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Korea's GDP Growth in the Third Quarter of 2021

The Korean economy expanded at a slower-than-expected pace in the third quarter of 2021. Its gross domestic product (GDP) rose by 0.3%, the slowest in five quarters, following a 0.8% growth in the previous quarter. This weak performance reflects a sharp decrease in private consumption and lower investments in construction and equipment investments. Korea's GDP grew by 4% from a year earlier in part because of the last year's low base.

As the resurgence of COVID-19 undermined consumer sentiment, private consumption declined by 0.3% during July through September after growing by 3.6% in the preceding three months. The growth of government spending also slowed to 1.1% from 3.9% over the same period. There was a deeper contraction of 3% in construction investment, while equipment investment growth swung to a decline of 2.3% with the decrease mostly coming from the transportation sector. Global supply disruptions caused shortages of construction equipment and auto semiconductors, leading construction and equipment investments to drop.

Quarterly Economic Growth
*Figures in ( ) refer to year-on-year growth rates. (Source: Bank of Korea, Oct 26, 2021)

Exports slightly improved on strong sales of semiconductors and petroleum products, increasing by 1.5% quarter on quarter. On the other hand, imports shrank by 0.6% due to decreased shipments of cars and other transportation equipment.

The emergence of the Omicron variant, global supply shortages, and inflationary pressure coupled with soaring energy prices may pose risks to the fourth-quarter outlook. Although exports have held up well so far this year, the outlook remains uncertain due to the possibility of a deceleration in China and a continued shortage of key components. However, there are also positive drivers, such as the government's second supplementary budget and rising vaccinations. Moreover, with the transition to a new COVID-19 scheme called "Living with COVID-19" in November, an uptick in private consumption is likely to support the economic recovery, and consumption may also be boosted in the wake of a 20% cut in oil tax, which was introduced from November 12 for six months to reduce pressure from surging global energy prices.

BOK's Interest Rate Hike amid Growing Household Debt and Inflationary Pressure

The Bank of Korea (BOK) raised its benchmark interest rate to 1% from 0.75% at its monetary policy meeting on November 25, 2021 in a bid to address growing concerns over the financial stability of the economy. The recent rate hike has brought an end to 20 months of the rate staying below 1% after the BOK trimmed it by 50 basis points to 0.75% in March 2020, which was followed by another cut to a record low of 0.5% in May 2020. The benchmark rate had remained at the all-time low level until August 2021 when the BOK increased the rate by 25 basis points to 0.75%, making it the first major central bank in Asia to raise the base rate since the outbreak of COVID-19.

Given the worsening financial imbalances in Korea, a rate hike will do more good than harm according to a recent report by the BOK. Among others, it will help curb the growth of household debt and lower expectations on an additional increase in asset prices. The report suggests that an interest rate rise of 25 basis points is estimated to reduce the growth of household debt and house prices by 0.4%p and 0.25%p respectively. It is true that rate hikes will adversely affect economic growth while reducing inflationary pressure, but the impact will be smaller on GDP growth and consumer prices if the economic recovery momentum is maintained. When the BOK lifts the interest rate by 25 basis points, the country is expected to see a 0.1%p decline in GDP growth and a 0.04%p drop in consumer prices according to the BOK report.

At the end of March 2021, Korea's household debt to GDP ratio stood at 104.9%, which was the sixth highest among the 43 largest economies in the world based on nominal GDP. In terms of the rate of household debt growth, Korea ranked third among the major economies. Many households in Korea have become more exposed to asset price shocks due to the higher leverage in their balance sheets, and more exposed to changes in interest rates because of higher debt payments relative to income. The rapid increase in household indebtedness has been caused by soaring house prices and growing tendency among young adults to borrow to invest. Debt growth among Koreans in their 20s and 30s was much faster than other age groups, with debt held by people in their 20s and 30s rising by 12.8% year on year in the second quarter of 2021 compared to the 7.8% increase for other age groups.

Inflation was another important factor that strengthened the case for the further interest rate hike. In October, the inflation rate accelerated to a near 10-year high, with the consumer price index (CPI) rising by 3.2% from a year earlier. It was the fastest increase since January 2012, and the inflation remained above the central bank's 2% target for seven months in a row. The main driver was a hike in the prices of petroleum products, which led the government to cut domestic tax on key oil products by 20% temporarily.

