federal Reserve.

4. North Korea

Relations with North Korea remain difficult and uncertain. In December 2013, the uncle and mentor of supreme leader of North Korea Kim Jong-un, Jang Song-thaek, was executed for treason. He was seen as a moderate, and his death therefore suggests that hardliners within North Korea are getting more powerful. This spring, North Korea fired some artillery shells into the Yellow Sea across the line that separates its waters from South Korea’s. In response, South Korea also fired artillery shells into North Korean waters. Similar exchanges have happened before though.

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 labor-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 (2013 International investment position data: Macrobond)

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