beyondbrics

Kim Choong-soo of the BoK

Is South Korea’s economy skating on thin ice? Not yet, economists say, but it may next year if the European debt crisis worsens and the global economy slows further.

With the export-driven economy increasingly feeling the chilling effects from slowing growth in advanced economies, the Bank of Korea on Friday had to cut the country’s economic growth forecast to 3.8 per cent from its previous estimate of 4.3 per cent. It also slashed next year’s growth forecast to 3.7 per cent from 4.6 per cent.

Still worried about the growing external risks, the BoK warned of possible further downgrades if the European crisis is drags on beyond the first quarter of next year, although it said the possibility seemed low.

The move came a day after the central bank held the country’s interest rates steady at 3.25 per cent for the sixth straight month, the longest pause since tightening began in July 2010. There is no sign of the BoK considering monetary easing yet with governor Kim Choong-soo still saying that the central bank retains its normalisation stance.

However, an increasing number of economists expect the central bank to reverse its course and start cutting interest rates in the first quarter. Kwon Goo-hoon at Goldman Sachs forecasts a half-percentage point cut in the first half of 2012 as inflation is expected to fall next year on the back of lower commodity prices amid the slowing global economy. The BoK expects inflation at 3.3 per cent next year – within the 2-4 per cent target range, from an estimated 4 per cent this year. “Domestic inflation is moderating but the European situation is getting worse, increasing downside risks for the economy,” he said. “I expect the output gap (actual growth minus the potential growth rate) to turn negative early next year, paving the way for rate cuts.”

South Korea’s economy has held up relatively well thanks to China’s robust economic growth. China is South Korea’s biggest export market, taking a quarter of the country’s overall overseas shipments. However, export growth is slowing and feared to slow further next year as China’s economy braces for a soft landing, while domestic spending remains sluggish amid record-high household debt. Such problems have prompted Nomura Securities to forecast a contraction in Korea’s economic growth. Kwon Young-sun at Nomura now expects the economy to shrink by 0.1 per cent in the first quarter from the previous quarter.

However, a contraction is unlikely as the government is expected to opt for a fiscal boost, in addition to monetary easing, to support the economy ahead of key elections next year. The government has spending room to protect the economy as the country’s budget deficit is set to come in less than 2 per cent of gross domestic product this year. The government this week announced measures to boost the sluggish property market including tax benefits for multiple home owners. Kwon expects the government to come up with a Won12tn ($10bn) supplementary budget early next year, which amounts to 1 per cent of Korea’s 2012 budget.

“Korean growth needs help next year,” says Ronald Man at HSBC. “Even if an outright recession is not on the cards, the case for a rate cut to cushion growth has clearly become stronger.”

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