South Korea 09 update

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					                   Country update
                   SOUTH KOREA




Summary
South Korea has managed to achieve an impressive recovery in recent months. Industrial
production was down by 25.5% yoy in January, but has recovered rapidly afterwards. In July 2009
it was even 0.7% above the pre-crisis figures of one year ago. Meanwhile, economic growth in the
second quarter was 2.6% qoq, the fastest pace in almost six years, although on a yoy-basis,
growth is still negative. Exports have recovered across the board to all major markets, thanks to
the weaker won. The country is now likely to post a current account surplus in 2009. At end-August
the foreign reserves stood at USD 245.5bn, which means that they are approaching their early-
2008 peak of USD 264bn, after falling to USD200bn at end-2008. However, the extent to which the
recovery will continue depends on the global economic climate. Consumer spending is likely to
remain dented, as consumers remain indebted. Moreover, public debt will be substantially higher
than before the financial crisis. The government’s efforts to shore up the banking system seems to
have been successful, with banks regaining access to global financial markets.


Things to watch:
•   Will the recovery continue?
•   Consumer spending




Author:                 Herwin Loman
                        Country Risk Research
                        Economic Research Department
                        Rabobank Nederland

Contact details:        P.O.Box 17100, 3500 HG Utrecht, The Netherlands
                        +31-(0)30-21-31105
                        H.Loman@rn.rabobank.nl




September 2009                    Rabobank   Economic Research Department         Page: 1/5
Country update SOUTH KOREA

South Korea
National facts                                                         Social and governance indicators                         rank / total
  Type of government                   Republic                          Human Development Index (rank)                           25 / 179
  C apital                             Seoul                             Ease of doing business (rank)                            23 / 181
  Surface area (thousand sq km)        100                               Economic freedom index (rank)                            40 / 179
  Population (millions)                49.0                              C orruption perceptions index (rank)                     40 / 180
  Main languages                       Korean                            Press freedom index (rank)                               47 / 173
                                                                         Gini index (income distribution)                           31.6
  Main religions                       C hristian (26.3%)                Population below $1 per day (PPP)                         <2%
                                       Buddhist (23.2%)
                                       None (49.3%)                    Foreign trade (2008)
  Head of State (president)            Lee Myung-bak                   Main export partners (%)             Main import partners (%)
  Head of Government (prime-minister) Han Seung-soo                      C hina                   22         C hina                    18
  Monetary unit                        won (KRW)                         US                       11         Japan                     16
                                                                         Japan                    7          US                         9
Economy (2008)                                                           Hong Kong                5          Germany                    3
Economic size                            bn USD     % world total      Main export products (%)
  Nominal GDP                                929        1.54             Information & communication products                          13
  Nominal GDP at PPP                      1359          1.98             Semiconductors                                                10
  Export value of goods and services         509        0.00             C hemicals                                                    10
  IMF quotum (in mln SDR)                 2927          1.35             Machinery & equipment                                         10
Economic structure                                   5-year av.        Main import products (%)
  Real GDP growth                             2.2         4.3            C rude petroleum                                              20
  Agriculture (% of GDP)                      3             3            Machinery & equipment                                         11
  Industry (% of GDP)                         37            37           Semiconductors                                                 8
  Services (% of GDP)                         49            48           C hemicals                                                     8
Standards of living                          USD    % world av.        Openness of the economy
  Nominal GDP per head                    18881           195            Export value of G&S (% of GDP)                                55
  Nominal GDP per head at PPP             27626           250            Import value of G&S (% of GDP)                                56
  Real GDP per head                       19402           243            Inward FDI (% of GDP)                                         0.2


Source: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters
Without Borders, World Bank.


