Asia | COVID | Emerging Markets | Monetary Policy & Inflation
South Korea’s economy is finally picking up. The September PMI was the highest since January, exports have bounced, declines in retail sales are slowing and unemployment remains low. The IMF revised its projections for Korea in its latest WEO and now expects only a modest contraction of -1.9% this year, picking up to 2.9% in 2021. Recent won performance reflects this improving macro backdrop, with KRW Asia’s best-performing currency since September, strengthening 3.2% versus the USD.
Importantly for the won, the current account is also improving. August’s $6.6bn surplus was almost $2bn higher than the same month last year. And the 12-month rolling surplus is now moving higher again after a long period of decline. The 7.7% YoY gain in September exports was the fastest since 2018 and boosted by an 11.8% gain in semiconductor exports. Tech exports had underperformed in recent months, with the 5.4% average growth from May through August significantly below the 19.6% increase in Taiwan’s electronics exports.
Lower chip prices are one factor. A multi-year decline in DRAM prices has been a significant drag on Korea’s C/A surplus given semiconductors account for 20% of total exports (Samsung is the world’s largest memory chip maker). Chip prices rose again in September after a sharp fall at the start of the year, which bodes well for further strength in exports. Samsung’s smartphone sales may also benefit from US restrictions on Huawei. And as well as improved C/A dynamics, capital account trends have also turned more favourable. Equity inflows have picked up again, with one-month rolling inflows now back close to the August highs.
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Summary
- KRW is Asia’s best-performing currency since the start of September
- The recovery is slowing picking up and exports are rebounding
- Still-low mobility levels suggest possible need for more policy support
Market Implications
- Medium term – positive KRW, given the improved C/A position and equity inflows
South Korea’s economy is finally picking up. The September PMI was the highest since January, exports have bounced, declines in retail sales are slowing and unemployment remains low. The IMF revised its projections for Korea in its latest WEO and now expects only a modest contraction of -1.9% this year, picking up to 2.9% in 2021. Recent won performance reflects this improving macro backdrop, with KRW Asia’s best-performing currency since September, strengthening 3.2% versus the USD.
Importantly for the won, the current account is also improving. August’s $6.6bn surplus was almost $2bn higher than the same month last year. And the 12-month rolling surplus is now moving higher again after a long period of decline. The 7.7% YoY gain in September exports was the fastest since 2018 and boosted by an 11.8% gain in semiconductor exports. Tech exports had underperformed in recent months, with the 5.4% average growth from May through August significantly below the 19.6% increase in Taiwan’s electronics exports.
Lower chip prices are one factor. A multi-year decline in DRAM prices has been a significant drag on Korea’s C/A surplus given semiconductors account for 20% of total exports (Samsung is the world’s largest memory chip maker). Chip prices rose again in September after a sharp fall at the start of the year, which bodes well for further strength in exports. Samsung’s smartphone sales may also benefit from US restrictions on Huawei. And as well as improved C/A dynamics, capital account trends have also turned more favourable. Equity inflows have picked up again, with one-month rolling inflows now back close to the August highs.
COVID Resurgence Has Left Low Mobility Levels
The more sluggish recovery in South Korea, when compared with Taiwan or China, is partly attributable to the renewed resurgence of COVID in late Q2 and into Q3. Social distancing measures were reintroduced and business restricted. With new daily cases now below 100, restrictions are being eased. But mobility levels remain low (Chart 3). According to both Apple and Google measures, mobility in South Korea is one of the lowest globally, with only Argentina lower. This is reflected in the fact that while Korea’s PMI has improved, it is the only one in Asia to remain sub 50.
Such low mobility levels leave downside risks to Korea’s recovery. The government responded to the second COVID wave with a fourth support package, taking total fiscal stimulus to around 14% of GDP, one of the largest in Asia. Should the recovery stall, we expect fiscal rather than monetary stimulus will be the likely option. With government debt around just 40% of GDP prior to the COVID crisis, and two decades of fiscal surpluses, Korea had sizeable fiscal space. The government is nevertheless keen to reinstate its reputation for fiscal discipline, partly driven by the future financial liabilities from the country’s ageing society. New fiscal rules are under consideration, which would see a debt ceiling at 60% of GDP and fiscal deficit at 3% of GDP (from 2025 onwards).
Further cuts to the policy rate are unlikely. After rate cuts at the start of the year the policy rate has been at 0.5% since May. And with inflation starting to tick back up (September’s 1.0% YoY reading was the highest since March) and the recovery gathering momentum, there is little reason to expect lower rates. BoK Governor Lee Ju-yeol also ruled out a formal QE program at this week’s policy meeting. The bank has committed to stabilize the bond market, if needed, and has already purchased around KRW8trn in government bonds in recent months, out of a planned KRW11trn.
Financial stability concerns also argue against any further rate cuts. The recent BoK statement noted that ‘household loan growth has picked up and housing prices have continued to increase at high rates in all parts of the country’. Household loans are now above 80% of GDP, with the stock up by more than 5pp over the first half of the year. Such sharp gains in borrowing in the context of a weak macro backdrop bodes poorly for future consumer strength, particularly given Korea’s low unemployment rate is expected to move higher.
Low rates and the earlier COVID spike have not impeded recent won appreciation. Global risk sentiment and the strong BoP position have dominated, and, with the improved BoP dynamics set to continue, we expect KRW to appreciate further.
Caroline Grady is a Senior Researcher at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)