As Korea is vulnerable to shock waves from the United States, it is almost certain that a hard landing for the US will deal a heavy blow to the Korean economy, especially in stock markets, exports and foreign direct investment. The nation's strong export growth was mainly attributable to an increase in shipments to emerging market economies. Accordingly, if the U.S. recession leads to a slowdown in these economies, it will hurt Korea's exports and widen the nation's current account shortfall. Korea's exports rose by 12.5 percent for the first 20 days of September, a setback from the 22.1 percent expansion during the January-August period. The growth rate stood at 18.7 percent in August and 36 percent in July. As a result, the shortfall in the trade account reached $6.19 billion for the first 20 days of September, compared with a $12.3 billion trade deficit between January and August. Affected by the fallout from the global recession creeping into the Korean economy, a number of economic institutions both at home and abroad have lowered their GDP growth forecast for the Korean economy to below 4 percent.
Bank of Korea Governor Lee Seong-tae recently said that the Korean economy will not grow beyond 4 percent in the first half of next year and economic conditions will not improve much in the latter half due to the international financial market turmoil and a global economic slowdown. In its latest world economic outlook report, the International Monetary Fund (IMF) anticipated Korea's GDP growth will drop to 3.5 percent in 2009, a steep fall from its earlier prediction of 4.3 percent expansion. Morgan Stanley also downgraded its forecast for Korea's economic growth for 2009 to 3.8 percent from its previous prediction of 4.3 percent, citing the global liquidity crunch and lack of domestic growth drivers. In the wake of the financial turmoil triggered by growing jitters over a global recession, consumer confidence was also severely dampened. Reflective of such gloomy prospects, the KOSPI has lost more than 45 percent of its value so far this year, while the local currency has fallen about 35 percent against the U.S. dollar.
The central bank's largest-ever rate cut on October 27 was designed to prevent falling consumer confidence from spilling over into other sectors of the economy. The BOK slashed its base rate by 0.75 percentage points to 4.25 percent. The central bank's powerful action reflects its growing concerns over the possibility that sluggish consumer spending will lead to a reduction in corporate investment and job losses. It means that banks may suffer losses in consumer and commercial property loans, which will have negative effects on the financial markets. It is almost certain that Korea, just like many other economies, will be affected by the problems in the U.S. Accordingly, the government is planning to cut taxes, remove regulations, increase fiscal spending and ease a liquidity shortage to inject fresh vigor into the ailing economy. However, such stimulus packages will not be effective unless Korean policymakers restore confidence from both local and foreign investors. The most important thing to escape from the financial turmoil where stock prices plummeted and the won fell to a 10-year low against the US dollar is to recover confidence in the Korean economy in domestic and foreign investors.
Unless the country restores confidence, upcoming bailout measures, including additional rate cuts and the central bank's purchase of bank bonds, will not stabilize the financial markets and stimulate the economy. Korea is the world's 13th largest economy with foreign reserves of $239 billion in September, the sixth largest in the world and the second largest among OECD member countries. Corporate debt ratio has dropped to around 95 percent from 420 percent in 1997, while local lenders' Bank for International Settlement (BIS) ratio stood at 10.5 percent, well above the international average of 8 percent. Despite the nation's sound fundamentals, the won has been depreciating at a much faster pace than other major currencies. It has lost about 34 percent of its value against the dollar since the beginning of this year, compared to Thailand (-13.2 percent) and Taiwan (-2.6 percent). Second, the government should make all-out efforts to make the nation's current accounts shift into the black.
Fortunately, this is expected to shift into the black in October on the back of falling oil prices. The nation is likely to post a handsome surplus in November and December of this year and the current account surplus is expected to reach $4 billion in the fourth quarter. The turnaround will help calm the domestic currency, which has been extremely volatile on concerns over an acute shortage of dollars here amid widening shortfalls in the current account. The current account deficit reached $12.59 billion between January and August, putting additional constraint on the local currency. In August, the shortfall reached a record high of $4.7 billion as the goods balance posted the largest shortfall in 12 years. Third, the nation needs to exploit the slowdown of the Chinese economy. The Chinese government is moving to launch large infrastructure projects to boost domestic demand, which can create numerous golden opportunities for Korean firms and individuals. China is also facing a serious economic problem as the US economy heads toward a recession.
The Chinese economy expanded by just 9 percent in the third quarter, the slowest rate since 2003. The economy grew 10.6 percent in the first quarter and 10.1 percent in the second quarter. On a short-term basis, Korea will suffer from a Chinese slowdown because Korean firms supply Chinese factories with important machines and equipment. However, there will be good opportunities for Korean companies on a long-term basis. If China employs a measure to stimulate domestic demand, Korean exporters could enjoy benefits. One piece of good news is that Korea signed a $30 billion currency swap agreement with the United States on October 30. It is expected to serve as a stepping stone toward the won's convertibility and boost the international status of the local currency, helping stabilize the domestic financial markets and upgrade the nation's credit rating in the near future.
