A new year has dawned. After a tough year, we naturally hope this one will be much better than the last. Yet 2012 promises to be just as demanding, if not more so, for the nation.
This year, as in the one that just ended, economic growth is expected to be lackluster as the government will put the emphasis of economic policy on stability rather than growth in the face of escalating uncertainties.
The government and the Bank of Korea both forecast that the economy would grow 3.7 percent this year, 0.1 percentage point lower than the estimated growth rate for 2011. Private research institutes all offer similar estimates.
The growth projection is much lower than Korea’s potential growth rate of around 4.3 percent. But policymakers say the economy may not attain even the relatively low growth target as downside risks are growing.
In 2012, three major risk factors threaten the Korean economy ― the ongoing eurozone debt crisis, the uncertain future of North Korea following Kim Jong-il’s death and the crucial parliamentary and presidential elections in April and December, respectively.
The sovereign debt crisis in the eurozone, which started in 2009 in Greece, has continued to escalate. Having engulfed Italy and Spain, it is now threatening the region’s core economies ― France and Germany.
The Korean economy is likely to face a severe test in the first quarter of the year as the eurozone turmoil is expected to reach its peak during this period. In the three-month span, the five crisis-stricken PIIGS countries ― Portugal, Ireland, Italy, Greece and Spain ― have to refinance 207 billion euro worth of maturing treasury bonds.
To get a sense of the risks involved, it must be remembered that the amount is larger than what the five countries refinanced for the whole of last year. Furthermore, they have an additional 410 billion euro worth of bonds which will be due during the remainder of the year.
If these countries have difficulty selling new bonds to redeem the maturing ones, it could deal a devastating blow to financial companies that have invested in their sovereign debt. This in turn could rattle global financial markets, causing serious dollar funding problems for Korean financial institutions.
Another factor that could destabilize domestic financial markets is the strengthened capital adequacy rule for European banks. Under an agreement reached at a summit of European leaders in October, major banks in Europe are required to raise their capital adequacy ratios from the current 6 percent to 9 percent by June.
This requirement could prompt big European lenders to ramp up deleveraging efforts. Korean banks have borrowed a total of $59.2 billion from European lenders. If these lenders call in the loans, Korean banks could be drained of foreign exchange reserves.
The eurozone financial turbulence is also expected to hit the nation’s real economy. It has already pushed major economies in Europe into recession, weakening their demand for Korean products. Korea’s export growth is forecast to significantly slow this year as the eurozone crisis is taking its toll on emerging economies as well as developed countries.
To make matters worse, the geopolitical risks associated with North Korea have been heightened following the death of Kim Jong-il. Thus far, the transition of power to Kim Jong-un, the departed leader’s youngest son and heir, appears smooth.
In addition, countries like China, the United States and Japan, as well as South Korea, have been making diplomatic efforts to help the new leadership in the North stabilize as early as possible.
Yet it is an open question whether the young and inexperienced leader can consolidate his position in the absence of his father. If a power struggle erupts in the North, which is deemed highly likely, it could sharply increase risks on the Korean Peninsula and in Northeast Asia.
If political instability in the North is prolonged, people in the South could feel restless, which would weaken consumption and investment. It could also hurt exporters as scared foreign buyers would place orders with suppliers in third countries.
Furthermore, it would disrupt domestic financial markets, causing difficulties for companies that need funding. It could also trigger capital outflows, sending the Korean currency into a tailspin.
According to a domestic think tank, if this bleak scenario materializes, it could knock off 1 percentage point from this year’s GDP growth rate, reduce the nation’s current account surplus by 28 percent and boost inflation to 3.9 percent.
This year is also an election year when political risks heighten. Political parties are expected to go all-out to win the crucial general and presidential elections. Policy uncertainty is bound to increase as they will pile pressure on the government to adopt policies that cater to the electorate.
Against this backdrop, the government needs to prioritize macroeconomic stability over anything else. It needs to stay vigilant against any development in global financial markets. It should encourage domestic banks to improve their ability to secure foreign exchange funding in preparation for a possible global credit squeeze.
The government also needs to take steps to alleviate the impact of slowing economic growth. As economic difficulties are expected to be more severe in the early months of the year, it needs to frontload budget spending.
For Korea, the most effective way to boost growth is stimulating exports. Although overseas market conditions are not favorable, Korean companies need to explore new markets and take advantage of the free trade agreements with the United States, EU and other countries.
The government, for its part, should endeavor to reduce the volatility of the Korean won, since currency stability is indispensable to increasing exports.
While promoting export growth, the government needs to boost domestic demand to take up some of the slack left by a drop in overseas demand for Korean goods.
Efforts in this direction should include regulatory reform of domestic market-oriented industries, especially the service sector. Entry barriers need to be lowered to revitalize these industries.
As job market prospects are bleak, the government needs to encourage corporations to adopt smart working and flexible work arrangements, which will not only help employees harmonize work and family life but increase employment.
The Bank of Korea, for its part, should keep consumer prices under control to make life less difficult for ordinary people. Last year, it allowed inflation to grow to 4 percent, the upper ceiling of its 2-4 percent target band. This year, it may have to cut its key rates if the eurozone crisis goes out of control.
Regarding North Korea, the government should step up monitoring and enhance its intelligence collecting capability. As the situation in the North remains highly uncertain, it should take all possibilities into account and ensure that the nation is prepared against all possible contingencies.
