I have just got back from a visit to Korea. It’s booming. National output rose 3% in real terms last year. Economic growth is accelerating. It grew at an annual rate of 3.7% in the past quarter and I reckon it’s got further to go. Something near 6% this year looks likely.
The equity market has been riding a global tide of liquidity for some months. The central bank pumped up money supply by 20% in 2000 and another 10% last year. Stock prices have been underpinned by a recovery in industrial production and raised profit expectations.
And more money is entering than leaving the country, with foreigners buying up Korean stocks.
With inflation low and the currency stable, domestic monetary policy should continue to be supportive too.
Most important, there is a global recovery in manufacturing and IT goods in which Korea is well placed to gain market share. Korea is shifting its exports up market and usurping Japan’s role as the industrializer of snazzy branded products. Samsung mobile phones are a good example.
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The second big change is the rise of the Korean consumer who has become king in the domestic economy. Consumer sentiment is at a three-year high and for good reason.
The household savings rate is falling and consumer credit is rocketing, providing domestic demand-led economic growth. Whereas consumer credit was 44% of GDP in 1999, it is heading for 69% by the end of this year. At the same time, property prices in Seoul have jumped 20% in the past year.
Because they start with such a high rate of household savings (over 30% compared with the UK’s 4% and the US at 2%) Koreans can cut their savings rates, so boosting consumption, without creating an unfinanceable deficit on the country’s external accounts. So even this strong boom is not going to create a large current account deficit this year or next.
And despite fears expressed by Korea’s central bank governor, I reckon this boom poses no inflation risk. Korea is now a more competitive marketplace, with cheap foreign imports keeping domestic prices low.
Korea’s exports are less price-elastic than in the past because they are higher value-added and better-branded. So a 10% fall in the value of the won against other currencies would boost inflation by only 0.8%, while increasing exports by 1.5%.
But here are long-term risks. Korea’s reform story may be the best in Asia but it is still incomplete. Korea is a half-painted house and will stay so.
Korean household balance sheets are not as strong or as well invested to create wealth as their US peers’.
Korean net worth is much lower. And over 60% of household financial assets are in bank deposits. Much therefore depends on the financial sector cleaning up its act and investing in growth.
The government’s bad-debt agency, KAMCO, has done a great job at cleaning up and selling the non-performing assets of the banks. And the top Korean conglomerates (chaebol) have mastered working for shareholder wealth. But the next tier has only mastered the semantics for visiting portfolio managers.
Below that, the swamp is full of ghouls, many supported by government through guarantees and Korean Development Bank loans.
The domestic market is still not liberalized enough to attract sufficient long-term direct investment. It’s got more foreign direct investment (FDI) recently but the bulk of foreign capital inflows are still for the stock and bond markets.
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Without big-time policy action to relaunch reform, Korea’s economic performance and profitability will continue to be constrained by poor allocation of resources and low return on capital.
The bull story for Korea is the potential “de-Japanization” of the old-guard political leadership.
This year’s December presidential election will only achieve this if President Kim Dae-jung’s likely successor, the younger Lee Han-dong, is nominated and wins. If the winner is the opposition’s Grand National Party old-timer, Lee Hoi-chang, who is steeped in the Japanese way by background and education, nothing much will change.
Then the next Korean crisis will run like this. Productivity and investment will be limited by continued misallocation of capital and the increasing fiscal burden of a growing (Japanese-style) public debt load.
The won will be chronically weak because the current account surplus will become a long-term deficit, thanks to the profligate consumer. Failure to liberalize local markets will keep return on capital low.
Interest rates and the cost of capital will stay high to defend the won in forex markets. This will feed into lower investment and lower growth.
The debt burden will start to spiral and equity will be destroyed by the corporate sector systematically.
Korea’s state sector is a suburb of Japan’s fiscal hell city. Public debt is officially 43% of GDP. But add in guarantees for loans to the ghoul corporations, the state-owned Korean Development Bank policy loans and unfunded state pension liabilities and the ratio jumps to 95% of GDP.
Of course, that still pales besides Japan’s public debt to GDP ratio of 300% calculated on the same basis.
But, unlike in Japan, much of Korea’s debt is owed to foreigners. So a debt and currency crisis could happen in tandem and much faster than in Japan. That’s even more so because Korean culture is individualistic, extreme, creative and a bit rough compared with the elegance of Japan, which prizes harmony above all else and is adept at lying to itself to achieve it.
The prospect of a crisis of this sort is some way off. In the meantime, foreigners are buying into the boom through the stock market. And Korea’s consumers and property developers are having a ball.
