Bracing for the worse-case scenario

The government and central bank must ready against such a negative scenario.

The South Korean economy muddled along in positive territory in the first half. According to the GDP data released by the Bank of Korea (BOK), the economy grew 0.6 percent against the past three-month period in the second quarter. It narrowly managed to avoid a recession after reporting a contraction in the fourth quarter of 2022 due to sinking exports.

Strong auto exports and recovery in the chip cycle helped push growth, but the growth is a typical recession type as it owed more to a bigger fall in imports than to exports. The decline in private consumption and stagnant corporate investment also raise worries in the second-half.

The central bank says the economy will do better in the second half. But variables are many. The Chinese economy is performing poorer than expectations. The reopening effect after strict lockouts and restrictions were lifted was less than expected. There are even worries about the world’s second largest economy entering secular slow-motion. The chip cycle must pick up for Korea’s exports to gain strength. Although the widening market for artificial intelligence bodes well for chip demand, the smartphone industry is on the downturn.

The financial market remains unstable. A bank run at the Korean Federation of Community Credit Cooperatives has eased, but the delinquency rate of loans related to property-backed project financing is soaring. The gap between the U.S. and Korean base rate is also widening.

There is hope that private consumption can recover in the second half, as expected by the BOK on recent positive signs. When chip demand revives, exports could strengthen, too. If the rate hike in the U.S. slows, the foreign exchange and capital market could stay resilient. This is the positive scenario.

If household and corporate spending droop, while chips and the Chinese economy do not pick up as hoped, the economy could fall into a double dip. If the rate increases go beyond one or two times, the FX market also could turn unstable. Crumbling of one or two PF locations could cause a domino effect to unsettle the financial market. The government and central bank must ready against such a negative scenario.

South Korea has the world’s third largest household debt ratio against GDP. Household debt must be contained. The rises in apartment prices in Seoul and the capital region have been accelerating. Mortgage loans at banks also have been on the rise. Intentional neglect of bubbles in the property market to lessen the risk over PF loans should be avoided. To contain the rise in the household debt, exceptions on the debt service ratio should be minimized. The principle on debt servicing could be impaired if too many exceptions are made.