[Yoo Choon-sik] Divide between exports, domestic demand

South Korea’s revised gross domestic product data, released late last week, showed its economy grew at the fastest rate in just over two years during the first quarter of this year. While the overall growth rate matched the earlier official estimates, details from the revised data raise a louder alarm about the magnitude of the slump in domestic demand.

The country’s GDP grew by a seasonally adjusted 1.3 percent in the January-March period over the previous quarter, the same as the official estimate published in late April and the strongest growth since hitting 1.6 percent during the final quarter of 2021, according to the Bank of Korea’s data. It was also more than twice the 0.5 percent growth posted during the final quarter of 2023.

On the surface, the strong rebound in economic growth after an extremely poor performance in 2023, when GDP expanded at the slowest pace in the country’s modern history excluding crisis years, should allow policy authorities to keep the focus of their fiscal and monetary policy stance on further lowering inflation. However, a deeper look into the breakdown of the figures points to a severe and widening division between external and domestic sectors.

For instance, net exports lifted GDP by 0.8 percent during the first quarter while domestic demand pushed it up by just 0.5 percent, according to the Bank of Korea data. Moreover, domestic demand contributed positively to GDP growth for the first time since the first quarter of last year, suggesting that the contribution recorded in the January-March period could still be little more than a technical rebound.

Even capital investment, such as spending on new production facilities, dragged GDP by 0.2 percent despite strong exports as companies were hesitant to increase capacity out of concern that the recovery in exports, led by a handful of sectors and distorted by cyclical price increases, may not last long. A leading domestic research institute also warned recently that uncertainty surrounding exports remained elevated.

In a research report published in late May, the Hyundai Research Institute cited a slowing global economy, continuing geopolitical risks in several areas, and a possible deepening of the trade war between the United States and China as factors making export prospects uncertain. In their conclusion, the institute called for policy authorities to take steps aimed at helping domestic demand secure a firm recovery momentum.

Meanwhile, local media reported that the ratio of failed restaurants out of the total in Seoul City during the first quarter reached the highest since the COVID-19 pandemic, hit by the slump in private consumption as both inflation and interest rates remained high for an extended period. The ratio rose to 4.0 percent during the January-March period of this year, up from 2.7 percent in the comparable period of 2022, according to the reports.

Household income data from Statistics Korea also showed self-employed families were hit hardest by the pair of high inflation and high interest rates as these households posted a monthly surplus of just 1.08 million won ($660) on average during the first quarter of this year, compared with 1.44 million won in the same quarter of 2022.

The still-struggling construction sector also poses a serious risk to the overall economy as the industry is a major employer in the labor market. The delinquency ratio on real estate project-financing loans across the financial industry rose to 3.55 percent at the end of the first quarter from 2.70 percent three months earlier, according to official data. The ratio stood at as high as 17.57 percent for securities companies.

The government is betting on signs of the domestic real estate market improving gradually from years of slump while pledging to implement emergency measures when the situation with the project-financing loans turns serious again. However, the Bank of Korea provided little indication at its latest policy meeting in late May of when it will change its tightening stance.

The Bank of Korea has promised on several occasions to manage monetary policy independently from the US Federal Reserve, but there is increasing skepticism among investors about the pledge because its policy board members continue to express concerns about the widening gap in interest rates with the US. It is understandable that South Korea’s foreign exchange market remains volatile and could be affected by concerns about a wider interest-rate gap.

However, some of the world’s major central banks, such as those of the Eurozone and Canada, have already started cutting interest rates to prevent their economies from cooling too much. This does not necessarily mean that the Bank of Korea should follow suit and change its policy stance immediately, but the Bank of Korea can achieve the effect of policy easing by providing a clearer indication of the timing of and conditions for a policy change.

Yoo Choon-sik

Yoo Choon-sik worked as the chief Korea economics correspondent at Reuters and is now a business and media strategy consultant. The views expressed here are the writer’s own. -- Ed.