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The South Korean economy is near the brink

Next year holds five major risks that South Korea needs to watch out for, analysts say. These are the China risk, declining competitiveness of exports, interest rate policies after the US interest rate hike, corporate restructuring, and structural reforms.

On Dec. 15, the Korea Economic Research Institute (KERI), which is affiliated with the Federation of Korean Industries (FKI), held a seminar titled “Five Major Issues for the Korean Economy in 2016: Projections and Responses” at the FKI building in Seoul. Taking note of troubling indications of the China risk and a decline in South Korea’s export competitiveness, economists at the seminar called for adequate preparations to be taken for interest rate policies, corporate restructuring, and structural reforms.

“The decline in profits at Chinese companies is accelerating, the number of corporate bonds that will mature in two years is increasing sharply, and there are other risk factors, such as excessive liquidity and poorly performing banks,” said Lee Chi-hun, head of the China team at KERI’s international finance center.

The operating profit growth rate at Chinese manufacturers fell by 1.3 percentage points between January and May of this year, and the number of companies in the red increased by around 9%. Furthermore, corporate bonds that will mature in 2017 have an average yearly growth rate of 51.3%.

“Given the extreme dependence on China, a decrease in South Korea’s trade surplus with China could not only lead to a contraction in the real economy but also destabilize the exchange rate and trigger an exodus of foreign capital,” Lee said.

South Korea‘s average yearly trade surplus with China over the past five years has been US$73.6 billion. Tackling these problems, Lee suggested, would involve gaining a comparative advantage over China and increasing South Korean companies’ presence in the Chinese market.

“In the future, it is fairly likely that there will be further depreciation of the yuan. Recently, the trade relationship between South Korea and China has been shifting from a complementary one to a competitive one. A depreciation of the yuan would help China’s price competitiveness and hurt South Korea’s,” said Kim Chang-bae, an analyst at KERI.

“Between 2012 and 2015, Japan selectively decreased the price of its exports, focusing on the metal and electronics industries, which needed to boost their price competitiveness. In the near future, there will be an aggressive reduction of prices mostly in industries that have focused on expanding their profits while maintaining their export price,” Kim Chang-bae went on to say, predicting that South Korean exporters would continue to face difficulties in their competition with Japan.

“After raising the interest rate by 0.25% this month, the US is expected to raise it to around 0.75% or 1% next year. Because of concerns about capital outflow, the Bank of Korea will be forced to raise the interest rate as well, finding itself in an interest rate dilemma because of households defaulting on their debt and a worsening downturn,” said Kim Jung-sik, a professor at Yonsei University.

“The interest rate hike should take place gradually starting in the second half of next year. For now, given the difficulty of stimulating the domestic market, the Bank of Korea needs to adopt the policy of depreciating the won to the same extent as the yuan and the yen in order to increase exports,” Kim Jung-sik said.

Kim Chang-bae expressed a dissenting view. “The risk of capital outflow resulting from an interest rate hike in the US is lower in South Korea than in other emerging economies, so the South Korean economy will not be affected as strongly,” he said.

“Since the ‘one-shot bill,’ designed to reenergize corporations, has been brought before the National Assembly in recognition of the need for voluntary and preemptive corporate restructuring, this should not be limited to industries with excess capacity but should be expanded to all industries,” said Jo Dong-geun, a professor at Myongji University, who urged the National Assembly to pass the bill before it lost this golden opportunity.

By Kwack Jung-soo, business correspondent

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