South Korea resumes positive GDP growth in early 2023 (2024)

ECONOMICS COMMENTARY May 02, 2023

The South Korean economy returned to positive economic growth inthe first quarter of 2023, albeit at a modest pace of 0.3%quarter-on-quarter. This followed a contraction in GDP of 0.4%quarter-on-quarter (q/q) in the fourth quarter of 2022. South Koreais expected to face continuing economic headwinds during 2023, dueto the impact of weak exports and the cumulative transmissioneffects of monetary policy tightening by the Bank of Korea during2022.

Weak economic growth in the US and the European Union (EU)remain a key downside risk for South Korea's manufacturing exportsector in 2023. However, this is expected to be mitigated byimproving exports to Mainland China, as economic growth strengthensduring 2023 due to the easing of COVID-19 restrictions.

GDP resumes positive growth in first quarter of2023

South Korea's real GDP grew at a pace of 0.3% quarter overquarter in the first quarter of 2023, showing a return to moderatepositive growth after contracting by 0.4% quarter over quarter inthe fourth quarter of 2022. On a year-over-year basis, real GDPgrowth slowed to an increase of 0.8% year over year in the firstquarter of 2023, compared with 1.4% year over year in the fourthquarter of 2022.

The resumption of positive growth was helped by a rebound inprivate consumption, which grew by 0.5% quarter over quarter, afterhaving declined by 0.6% quarter over quarter in the fourth quarterof 2022. Private consumption was up 4.5% year over year in thefirst quarter of 2023, while government consumption rose by 3.9%year over year.

Exports of goods and services also improved, growing by 3.8%quarter on quarter, after having declined by 4.6% quarter overquarter in the fourth quarter of 2022. Imports also grew in thefirst quarter of 2023, rising by 3.5% quarter over quarter, afterhaving fallen by 3.7% quarter over quarter in the fourth quarter of2022.

On an industry sector basis, manufacturing output rose by 2.6%quarter over quarter in the first quarter of 2023, after threeconsecutive quarters of quarter over quarter declines inmanufacturing output. The construction sector also posted positivegrowth of 1.8% quarter over quarter in the first quarter of 2023.However, the services sector recorded a small contraction of 0.2%quarter over quarter in the first quarter of 2023. Compared with ayear ago, manufacturing output fell by 3.3% year over year in thefirst quarter of 2023, while services output rose by 3.2% year overyear and construction output rose by 5.1% year over year.

The seasonally adjusted S&P Global South Korea ManufacturingPurchasing Managers' Index (PMI) dipped from 48.5 in February to47.6 in March, remaining well below the 50.0 no-change mark, tosignal continued contractionary conditions in South Korea'smanufacturing sector. The March PMI data indicated an eleventhconsecutive monthly decrease in output at South Koreanmanufacturers. Panel members largely attributed the decline tomuted domestic and external demand conditions.

At the same time, manufacturing companies registered a quickerreduction in new orders that was the fastest for three months. Anumber of firms mentioned that sustained economic weakness and weakclient confidence had placed downward pressure on sales.

During the second half of 2022, moderating economic growth inmainland China due to the impact of pandemic-related restrictivemeasures on domestic demand had been an important factorcontributing to weaker external demand for South Korean exports,since mainland China is South Korea's largest export market. Incalendar year 2022, South Korean exports to mainland China fell by4.4% y/y, having deteriorated considerably in late 2022 and early2023. Merchandise exports have remained weak in early 2023,declining by 13.6% y/y in March 2023, mainly as a result ofcontinued contraction in exports of semiconductors anddisplays.

As the US and EU are also among South Korea's largest exportmarkets, weakening economic growth in the US and EU since mid-2022has also become a negative factor for South Korea's manufacturingexport sector. However, easing of COVID-19 restrictions is expectedto result in strengthening domestic demand in mainland China as2023 progresses, which should help to support a rebound in SouthKorean exports to that key market.

Receding supply chain pressures fed through to moderating inputcosts in the latest survey period, with operating expenses risingat the weakest pace since December 2020. According to firmssurveyed, falling international oil prices helped to alleviate somepressure on costs.

In terms of prices, both input cost and output price inflationaccelerated and remained historically sharp according to the latestPMI survey. Inflation across a range of inputs was mentioned bysurvey members, with specific mentions of rising raw materialprices and weakness in the won. As such, firms continued topartially pass increased input costs to their clients in the formof higher selling prices, which rose at a moderate pace.

South Korean CPI inflation rose significantly during 2022,largely reflecting the impact of the Russia-Ukraine war on globalcommodity prices, particularly for oil and gas. The annual averageCPI inflation rate of 5.1% for 2022 compares with an average CPIinflation rate of 2.5 percent in 2021. The 2022 average CPIinflation rate was the highest annual average since 2011.

Due to the upturn in inflation pressures during 2022, the Bankof Korea (BOK), South Korea's central bank, tightened monetarypolicy seven times in 2022, lifting the Base Rate to 3.25%. At itsJanuary meeting, the Monetary Policy Board of the BOK decided toraise the Base Rate by a further 25bps, raising the Base Rate to3.50%. This has brought total cumulative tightening to 300 basispoints (bps) since August 2021. This has impacted domestic demand,with household lending having continued to decrease owing to risinginterest rates and falling prices in the residential propertymarket.

In early 2023, there have been signs of easing inflationpressures. South Korea's headline CPI inflation rate moderated to4.2% year-on-year (y/y) in March 2023, compared with 4.8% y/y inFebruary. The Monetary Policy Board of the Bank of Korea decided atit* 11th April meeting to leave the Base Rate unchanged at 3.50%.In its April Monetary Policy Decision, the Monetary Policy Boardassessed that consumer price inflation will continue to moderateand decline to the 3% range from the second quarter of 2023,reflecting base year effects from the sharp rises in global oilprices in 2022 as well as weakening pressures from the demandside.