Will the impressive recovery continue?
South Korea has managed to achieve an impressive recovery after its economy received
unrelenting blows in the final months of 2008. A combination of factors made the first effects of the
global economic crisis especially harsh for South Korea. First, the country’s strong reliance on
exports exposed it disproportionally to the faltering external demand. This effect was reinforced
due to South Korea’s specialization in the capital goods sector, which was hit particularly hard.
Second, the financial sector was struggling with worsening liquidity conditions due to their reliance
on the international capital markets for funding. This made the banks less willing to extend credits.
Third, highly leveraged Korean consumers were cutting back on spending on the back of tighter
credit conditions, falling incomes and greater job insecurity. Finally, as foreign reserves had
already declined for some months at that time, investors started to get worried about the short
term debt which had grown rapidly in preceding years, from USD 65.9bn in 2005 to USD 160.2bn
in 2007. It should be noted that this rise in short term foreign debt was partially explained by
hedging activities of ship builders. Nevertheless, these numbers, coupled with the fact that the
current account went into deficit, led to strong downward pressure on the won. In fact the currency
went down from 918 won per USD in November 2007 to 1,590 won per USD in early March 2009.
As a result of the sharp deterioration of the financial and business climate, the economy took a
sharp hit, leading to a 5.1% seasonally adjusted contraction in the final quarter of 2008.
About half a year later, South Korea’s economy is now much less under pressure. The first reason
is the impressive recovery of industrial production. Industrial production reached its trough in
January 2009, when it was down by 25.5% yoy in January 2009 (or 26.5% below the March 2008
peak levels). Afterwards it has recovered rapidly. In July 2009 South Korea posted a 0.7% yoy
growth of industrial production, which meant that they were only 3% below the March 2008 peak



September 2009                               Rabobank            Economic Research Department                         Page: 2/5
Country update SOUTH KOREA

levels. This recovery was also visible in the GDP data. GDP grew by 2.6% qoq in the second
quarter of 2009, which was the strongest growth in almost six years, after a mom growth of 0.1%
in the first quarter of 2009. Still, the economy has not recovered fully: in year-on-year terms GDP
in the second quarter was 2.2% below the levels of a year ago, slightly better than the 2.5% yoy
decline of the first quarter. The recovery was fuelled by many sectors: private consumption grew
(by 3.6%), just like (gross fixed capital formation (4.3%), and exports (10.1%).

Chart 1: Growth performance                                            Chart 2: Current account
     % change p.a.                                % change p.a.              of GDP
                                                                            %% change p.a.                                                % of GDP
                                                                                                                                     % change p.a.
 8                                                                8    12                                                                            12


 4                                                                4     8                                                                            8

                                                                        4                                                                            4
 0                                                                0

                                                                        0                                                                            0
-4                                                                -4
                                                                       -4                                                                            -4
-8                                                                -8
       04            05   06   07   08e     09f         10f            -8                                                                            -8
      Inventory changes             Private consumption                         04           05        06       07     08e     09f         10f
      Gross fixed investment        Government consumption
      External demand               ex                                       Transfers        Income        Services   Trade    Current account


Source: EIU                                                            Source: EIU


In particular exports to China grew rapidly. The decent growth suggests that Korea benefited from
the policy interventions of the government – such as expansionary fiscal and monetary policies,
and liquidity support for the banking sector – and a lower won. However, the big question is
whether the recovery will continue, as the effects of the stimulus efforts will gradually taper off. On
a positive note, business confidence has been rising in recent months. However, the August export
data were disappointing, showing a decline from USD 32.3bn in July to USD 29.8bn in August.
Although one month data may be distorted by inherent volatility, a decline in exports is bad news,
given that exports now account for a sizeable 50% of GDP. Moreover, Korean consumers remain
indebted, which will put a drag on consumption.


A better risk profile
Although we are thus not yet convinced about the sustainability of the recovery, we consider the
risk profile of South Korea to have improved significantly in recent months. First, partially because
of the authorities swift interventions, the banking sector has regained its access to foreign currency
funding. While Korean banks managed to refinance only 50% of their external short-term debt in
the final quarter of 2008, this ratio increased to 105% in the second quarter of 2009. Access of the
banks to long-term foreign borrowing has also greatly increased. The outlook for the banking
sector has thus improved, though banks will still be affected by the downturn. The regained access
to foreign funding also has a positive influence on the foreign reserves. In late 2008 the
government used the foreign reserves to backstop the banking sector, but with the need for this
support now much lower, the risk of a rapid depletion of these reserves has greatly decreased.
Indeed, foreign reserves are now on an upward trend again. At end-August the foreign reserves
stood at USD 245.5bn, which means that they are approaching their early 2008 peak of USD
264bn, after falling to USD200bn at end-2008. This rise was not only caused by greater capital
inflows, but also by an improvement in the current account. The lower won and strong demand
from e.g. China have moved the current account back into surplus. The surplus totalled USD
21.8bn in the first half of 2009, against a deficit of USD 5.4bn in the same period one year earlier.




