In June, we met with institutional clients, real-money investors and hedge funds in Hong Kong and Singapore to discuss Korea’s economy and markets. Most saw the Korean financial market as a safe haven for foreign investors, but caught off-guard by periods of unexpected volatility.
Most investors we met did not think the Bank of Korea would hike the base rate in the near term, given their cautious view on the Korean economy. The clients expressed concerns about a slowdown in Korea’s economic growth, remarks by the Governor of the Bank of Korea, Lee, that economic sentiment is weak, and the negative impact that minimum wage rise would have on the job market. They also found the argument that a rate hike is needed to reduce the Korea-US rate differential unconvincing, as they do not see a risk of large capital outflows from Korea if the rate spread between the U.S. and Korea expands. They perceived Korea as a safe haven relative to other emerging markets, and reasoned that a 50bps rate differential would not drive sudden capital flight
During the meetings, clients questioned whether the higher taxes - which resulted in a 9.4% increase in the government’s tax collection in 2017 - may offset the impact of higher government spending. The Korean government has increased its fiscal budget by about 7.1% y/y for 2018, compared to an average increase of c.4% over the previous five years. The National Assembly also passed an additional budget of KRW 3.7tn to support the job market, funding this with increased tax revenue. We believe higher fiscal spending will have a better economic effect over the impact of reduced household income. Various studies, including by the Bank of Korea and the National Assembly, have compared the multiplier impact on GDP of fiscal spending and tax relief, and found that the former has a greater impact.
Clients also expressed concerns about a possible slowdown in exports if the current IT up-cycle ends, citing Taiwan’s case in support of this view. According to The Bank of Korea’s Economic Outlook report, IT investment in Korea is expected to slow down due to the base effect in semiconductor investment and also changes in other IT industries. It will remain as the government’s task to diversify export industries which have been unequally inclined to semiconductor and display products.
Oil prices and their impact on domestic inflation were another topic of interest. Clients were keen to understand why Korea’s CPI inflation is slowing despite the rise in global oil prices. We explained that since the government imposes large amount of tax on imported oil, the changes in global oil prices have minimal effects on the domestic oil prices. Although the CPI index marked 1.5% for both May and June, the BoK expects headline inflation to pick up to 1.8% in the second half and near 1.9% in 2019 of which figures are close to the government’s target rate, 2.0%.
In spite of the economic indexes showing negative outlook, the BoK thinks that continuous expansions in exports supported by the ongoing global economic growth and rising consumption will bring about a steady pace of growth in the Korean economy. However, foreign investors seems to think that downside risks is larger as Korea’s export conditions could aggravate as a result of the global trade wars. 【The contributions from outside analysts are unrelated to the views of the publisher. They have been contributed in English and the wordings have been mildly edited.】
By Head of SC Bank Korea Economic Research, Park Chong Hoon
[ⓒ Pulse by Maeil Business News Korea & mk.co.kr, All rights reserved]