World Economy

Economic Downturn Looms in S. Korea

Economic Downturn Looms in S. KoreaEconomic Downturn Looms in S. Korea

For emerging economies and neighboring countries, competitive currency devaluation means trouble. In South Korea, Hyundai Economic Research Institute reported that South Korea loses 3% of total export when the value of the yuan falls 5%.

The downward pressure in the consumption in China and the devaluation of the yuan has already affected South Korea’s economy, as a quarter of its total export is to China and China is its largest trading partner. The data released in August showed that South Korean exports fell 15% and exports to China dropped 8.8%, Global Risks Insights reported.

So far, the South Korean government has proven unable to read the market by constantly changing stances in its economic outlook, exposing its inefficacy in acting decisively against the market volatility. Investors should be wary of the government’s lack of confidence.

When China devalued the yuan for the first time on August 11th, the Minister of Strategy and Finance and Economic Deputy Prime Minister Choi Kyung Hwan said that devaluation would strengthen China’s exports and thus increase demand in China’s import of South Korea’s products.

His stance changed on August 20, when he said the devaluation of the yuan is instigating currency war and anxiety in emerging markets.

When China’s stock market crashed on August 20, he said it would have limited impact in the South Korean economy. In contrast, with the release of weak August export data and a lower growth forecast for 2016, Choi warned of China’s “extremely huge impact.”

 Housing Crisis, Household Debt

South Korea has bigger underlying problems than its dwindling export, however. A housing crisis looms, coupled with a bubble in housing prices and record-high household debt.

The engine of record growth in the wealth of 1st and 2nd generation South Korean households relied on its unique rental system, named “chonsei.”

Chonsei is a Korean lease contract in which the tenant pays an up-front deposit of 40-70% of the housing price with no requirement for periodic rent payments. This provided a way to save tenant’s rent money and freed up the circulation of investment for landlords.

Currently, the chonsei system is becoming obsolete, as landlords cannot make any profitable return on investment with a low-interest rate. What does this mean? In a period of market volatility and uncertainty, there is excess demand for chonsei, but no supply.

As a result, households are borrowing more to own properties in the already expensive housing market. By the end of last year, the household debt to disposable income ratio had jumped to 164%.

Due to stagnant growth in the housing market, Deputy Prime Minister Choi eased mortgage restrictions, such as relaxing DTI & LTV loan requirements, and pressured Bank of Korea Chairman Lee Joo Yeol to cut the interest rate to 2%, making it easier for households to borrow capital. Household debt rose 6.6% in 2014.

 Record-Low Rate

Because of the MERS outbreak last June in South Korea, the Bank of Korea has cut its base rate to a record-low 1.5% to prop up the economy. The next day, Chairman Lee said the risk of household debt leading to repercussion in the financial system is low. Conversely, on August 20, Lee said “low interest rate policy has led to growth in the household debt and the weakening consumption and macroeconomic conditions.”

The government has been sending mixed signals by making statements that heavily indebted households are from upper-middle class families who have the capability to pay back their loans. Nonetheless, in the worst-case scenario, a recession in China will slash overall income in South Korea, and the forthcoming Feds rate hike will put more burden on the nation’s debt.

The consistent low-interest rate policy and the soaring household debt have placed South Korea in a difficult position, and investors are losing confidence.