September 2009                                         Rabobank             Economic Research Department                                                  Page: 3/5
Country update SOUTH KOREA


Chart 3: Foreign debt                                                                     Chart 4: Net foreign assets proxy
         bn USD                                                         bn USD                   bn USD                                                    bn USD
400                                                                                 400   400                                                                           400

                                                                                          350
320                                                                                 320
                                                                                          300

240                                                                                 240   250
                                                                                          200                                                                           350
160                                                                                 160   150
                                                                                          100
 80                                                                                 80
                                                                                           50
     0                                                                              0       0                                                                           300
            04         05        06        07       08e       09f      10f                           04          05        06         07      08e          09f
          Public MLT         Private MLT        IMF debt     Short-term debt                               Total external debt               FX-reserves


Source: EIU                                                                               Source: EIU


Noteworthy is the steep decline in total external liabilities between 2007 and 2008, from USD
826bn to USD 602bn. This fall was primarily caused by a decline of the inward portfolio stock,
probably as a result of falling equity and bond prices. The government of South Korea entered the
crisis in a relative sound state, with a total public debt close to 30% of GDP. This was a result of
the conservative fiscal policy in the preceding years. Just like other countries, debt levels are likely
to increase significantly. Still, we consider the fiscal stimulus to be appropriate in these special
times. Moreover, we are quite convinced that the government will roll back the expansionary
policies on time to protect its the decent fiscal position.


Politics
President Lee Myung-bak from the Grand National Party has so far failed to impress South Korea
with his leadership. Both outside and inside his party he faces strong opposition. The suicide, in
May, of the previous president, Roh Moo-hyun, fuelled the opposition. Critics of the government
claim that the indictment of corruption, that may have induced him to kill himself, was politically
motivated. It is estimated that 5 million people visited memorial altars, which can be interpreted as
a political signal. South Korea’s trade unions used to be powerful and militant, but appear to have
lost some of their power. So far, the unions have remained remarkably quiet in these difficult
economic times. A shock to the country came when North Korea performed nuclear tests on May
25. The sudden release of water in early September in a border river between the two countries
which killed six people on the southern side looks like another surprise action by the North Korean
dictatorship. Both are reminder that North Korea remains a possible source of regional political
instability that can be damaging. Moreover, should South Korea ever reunify with the North, this
will come at a huge fiscal cost.

Chart 5:                                                                                  Chart 6: Fiscal indicators
     months                                                               %                     % of GDP                                                % of GDP
12                                                                             400        80                                                                        5
                                                                               350        60
10
                                                                               300                                                                                  3
                                                                                          40
 8
                                                                               250
                                                                                          20                                                                        1
 6                                                                             200
                                                                                           0
                                                                               150                                                                                  -1
 4                                                                                        -20
                                                                               100
 2                                                                                        -40
                                                                               50                                                                                   -3
                                                                                          -60
 0                                                                             0
          04       05          06      07         08e      09f      10f                   -80                                                                       -5
          Import cover (l)                         Short-term debt cover (r)                        04      05        06         07    08e     09f      10f
          Debt service cover                       Total foreign debt cover                                Public debt                 Budget balance


Source: EIU                                                                               Source: EIU




September 2009                                                      Rabobank                    Economic Research Department                                                  Page: 4/5
Country update SOUTH KOREA