BOK Benchmark Interest Rate (2010-2021)
(Source: Bank of Korea, Nov 25, 2021)

Korean Economic Outlook Update for 2021 - 2022

Korea is sustaining economic recovery in 2021 in spite of its depressed growth momentum on the resurgence of COVID-19 in the third quarter of the year. The country's GDP growth is forecast at 4% in 2021 and 3% in 2022. The recovery will be led by a pick-up in consumer spending, strong equipment investment growth and robust exports. Pent-up demand for private consumption and business investment is helping the economy regain strength.

The Korean economy has performed relatively well since the onset of the pandemic compared with many other advanced economies, demonstrating greater resilience in the face of economic downturns triggered by the pandemic. This relative economic durability was attributable to the government's strong fiscal and monetary policy response, well-established online shopping base, and robust external demand, especially for semiconductors, consumer electronics and health products. These growth drivers will likely continue to shore up the economy.

GDP Growth Trend (2011-2022(E))
(Source: Bank of Korea, Nov 25, 2021)

Consumer spending growth is projected to rebound to 3.5% in 2021 and 3.6% in 2022 after a sharp contraction in 2020. Household savings have increased as the COVID-19 pandemic caused uncertainty regarding future income and employment prospects. These increased savings may turn into a driver of consumption growth, with the government lifting many of the restrictions to curb the spread of COVID-19. The Living with COVID-19 scheme, which started in November 2021, is likely to boost a recovery in consumer sentiment.

Equipment investment is expected to rise by 8.2% in 2021 and then moderate to a 2.4% growth in 2022, driven by solid investment spending in the IT sector and a recovery in non-IT investment. Construction investment will continue to contract by 0.7% in 2021 but will rebound to a 2.6% growth in 2022. The civil engineering construction sector will continue to fare well thanks to the government’s investment in infrastructure, while the severe contraction in residential construction is set to slow down.

Korean Economic Growth Outlook
(Source: Bank of Korea, Nov 25, 2021)

A steady upward trend will continue for intellectual property investment, which is forecast to grow by 4.1% in 2021 and 3.9% in 2022. R&D investment is expected to be on the rise thanks to improving corporate revenues in the private sector and an increase in government budget for R&D. Growing demand for software applications for online platforms and services will also help boost investment activities in other intellectual property sectors.

Global trade conditions are improving, with a broad recovery in global demand. Korea's merchandise exports are projected to grow by 8.5% in 2021 and 2.6% in 2022, backed by the IT sectors, particularly the semiconductor industry. Non-IT sectors are also heading for a robust recovery as demand for petroleum-based products is likely to expand.

Korea's current account surplus is projected to increase to USD 92 billion in 2021 and USD 81 billion in 2022 thanks to a decrease in service account deficit. Since the outbreak of the COVID-19 pandemic, many countries have imposed travel restrictions, and the resulting plunge in international travel has been leading to a decline in service account deficit. When the spread of coronavirus is subdued, the amount of deficit may widen again. The nation's merchandise account surplus is likely to narrow as international oil prices are going up.

Consumer price inflation will likely trend up from 0.5% in 2020 to 2.3% in 2021 and 2% in 2022 as upward pressures will gather some strength in line with a rising pace of economic recovery. Rising prices of crude oil and agricultural produce and a hike in housing rental costs will become factors that push inflation up. Core inflation, which excludes food and energy prices, is also forecast at 1.2% in 2021 and 1.8% in 2022.

Labor market conditions remain weak in 2021, although the number of the employed people is bouncing back. Around 350,000 people are expected to be added to the workforce in 2021 compared to a decrease of 220,000 in 2020. The unemployment rate is projected to improve to 3.7% in 2021 and 3.6% in 2022. With the transition to the Living with COVID-19 scheme, a modest recovery is expected in the most impacted sectors such as hospitality, brick-and-mortar retailers, restaurants, entertainment and recreation. The job reduction in the manufacturing industries will also slow down, backed by demand recovery at home and abroad.

The speed of economic recovery inevitably depends on effective and sustained control of COVID-19 and swift vaccination. There are other risks that may lead to a delayed recovery, such as global supply chain disruption and China's growth slowdown. If the recent shortage in urea water solution and other strains on global supply chains are not addressed soon, Korea's economic recovery may lose steam. The economy, which heavily relies on exports to China, may also suffer some setbacks if China faces more difficulties from power shortage and corporate liquidity crisis.