The recent rebound of the Korean won against the USD has alsohelped to somewhat mitigate the upside risks to inflation. The KRWhad depreciated from 1,189 against the USD on 1st January 2022 to1,428 by 12th October 2022, but has since appreciated to 1,337 by26th April 2023.

Electronics sector downturn hits South Korean exports

The electronics manufacturing industry is an important part ofthe manufacturing export sector for South Korea which is one of theworld's leading exporters of electronics products to key marketssuch as the US, China and EU. As Vietnam is an important productionhub for South Korean electronics multinationals such as Samsung andLG for a wide range of electronics products such as mobile phones,Vietnam is also a key export market for South Korean electronicscomponents.

Exports of South Korea's information and communicationstechnology (ICT) goods for calendar year 2022 amounted to USD 233billion, up 2.5% y/y and accounting for 34.1 percent of SouthKorea's total merchandise exports. However, deteriorating globaleconomic conditions through the course of 2022 resulted in weakerICT exports in late 2022, with ICT exports in December 2022 down23.6% y/y.

South Korea's ICT exports have remained weak in early 2023.South Korea's Ministry of Trade, Industry and Energy trade datashowed that South Korea's exports of ICT goods in March 2023 wereUSD 15.8 billion, down 32.2 percent year-on-year. Semiconductorsexports fell by 33.9 % y/y to USD 8.7 billion, with exports ofsystem chips down 18.4% y/y to USD 3.6 billion and memory chipexports down 44.3% y/y to USD 4.6 billion.

The downturn in South Korea's ICT exports reflects the slowdownin the global electronics industry since mid-2022. The headlineseasonally adjusted S&P Global Electronics PMI fell from 51.4in February to 48.4 in March to signal a renewed deterioration inoperating conditions across the global electronics manufacturingsector. A solid decline in order book volumes drove the latestdownturn and contributed to the eighth fall in output in the pastnine months.

New orders placed with global electronics producers fell for theeighth time in nine months during March. The reduction was solidoverall and often attributed to weak demand conditions in the US,Europe and China. As a result of weak demand, average supplierdelivery times shortened to the greatest extent since December2001, as subdued input demand reduced pressure on suppliers andlogistics capacity.

Near-term economic outlook

South Korean GDP growth is forecast to moderate from 2.6% in2022 to 1.6% in 2023, according to the latest forecast by S&PGlobal Market Intelligence.

South Korea's export sector, which accounts for an estimated 38%of GDP, is expected to face continuing headwinds during 2023 dueweak growth in the US and EU and the slowdown in the globalelectronics cycle.

Due to the upturn in inflation pressures since late 2021, theBank of Korea has tightened monetary policy by 300 bps since August2021, including a 25bp which has lifted the Base Rate to 3.50%.Higher policy rates have also resulted in a cooling propertymarket, with South Korean apartment prices estimated to havedeclined by 4.7% y/y in 2022 according to the Real EstateBoard.

Inflationary pressures remain an important risk to the near-termoutlook. This reflects a number of factors, including higher inputprices and supply chain disruptions, which have contributed torising input price inflation pressures.

Medium term outlook and key risks

Over the medium-term outlook, South Korean exports are expectedto grow at a rapid pace, helped by the sustained strong growth ofintra-regional trade within APAC, as China, India and ASEANcontinue to be among the world's fastest-growing emerging markets.South Korea's strong competitive advantage in exporting keyelectronics products, notably semiconductors and displays, as wellas autos and auto parts, are expected to be an important positivefactor underpinning export growth.

The rapid growth of South Korean exports is also expected to bestrengthened by the APAC regional trade liberalizationarchitecture. This includes the large recent RCEP multilateraltrade agreement and major bilateral FTAs. The RCEP trade deal,which South Korea has ratified, entered into effect from 1stJanuary 2022 for the first ten ratifying members, and from 1stFebruary 2022 for South Korea.

An important macroeconomic risk to the South Korean economy overthe medium to long-term outlook continues to be from the high levelof household debt as a share of disposable income. This has risento 206% by 2021, the fifth highest amongst all OECD countries. Akey factor driving this debt ratio higher has been large mortgagelending flows for residential property purchases. Such a highhousehold debt ratio creates macroeconomic vulnerability tosignificant monetary policy tightening, with Bank of Korea ratehikes during 2021-23 having increased financial pressures on highlyleveraged households.

Managing the energy transition towards renewable energy is alsoa key policy priority for South Korea. South Korea has already beenat the forefront globally in planning initiatives to develophydrogen as a key future fuel source for domestic powergeneration.

Among South Korea's greatest economic challenges will belong-term demographic ageing, which will have severe implicationsfor South Korea's economy and society. The number of seniors aged65 or over has already reached 16.5% of the population and by 2025is projected to rise to 20% of the population. Meanwhile theworking age population (aged 15 to 64) is declining as a share ofthe total population, from 71.4% in 2021 to a projected 55.7% by2041.

Demographic ageing has already contributed to the moderation ofSouth Korea's potential GDP growth rate from around 7% per year inthe mid-1990s to around 2.5% per year by 2021. South Korea'spotential growth rate could drop to a range of around 1% to 1.5%per year by 2050 due to demographic ageing.

Consequently, structural reforms to increase the potentialgrowth rate will be a key policy priority over the medium term.These reforms would include policy changes to lift the labour forceparticipation rate, improve services sector productivity,accelerate digitalization and further boost the adoption ofindustrial automation.

Rajiv Biswas, Asia Pacific Chief Economist, S&PGlobal Market Intelligence

Rajiv.biswas@spglobal.com

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