South Korea
Selection of economic indicators                               2004            2005          2006         2007          2008e            2009f          2010f
Key country risk indicators
  GDP (% real change pa)                                       4.6             4.0           5.2           5.1            2.2            -1.8            2.0
  C onsumer prices (average % change pa)                        3.6             2.7          2.2           2.5            4.7             2.6            2.3
  C urrent account balance (% of GDP)                          3.9              1.8          0.6           0.6           -0.7             3.2            2.8
  Total foreign exchange reserves (mln USD)                  198997         210317          238882        262150        201144          235790         247460
Economic growth
  GDP (% real change pa)                                       4.6             4.0           5.2           5.1            2.2            -1.8            2.0
                                                             2.1
    South Korea, Gross fixed investment (% real change pa), N/A                1.9           3.4           4.2           -1.7            -6.0           -1.8
    South Korea, Private consumption (% real change pa), N/A 0.3               4.6           4.7           5.1            0.9            -1.5            0.8
                                                          3.8
    South Korea, Government consumption (% real change pa), N/A                4.3           6.6           5.4            4.2             7.2            4.5
    South Korea, Exports of G&S (% real change pa), N/A        19.7            7.8           11.4          12.6           5.7            -4.8            3.8
    South Korea, Imports of G&S (% real change pa), N/A        11.7            7.6           11.3          11.7           3.7            -8.1            5.2
Economic policy
  Budget balance (% of GDP)                                    0.7             0.6           0.4           3.5            1.2            -5.0           -3.8
  Public debt (% of GDP)                                       21.3            23.1          25.7          27.2          24.4            28.2           29.9
  South Korea, Money market interest rate (%), N/A              3.6            3.3           4.2           4.8            4.8             1.9            1.9
  M2 growth (% change pa)                                      -0.6            3.1           4.4           0.3           15.9            10.0            2.0
  C onsumer prices (average % change pa)                        3.6             2.7          2.2           2.5            4.7             2.6            2.3
  Exchange rate LC U to USD (average)                        1145.32        1024.12         954.79        929.26        1102.05         1306.37        1243.90
  Recorded unemployment (%)                                    3.7             3.7           3.5           3.3            3.2             4.1            4.4
Balance of payments (mln USD)
  C urrent account balance                                       28173           14981            5385          5954        -6349          25230          24100
    Trade balance                                                37569           32684         27906         29409             6051        30000          26620
      Export value of goods and services                        257711          288971        331842        378982        433472          344260         377930
      Import value of goods and services                        220141          256287        303938        349573        427420          314260         351310
    Services balance                                              -8046         -13657        -18958        -20575        -16734          -12380           -8010
    Income balance                                                   1082        -1563              535           769          5106           8270           6200
    Transfer balance                                              -2432          -2482         -4093         -3647              -774            -660           -710
  Net direct investment flows                                        4597            2018      -4540        -13696        -10592            -3220          -3970
  Net portfolio investment flows                                  -2283         -11728        -32745        -29092        -37700           40300         -15680
  Net debt flows                                                 27512           25989         81141        108699        -10076          -45660          25950
  Other capital flows (negative is flight)                      -14285          -19939        -20675        -48597             3712        18000         -18730
  C hange in international reserves                              43714           11321         28566         23268        -61005           34640          11670
External position (mln USD)
  Total foreign debt                                            154714          180744        262117        375582        371847          318430         345910
    Short-term debt                                              56348           65911        113748        160249        151056          114830         136920
  Total debt service due, incl. short-term debt                  74842           78419         95779        157420        215432          200580         167070
  Total foreign exchange reserves                               198997          210317        238882        262150        201144          235790         247460
  International investment position                             -88473         -179476       -200948       -229538       -110406                n.a.           n.a.
    Total assets                                                325021          359968        451316        596793        491475                n.a.           n.a.
    Total liabilities                                           413494          539444        652264        826331        601881                n.a.           n.a.
Key ratios for balance of payments, external solvency and external liquidity
  Trade balance (% of GDP)                                     5.2             3.9           2.9           2.8            0.7             3.8            3.1
  C urrent account balance (% of GDP)                          3.9              1.8          0.6           0.6           -0.7             3.2            2.8
  Inward FDI (% of GDP)                                        1.3             0.7           0.4           0.2            0.2             0.0            0.1
  Foreign debt (% of GDP)                                      21.4            21.4          27.5          35.8          40.0            40.5           40.5
  Foreign debt (% of XGSIT)                                    48.6            51.0          64.6          79.5          68.1            73.1           72.7
  International investment position (% of GDP)                -12.3            -21.2        -21.1         -21.9          -11.9           n.a.           n.a.
  Debt service ratio (% of XGSIT)                              23.5            22.1          23.6          33.3          39.5            46.1           35.1
  Interest service ratio incl. arrears (% of XGSIT)             1.4            1.9           2.7           3.6            3.0             2.2            1.5
  FX-reserves import cover (months)                             11              10            9             9             6               9              8
  FX-reserves debt service cover (%)                           266             268           249           167            93             118            148
  Liquidity ratio                                              154             147           142           130           112             126            133

Source: EIU
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