Economy Escapes Recession in South Korea During Q1

Staving Off Recession

The South Korean economy skirted recession in the first quarter of 2009 after recording marginally positive growth. Advance estimates released by the Bank of Korea today showed that the economy expanded by 0.2% from the previous quarter. In the fourth quarter, growth reeled following the escalation of the global financial crisis in September. GDP in real terms shrank 5.1% quarter-on-quarter in the three months through December.

The economy has been hit hard by the global economic downturn. Collapsing exports have forced record declines in industrial output, while domestic demand has begun to wilt. Firms are engaged in aggressive inventory adjustment, while private capital expenditure has been slashed as earnings fall.

Further pressure on corporate cash flow has been exerted by tight credit conditions. South Korean banks were exposed to fallout from the global financial crisis following a sharp increase in borrowing overseas, and from wholesale markets to fund domestic lending. The resulting U.S.-dollar shortage exerted significant downward pressure on the won exchange rate, which lost around 40% of its value in 2008, while overseas borrowing increased sharply as financial entities sought to circumvent the choked financial system. The corporate sector subsequently faced increasing difficulties in raising finance. Short-term trade and production finance, in particular, proved difficult to secure with small and medium-sized enterprises acutely exposed to the credit squeeze. Erosion of equity value following volatility on stock markets further undermined confidence. The downturn also spread through the household sector as growing income and employment insecurity, relatively high levels of private debt and depressed asset prices constrained private consumer spending.

Macro-Economic Stimulus Feeds Through

However, authorities responded with aggressive counter-cyclical stimulus. The Bank of Korea (BoK) has slashed its leading interest rate by 325 basis points since September to a record low of 2.0%. Other measures to re-galvanise credit growth have also been deployed, including increases in the minimum threshold on the holdings of bonds and commercial paper in money markets and increased access to loans offered by the central bank at preferential interest rates. Finally, a huge fiscal stimulus package released in late March shifted focus of stimulus to the demand side. The 17.7-trillion-won (US$12.66-billion) supplementary budget is the largest on record, equivalent to 1.9% of total GDP. The supplementary budget adds to 55 trillion won of emergency fiscal measures already pledged. For 2009 as a whole, the government's total expenditure is set to rise to 302.3 trillion won from 262.8 trillion won in 2008.

Green Shoots of Recovery?

High-frequency indicators have pointed to stabilisation in the economy. Credit growth is staging a recovery. Lending by commercial banks to small and medium-sized enterprises (SMEs) rose 3.4 trillion won (US$2.58 billion) in March, standing as the largest gain since July 2008. In February, credit to SMEs rose 2.8 trillion won. Concurrently, loans to households rose 1.9 trillion won during the month following an increase of 2.8 trillion won in February. Credit growth has rebounded from a net negative position in January, when banks called in more loans than they disbursed. Meanwhile, exports, although still experiencing steep declines also appear to be rising from the nadir hit in late 2008 and early 2009 while plunging imports have pushed the net export position back into surplus. In March, measuring exports per working day indicated a rise to US$1.18 billion from US$1.16 billion and US$990 million in February and January, respectively while the overall trade balance accrued a US$4.6-billion surplus. Manufacturing output rose 6.8% in February from January while producer confidence rose to a five-month high. Stock markets and the won exchange rate have rebounded. Other data released today showed that apartment prices in the capital Seoul recorded their first back-to-back weekly increases in nine months, indicating that the combination of cheap financing and low pricing could be drawing investment back into the market.

Outlook and Implications

Typically cautious Bank of Korea officials even went as far as to state today that potential "upside" risks could emerge in the economy. With such a huge level of stimulus now in the economy, inflation risks could intensify on the heels of any upturn in growth. The Bank of Korea held its leading interest rate on hold at 2.0% for the second consecutive month following its monthly review of policy yesterday. It also signalled that the current level of the rate could mark the floor in the current monetary easing cycle barring any eruption of fresh volatility.