The Korean economy exhibited slow growth amid a moderation in domestic demand and continued slump in exports.
Economic growth recorded 2.7% YoY in the Q1, down from the previous quarter (3.1%) while annual QoQ growth receded to 1.5%, implying an overall economic slowdown.
By economic activity, although manufacturing production remains stagnant and service production slackens, strong construction has offset the slowdown.
Overall improvement in domestic demand has weakened, mainly in private consumption and facilities investment. However, additional slowdowns will be less likely.
Growth in private consumption slowed, burdened by the increase in life expectancy and diminishing effects from last year’s consumption stimulus packages. However, the consumption sentiment has begun to gradually improve from the Q2.
Facilities investment swung to a decrease YoY on reduced overseas demand and sluggish industrial production. Intellectual property product investment has stalled at around the 0% level.
Meanwhile, government consumption has expanded relatively largely due to the impact of early budget spending. Construction investment is projected to continue the favorable momentum, shoring up domestic demand.
Exports remained sluggish due to low global investment and weakened external competitiveness while imports exhibited slowing growth on moderations in domestic demand.
Exports and imports (value basis) have declined significantly on continued low oil prices since last year.
Current account continues to run a huge surplus (monthly average of around $10 billion) despite sagging exports due to low oil prices.
Headline CPI inflation remains at around 1% while growth in apartment prices has decreased to around 0%, raising concerns over a real estate slump.
Employment growth retreated as unemployment rate rose, implying a slight contraction in employment conditions.
Meanwhile, global economic growth has slowed, mainly in China and Japan and downside risks look to persist. Thus, it will be difficult to rule out the possibility of additional burden on the recovery pace of the Korean economy.
On the domestic side, the restructuring of distressed firms is deemed inevitable.
The number of marginal firms are soaring and sales are plunging in the aftermath of the financial crisis, hinting at mounting corporate insolvency and resultant vulnerability to external shocks.
Restructuring could yield different results depending on the method. Therefore, the most optimal solution must now be sought taking into account industrial characteristics and debt structure.
Hence, Korea’s economic policies need to be more active in restructuring distressed firms while taking strong action against the short-term negative repercussions to stabilize the macroeconomy.
The methods and action plans of corporate restructuring should satisfy both the minimum-cost principle and the principle of liability by imposing the burden of loss on the stakeholders adequately.
Meanwhile, macroeconomic policies should directly and indirectly support the restructuring efforts with active response measures to possible changes in macroeconomic conditions to pursue overall economic stability.
As for matters related to rising unemployment, more sectors should be allowed to hire dispatched workers while making the best use of existing programs such as unemployment allowance and special-employment support.
Ⅱ. Domestic Economic Outlook for 2016-17
1. Expected External Environment
The global economy will grow at a rate similar to that of 2015 then improve moderately in 2017, mainly in emerging markets.
IMF projects that the global economy will grow 3.2% in 2016, similar to 2015 (3.1%), on the continued economic slowdown in emerging markets including China and resource exporting countries, and then 3.5% in 2017 as emerging economies start to improve.
Oil prices (Dubai) will clock in at around $40 and $46 per barrel (annual average) in 2016 and 2017, respectively, meaning a drop of 22% YoY in 2016 and an increase of around 15% YoY in 2017.
The value of the Korean won, in terms of the real effective exchange rate (REER), will recede by 4% in 2016 and maintain the level in 2017.
2. Domestic Economic Outlook for 2016-17
Korea’s domestic demand is projected to rise at a modest pace mainly in construction investment while GDP growth will be around the mid-2% level in 2016 and 2017.
In 2016, Korea’s exports and facilities investment will stay subdued due to a slowing global economy, but growth is forecast to be in the mid-2% range influenced by expanding construction investment.
Although low interest rates and falling oil prices will help improve private consumption, structural factors such as rising life expectancy will continue to hinder.
Facilities investment will show a relatively sharp decline in 2016, as the manufacturing capacity utilization rate remains low amid sagging exports and mounting uncertainties at home and abroad. A moderate improvement is expected in 2017.
Construction investment is projected to grow mainly in the building construction sector influenced by a continued rise in pre-sales housing units since last year.
Exports will remain stagnant as export competitiveness weakens amid falling global investment demand while imports exhibit low growth due to sluggish economic activity.
The current account will continue to run a huge surplus due to structural factors, but is projected to decline slightly in 2017 influenced by deteriorating terms of trade.
