South Korea: Business investment faces roadblocks Asia Pacific Economic Outlook, Q1 2017

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South Korea’s GDP has grown in the last quarter, driven mainly by fixed asset investment, most of which came from residential construction. Business investment, on the other hand, faces several domestic and external challenges.

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In the third quarter of 2016, strong growth of exports and fixed asset investment drove the overall growth of the South Korean economy. Real GDP was up a strong 0.7 percent from the second to the third quarter, with exports up 0.8 percent and fixed asset investment up 2.0 percent. Much of the investment growth was driven by residential construction rather than business investment. This might not be sustained going forward, especially given the high level of consumer indebtedness. Indeed, household debt in South Korea is a higher share of GDP than in the United States, United Kingdom, Japan, Germany, or France. It is currently about 77 percent of GDP.

Moreover, business investment faces a number of challenges. The recall of the Samsung Note 7 smartphone, which has hurt exports and shaken business confidence, is but one of several challenges for the South Korean business sector. Another major one is the bankruptcy of Hanjin Shipping, one of the country’s largest container shipping companies. This is causing a big negative spillover impact on global trade. It is estimated that ships belonging to Hanjin, which are sitting idle, now contain about $14 billion in merchandise that is not getting delivered.1 The problems of Hanjin and other top global container shippers, which reflect global excess capacity, are creating a significant challenge for shipbuilders, including those of South Korea. Thus the restructuring currently taking place in the shipbuilding industry could hamper overall business investment in the near future. Political scandal, which has led to calls for the president’s resignation or impeachment, might have a negative impact on business sentiment. Resolution of the political crisis would probably be helpful to investment.

On the export side, the troubles in the telecom sector hurt export growth in October and could, consequently, hurt economic growth in the fourth quarter. In dollar terms, exports fell 3.2 percent in October versus a year earlier. Exports have also faced the challenge of weak demand in China, weak Chinese exports (which are dependent on a large volume of imported Korean components), and the weakness of the Japanese yen, which has allowed Japanese manufacturers to boost their competitiveness in relation to South Korea. In addition, Korean exporters might be worried about the rising protectionist sentiment in the United States and Europe.

Challenges

Observers of South Korea are worried about a variety of factors that could undermine growth and stability in the coming year. These include high household debt, competitive pressures from China and Japan, protectionism in the United States, a potential tightening of US monetary policy, instability in North Korea, and political paralysis in South Korea due to the current scandal. Indeed, South Korea’s need for help from the International Monetary Fund in 1997 is on the minds of some analysts. Yet there are substantial differences between now and then. On the positive side for the economy, the South Korean government runs a large budget surplus and has minimal overall debt. This gives the government wiggle room to assist the economy through fiscal stimulus in the event of economic deceleration. In addition, the country has a large external surplus. This gives the country plenty of room to stimulate domestic demand without being concerned about rising external debt. Plus, the central bank’s reserves are substantial, at more than $375 billion. This means that the country is well positioned to withstand any kind of external shock. That was not the case in 1997. Interestingly, South Korea has a better sovereign credit rating than neighboring Japan. This reflects the fact that, unlike Japan, South Korea’s debt level is not regarded as excessive.

Perhaps the biggest long-term challenge facing South Korea’s economy is the necessity to restructure multiple industries that have come under intense pressure. These include shipbuilding, steel, and petrochemicals. All of these industries face excess capacity and intense foreign competition. The government is now providing substantial financial support to the shipbuilding industry and providing tax cuts and other forms of support to other industries. It is helping them manage the process of cutting excess capacity. The government’s finance minister said, “The government doesn’t plan to delay corporate restructuring that is needed right now and will focus on proceeding with turnaround plans to help companies become more competitive in the global market.”2 The competitiveness of Korean industry is a major concern. In a recent survey by the Korean International Trade Association (KITA), only about a third of corporate respondents said that their products have a competitive advantage in the marketplace.3 The rest said that their products either have no advantage or are at a disadvantage competitively. Given that exports account for roughly half of GDP, this constitutes a significant problem. On the other hand, the perception of inadequate competitiveness might compel companies to invest more in innovation.