Korea 's Economy Outlook For 2008

I. Current Trends

Exports are holding up as the main pillar of the economy but rising inflation and turmoil in the global financial markets are causing sentiment to sag.

The economy entered 2008 on the heels of 5.5% year-on-year growth in the fourth quarter of 2007, the highest since the first quarter of 2006 (6.3%). Exports remained robust in January, rising 15% year on year.

Soaring oil, grain and raw material prices are pushing up inflation.

The record rise in the price of commodity prices as well as concerns about fallout from the slowing US economy and global credit crunch are weighing on both businesses and households. Their confidence in whether the Korean economy will be able to maintain growth momentum is falling. Indeed, sales for consumer goods in December 2007 fell 2.6%.

II. Outlook for 2008

1. External Conditions

Deceleration in the world economic growth is palpable on record energy and raw material prices and the US economy flashing signs of a recession.

Economic growth in the US , the Eurozone and Japan will plunge as uncertainties in global financial markets spill into the real economy.

2. Economic Growth

The double-digit growth rate in exports since 2003 is expected to continue this year, but weaker global economic conditions will slow down the pace.

Growth in domestic demand that began in 2007 is expected to wane as volatility in the local stock market erodes the wealth effect that bolstered consumption. Slow growth in job creation and worsening inflation is also likely to weigh down consumption.

Private consumption has already decelerated in the fourth quarter of 2007.

As a result, a moderating global economy will hold down export growth to a greater extent than can be offset by domestic demand recovery.

3. Private Consumption

In 2008, downward risks to consumption have increased and are likely to persist through the first half of the year. Meanwhile, inflationary pressure from crude oil and raw materials are fueling inflation, hurting real incomes.

In the second half of 2008, the negative trends are expected to ease and the effects of policies of the new government should be visible.

4. Fixed Investment

In 2008, facility investment is expected to increase thanks to a high capacity utilization rate and rising leading indicators but the growth rate will slightly fall to 6.9% from 7.5% last year due to an increase in downside risk factors.

Exports will likely remain on an upward trend primarily owing to those to developing nations. This will greatly increase facility investment in the manufacturing sector including the shipbuilding industry and machinery industry. IT sector is also likely to resume investment as sluggish investment in the sector is causing capacity to fall short of production. However, increasing downward factors such as the possibility of US recession, rising raw material prices will restrict the expansion of facility investment. Entering 2008, large firms planned more investment, expecting business-friendly policies of the new government, but business sentiment is weakening out of concerns over weaker-than-expected economic performance.

The new government intends to promote investment-stimulating policy in earnest from the second half, which will contribute to facility investment. However, this is not expected to produce a considerable increase in facility investment over the short term because it takes some time for tangible results to appear.

Facility investment will possibly increase 6.0% in the first half of 2008 and then higher 7.5% in the second half as a result of a base effect of high growth in the first half of 2007.

In 2008, construction investment is likely to grow an annualized 2.9%, led by more non-residential construction (e.g. shopping centers, offices, factories and warehouses), with residential construction shrinking.

5. Trade

Exports continue to be strong, rising 17% year-on-year in January. Shipments from traditional manufacturing industries to robust emerging economies and diversification of export markets offset sluggish exports to the US .

The US economic downturn will spread to other parts of the world. Given the expected lag time in feeling the US effects, Korean exports will likely be slower in the second half. For the whole year, exports are forecast to slow from 2007 but still maintain double-digit growth, rising 11%.

Meanwhile, imports are forecast to rise considerably this year due to skyrocketing prices of crude oil, grain and raw materials.

6. Employment

The unemployment rate has hovered around 3% and job creation has been on a downward trend since July 2007, falling below 300,000 per year.

The decline is attributed to three factors, sluggish growth in the service sector, many job seekers aim to land their ideal job and new labor laws have prompted businesses to tighten full-time employment.

In 2008, the unemployment rate is estimated at around 3.2%.

7. Exchange Rates

The annualized won-dollar exchange rate for 2008 is expected to be 935 won per US dollar, 0.6% up 929.2 won of last year, halting appreciation of the won against the dollar since 2002.

III. Policy Implications

Public optimism is high with the seating of a new administration that promises to focus on growth and job creation in contrast to the income distribution emphasis of its predecessor. Still, the new president will face challenges from labor unions and various interest groups. Under these circumstances, the year 2008 would be the year of “careful approach” to economic management.

In the short term, the primary focus will likely be maintaining both economic growth momentum and stabilization of consumer prices.

Besides the higher energy and commodity prices, the primary external threat is fallout from the US economy, which is nearing a recession, if not already in one. A severe downturn in the US , Korea 's No.2 trading partner, may force the government to adopt expansionary fiscal measures to keep the economy from rapid slowdown in 2008. Korea maintains a fiscal surplus, while interest rates are relatively higher than other nations, including the US , allowing room for the government to boost domestic demand.

From a long-term view, a sustained, higher level of domestic demand is needed for the Korean economy to realize its growth potential. Over-dependence on export continues to leave the nation vulnerable to external shocks. Accordingly, the new administration needs to deliver on its promises to retool business conditions and the economic environment. Private consumption could be bolstered by alleviating the burdens of the public such as reforming social welfare system, and stabilizing the asset market. It's also needed to energize the corporate investment climate through deregulations and corporate tax cuts.

(Source: Samsung Economic Research Institute)