CPI inflation will remain subdued in 2016 influenced by low expected inflation and slow GDP growth while 2017 will see a slight increase as the impact of falling oil prices vanishes.
CPI inflation continues to hover below the target as the expected inflation remains low and negative demand pressure persists. As a result, CPI inflation is forecast to stand low at 1.0% in 2016, and rise to 1.7% in 2017.
The labor market in 2017 is forecast to exhibit a decrease in employment growth and slight increase in the unemployment rate, compared to 2016, as the working-age population (aged 15-64) declines gradually and GDP growth shows frail performance.
3. Downside Risks
On the domestic side, the growth momentum could be undercut if negative consequences from corporate restructuring spread throughout the entire economy, such as growing uncertainties brought by delayed restructuring or large layoffs during the restructuring process.
A delay in restructuring will not only raise uncertainties and social costs but make the Korean economy more vulnerable to internal and external shocks, leading to an economic contraction, mainly in employment and investment.
Meanwhile, as the restructuring of distressed firms proceeds, it may bring negative consequences such as huge layoffs and financial market instability, hence the growth momentum could be curtailed.
On the external side, Korea’s growth momentum may be restricted if the global economy continues to slow and hover below the previous year’s level, China implements a rapid restructuring, or emerging economies enter a sharp slump on US rate hikes.
Since the global financial crisis, global growth has continuously slowed to below the projections of major forecasters.
China’s hard-landing is not imminent, but its fast-growing debt makes it hard to rule out the possibility of a rapid setback in the real economy when restructuring rapidly proceeds.
Ⅲ. Policy Recommendations
1. Fiscal Policy
Fiscal policy must play an active role in supporting the restructuring of distressed firms while improving fiscal prudence through strict fiscal discipline in the mid-term.
Preparations should be made for possibile yet unavoidable fiscal burdens which may arise during the restructuring process. If sudden increases in unemployment and decrease in real activity are evident, more aggressive measures should be taken to ensure macroeconomic stability.
However, the stance after supporting the corporate restructuring should be to strengthen fiscal prudence through strict fiscal disciplines.
Meanwhile, a strategic allocation of financial resources through expenditure restructuring is vital for fiscal policy to contribute to expanding growth potential and creating more jobs while improving fiscal prudence.
Expenditure restructuring should be carried out in such a way as to integrate similar and overlapping projects while implementing a priority-based allocation of financial resources according to performance evaluation results, under the fiscal management goal of expanding growth potential.
In the mid- to long-term, the high proportion of compulsory expenditure e.g. health care, welfare, employment, education, general and local administrative activities (64% of total expenditure as of 2016) urgently requires restructuring as it hinders flexible fiscal management.
2. Monetary Policy
Monetary policies should be more accommodative to enable inflation to near the target level. In doing so, it could also contribute to buffering against an economic slowdown resulting from restructuring.
Inflation is hovering at around 1% level, well below the target range, while the downward inflationary pressure caused by demand factors is expected to persist for some time.
Accommodative monetary policies are expected to help moderate a potential contraction in economic activities arising from corporate restructuring.
Meanwhile, the potential downside risks from more accommodative monetary policies have been reduced as stricter credit review lowers the possibility of fast-growing household debt as seen last year and US interest rate is raisedvery slowly.
3. Financial Policy
A stricter management of households’ financial soundness should be pursued by revising exceptional clauses in the credit review guideline, hence reducing the regulatory loopholes related to household loans including group loans.
Heightened regulations and monitoring are required for group loans that have expanded exceptionally fast recently.
As banks strengthen credit reviews of household loans, more and more marginal borrowers may turn to non-bank depository corporations or the secondary banking sector, which should also be checked with countermeasures.
Besides, home mortgages for business premises are not subject to credit reviews which necessitates the management of loans to the middle-aged and senior self-employed.
Corporate restructuring procedures should provide clear guidelines designed under loss sharing and minimum cost rules based on the liability principle, and the progress in implementation should be closely monitored.
The government should closely monitor whether creditors accurately assess the conditions of distressed firms through an in-depth credit risk evaluation while at the same time assisting distressed firms and their creditors to select the most optimal restructuring method, taking into account industrial characteristics and debt structure.
As for the cost of corporate restructuring, it would be desirable to let not only creditor banks but shareholders, executives and employees of distressed firms share the losses in accordance with the liability principle.