Abstract
This 2007 Article IV Consultation highlights that the Republic of Korea is enjoying its longest uninterrupted period of economic expansion since the Asian crisis. Growth reached 5 percent in 2006, buoyed by strong exports, and is only expected to slow marginally to 4¾ percent this year. The current account is expected to remain broadly in balance. The impact of the ongoing global financial turbulence has so far been manageable but downside risks to the outlook have increased, with the nascent consumption recovery vulnerable to a downturn in asset markets.
1. This supplement to the staff report summarizes the main developments since the staff report was issued on August 15, 2007. The thrust of the staff appraisal remains unchanged.
2. The Bank of Korea (BOK) tightened further monetary policy in August. For the second consecutive month, the BOK raised its policy rate by 25 bps, to 5.0 percent, citing continued concern with rapid money and credit growth, but signaled that interest rates were now near neutral levels. At its monthly monetary policy meeting on September 7, the BOK left rates unchanged.
3. The impact of the ongoing global credit market crisis in Korea has been manageable, notwithstanding a significant increase in volatility:
Korean financial institutions appear to have limited exposure to the U.S. subprime market. Current estimates are that direct exposure by banks amounts to less than 0.1 percent of total banking assets, with some additional small exposure for insurance and asset management companies.
The won has weakened modestly over the period since July 20, falling by 2½ percent against the dollar and just over 3 percent in nominal effective terms. There has been no indication of official foreign exchange intervention.
After an initial sharp drop, the Korean stock market has rebounded, broadly in line with other emerging markets. The KOSPI is down 5 percent since July 20, but has increased 15 percent since August 17. The market remains up more than 31 percent up since the start of the year. However, foreign investors have continued their sell-off, with net selling by foreign investors reaching $9½ billion in August, compared with $5 billion for July.
Domestic corporate spreads remain broadly unchanged but accessing overseas funding has become more difficult and several large firms have indicated their intention to freeze overseas bond issuance. Net external borrowing by foreign bank branches from home offices also are reported to have slowed in July, but this appears to be more a reflection of window guidance by the financial regulator and the recently introduced thin capitalization rules than market turbulence.
The authorities have taken several steps in response to the increased volatility. Immediately following the onset of the global turbulence, the BOK announced that they stood ready to provide liquidity to financial markets if needed. In addition, the Ministry of Finance and Economy has set up a task force along with the BOK and financial regulators to monitor both domestic and international markets on a daily basis and to devise contingency plans.
Korea: Developments Since the Subprime Crisis
(Percent change, unless otherwise indicated)
Basis points change.
Korea: Developments Since the Subprime Crisis
(Percent change, unless otherwise indicated)
| Year-to-date | Since July 20, 2007 | |
|---|---|---|
| Exchange rate (Won per US$) | -1.0 | -2.5 |
| Nominal effective exchange rate | -2.9 | -3.1 |
| Stock market index (KOSPI) | 31.4 | -5.0 |
| External debt spread 1/ | 19 | 15 |
Basis points change.
Korea: Developments Since the Subprime Crisis
(Percent change, unless otherwise indicated)
| Year-to-date | Since July 20, 2007 | |
|---|---|---|
| Exchange rate (Won per US$) | -1.0 | -2.5 |
| Nominal effective exchange rate | -2.9 | -3.1 |
| Stock market index (KOSPI) | 31.4 | -5.0 |
| External debt spread 1/ | 19 | 15 |
Basis points change.
4. Recent data releases indicate that growth remains solid, with inflation modest.
Second quarter GDP data indicate that growth reached 1.8 percent (q/q seasonally adjusted), marginally higher than earlier flash estimates, led by strong facilities investment and exports.
Exports have continued to perform well in the third quarter. Exports rose by 20 percent (y/y) in July, on strength in both the high tech sector and heavy industry, and the current account recorded a sizable surplus of $1.5 billion. Preliminary August trade data indicate export growth remained robust.
Indicators of domestic demand are solid. Industrial output expanded by 2.1 percent (m/m seasonally adjusted) in July, led by increased production of semiconductors. In addition, business confidence remained strong in August, despite the financial volatility. Both of these developments point to likely continued strong investment. On the consumption side, data are more mixed. In July, while service sector output rose 0.7 percent (m/m seasonally adjusted), it moderated from June, and large store sales were flat. However, consumer confidence rose in August.
In August, headline inflation declined by ½ percentage point, to 2 percent (y/y), below the lower edge of the BOK’s target band. The decline, which is expected to be temporary, reflects food and oil prices. Core inflation was unchanged at 2.3 percent.
5. Staff projections have changed only marginally since the issuance of the staff report, reflecting the downgrading of global growth prospects:
Growth projections for this year remain unchanged, but 2008 growth has been lowered by 0.2 percentage point, to 4.8 percent, reflecting weaker external demand.
Both exports and imports are projected to moderate compared with projections in the staff report, with the current account still broadly balanced. In light of ongoing global financial turbulence, however, staff’s projections of net capital inflows and reserves have been lowered for 2007, with some turnaround expected next year.
Key downside risks continue to be those highlighted in the staff report—further financial market turmoil, a sharper-than-expected U.S. slowdown, or higher oil prices—but these risks have increased in line with recent global developments.
Korea: Staff Report and Revised Projections
In billions of U.S. dollars.
Korea: Staff Report and Revised Projections
| 2007 | 2008 | |||
|---|---|---|---|---|
| Proj. | Rev. Proj. | Proj. | Rev. Proj. | |
| Real GDP growth | 4.8 | 4.8 | 5.0 | 4.8 |
| Export volume growth | 12.2 | 12.1 | 13.4 | 11.5 |
| Current account balance 1/ | 1.4 | 1.4 | -2.6 | -3.4 |
| Financial and capital account balance 1/ | 17.4 | 0.9 | 10.4 | 22.0 |
| Gross international reserves 1/ | 257 | 241 | 265 | 259 |
In billions of U.S. dollars.
Korea: Staff Report and Revised Projections
| 2007 | 2008 | |||
|---|---|---|---|---|
| Proj. | Rev. Proj. | Proj. | Rev. Proj. | |
| Real GDP growth | 4.8 | 4.8 | 5.0 | 4.8 |
| Export volume growth | 12.2 | 12.1 | 13.4 | 11.5 |
| Current account balance 1/ | 1.4 | 1.4 | -2.6 | -3.4 |
| Financial and capital account balance 1/ | 17.4 | 0.9 | 10.4 | 22.0 |
| Gross international reserves 1/ | 257 | 241 | 265 | 259 |
In billions of U.S. dollars.