Korea: Still The Best Comeback Story in Asia

By Jonathan Lemco

Since the "Asian Financial Crisis" of 1997-98, South Korea has made the greatest tangible effort to restructure its financial services industry, reform its Chaebols, and improve public policy making. The leading international credit rating agencies have taken notice, and have raised the nation’s sovereign credit rating to A3 (Moody’s) and A- (Standard and Poor’s). This is the highest rating of any of the Asian nations most affected by the financial crisis four years ago. It also reflects the fact that Korea has now graduated from the ranks of the "emerging markets" to "developed" economy status. This is not to suggest that there is not more work to be done. Inefficiencies remain in the financial, economic and political system. But the progress made thus far has been admirable.

Looking forward to the final months of 2002, we expect Korean economic growth to slow but to remain fundamentally healthy. Exports are poised to continue demonstrating strength, having increased by 19.9% year-on-year in July and August 2002. Furthermore, Korea’s solid external balance sheet is reinforced by its strong net foreign asset position of US $44.3 billion in July. Government finances are stable and in balance. The annualized fiscal surplus is currently at about 2% of GDP, and surveys of leading financial economists reveal that the Korean budget surplus is likely to be in the 1.4% range in FY 2002. At this time, inflation is not a serious worry. The core CPI was up by 2.8% in August 2002, and has been consistent throughout the year.

To the extent that there is reduced economic activity in 2003, it will likely be due to global weakness rather than any general stagnation in the Korean economy. Domestic demand was down from the torrid pace of the first quarter of 2002. We expect Korean growth of about 6% in FY 2002 and 5.6% in FY 2003. It was 6.3% in August. Under current economic circumstances, this is quite robust for an industrialized nation.

Furthermore, the government is cutting back on its economy-boosting infrastructure spending, such as for roads and other civil engineering projects, as the economy improves. Government spending rose 4.9% in the second quarter of 2002, compared with 5.5% in the first quarter.

There are obvious challenges to the Korean economy of course. On the political front, the December presidential election is too close to call between three viable candidates. Furthermore, relations between North Korea and South Korea, although much warmer of late, will remain unpredictable for the foreseeable future.

It should also be noted that some analysts have suggested that if oil prices spike up due to a potential invasion of Iraq and the consequent turmoil that might follow, a big "if", then Korea’s current account could be pushed into a deficit of –1.0% of GDP in 2003. This is because as oil imports increase and exports weaken, global growth could soften. Higher oil prices would effect Korean domestic consumption, production costs, and net exports such that GDP growth in 2003 could deteriorate by 0.8% in 2003. In addition, the balance of payments surplus that allowed Korea to accumulate $116 billion in foreign exchange reserves could fall. But we are not forecasting dramatic increases in oil prices for the foreseeable future. This is because it is most unclear at this time that there will be an invasion and, even if there is, it is also the case that Iraq exports only a fraction of the oil that it did before sanctions were imposed.

So Korea remains one of the best economic stories in Asia. Unemployment remains relatively low at 3.0%. Also, Korea has developed a consumer culture that was absent before the crisis. Credit cards are used everywhere and consumer debt is increasing at a pace typical of OECD levels. But Korea’s high savings rate (32.4% in 2000), its strong household balance sheets, and the resilient underlying economy suggest little reason for concern about the sustainability of the debt.

In addition, the nations’ financial institutions continue to improve their balance sheets, although much work remains to be done in this regard. Non-performing assets have been substantially reduced though sales, write-downs and restructurings. Overall, capital at the nation’s banks has risen 22% since 1998 and non-performing loans have dropped to just 4.1% of total loans (down from an "official" peak of 18% of loans in 1998 and an "estimated" peak of 25%).

We are confident that barring global calamity, Korea will remain an economic powerhouse in Asia. In fact, since the end of the financial crisis, investors have been amply rewarded for their confidence in the Korean credit.