hankyoreh

Brexit

The South Korean economy is facing an ambush after the United Kingdom’s decision to leave the European Union. The unprecedented “Brexit” decision, which comes amid full-scale restructuring in the shipbuilding industry and speculation about a possible interest rate hike by the US, means even darker clouds on South Korea’s economic horizon for the second half of 2016. Seoul is currently maintaining that the Brexit’s impact on the real economy will be limited, noting that the UK accounts for only a small portion of South Korea’s trade.

But signs are suggesting the South Korean economy now faces an even longer trek through the tunnel of protracted low growth.

The administration and Bank of Korea held two macroeconomic and financial meetings on June 24: one in the morning after the referendum vote closed in the UK, and another at 2 pm once the outcome was becoming clear. Macroeconomic and financial meetings are settings where second-in-command figures from the Ministry of Strategy and Finance (MSF), Financial Services Commission (FSC), Financial Supervisory Service (FSS), Bank of Korea (BOK), and Korea Center for International Finance (KCIF) meet to put their heads together. The two meetings in one day indicate how high Brexit-related tensions are running with financial authorities.

A foreign exchange dealer stands in front of screens showing the KOSPI and South Korean won-US dollar exchange rate

Both the administration and the BOK reaffirmed their position that the Brexit’s effects on the real economy would be limited. First, they held that the direct impact on exports would remain small because of the limited scale of South Korean trade with the UK. As of 2015, the UK accounted for just 1.4% of all South Korean exports, with a relatively low level of British foreign direct investment in South Korea.

Accordingly, the message from Seoul after the meetings was focused more on allaying financial market jitters rather than on the real economy.

“There is a possibility of increased short-term volatility, particularly with the financial market,” said Deputy Prime Minister and Minister of Strategy and Finance Yoo Il-ho. “If that volatility becomes excessive, we intend to respond proactively according to a pre-established contingency plan.”

For now, the BOK has reportedly begun intervening with foreign exchange market supplies to protect the value of the South Korean won.

“Foreign institutions like the International Monetary Fund (IMF) don’t believe the Brexit will have a very large impact on the real sector of the South Korean economy either,” said Korea Development Institute macroeconomic research department head Kim Sung-tae in a telephone interview with the Hankyoreh.

“The concern is that people interpreting the Brexit as having the potential to cause a huge shock to the real economy will only fan market anxieties,” Kim said.

But the Brexit clearly is a risk factor in terms of amplifying the uncertainties that are an economy’s greatest foe. There is also the possibility that the questions it raises about the sustainability of the EU - established in the post-war era as a means of bringing shared prosperity to Europe - could lead to a domino effect of other departures. Such a political upheaval has the potential to deal a sustained blow to the European economy as a whole, with effects that could spread around the world. In other words, it is a fire that, once started, wouldn’t be easily extinguished. The EU is South Korea’s fourth biggest trade partner after China, the US, and Japan, accounting for around 10% of exports each year.

Also unclear is whether the uncertainties in the Brexit’s wake will go beyond financial market volatility. Uncertainties in the domestic financial market were raised by the 2008 global financial crisis and the US declaring an end to quantitative easing in 2013, which also exacerbated consumption and investment fears that led to a drop-off in the real economy. The South Korean government’s message on June 24 about the limited effects on the real economy appears motivated by alarm about such growing worries.

Perhaps the biggest concern is the fact that the turnaround for the stagnation that has persisted for the past four to five years now appears even farther off. Even if the Brexit doesn’t deal any major shocks to the real economy, the likelihood that it will add momentum to an economic recovery is slim to none. For this reason, calls for the BOK to lower interest rates further or for Seoul to expand its outlays appear likely to grow.

“After the Brexit decision, market interest rates in the major economies took a nosedive, and the South Korean rate fell sharply,” noted Societe Generale economist Oh Suk-tae.

“People are now predicting a monetary policy response of zero interest rates worldwide or expanded quantitative easing,” Oh noted.

The analysis suggests that a heavily open economy such as South Korea’s will be hard-pressed to escape the effects of falling interest rates, which are likely to cause global conditions of low growth to persist even further. On June 24, the South Korean government reported to the ruling Saenuri Party that the national economic growth rate would remain at 2.8% for the year - down 0.3 percentage points from the 3.1% rate predicted in late 2015.

By Kim Kyung-rok, staff reporter

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