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The Peninsula

Korea Adjusts Policies as the Economy Hangs in the Balance

Published August 21, 2012
Category: South Korea

By Seongjin James Ahn


Uncertain Times Ahead

Due to its place in the global economy, it was inevitable that South Korea would feel the pinch of weakening global economic conditions. To say that the country is on the verge of a crisis would be going too far, but issues that have been brewing over the past several years have nevertheless given rise to a formidable number of challenges which now put Korea’s economy on precarious footing.

So far in 2012 there are two key external factors affecting Korea’s economy.  First, demand for Korean exports from two of its top trading partners has declined as a result of the slow recovery in the U.S. and the economic cool down in China. Secondly, the ongoing debt crisis in the EU has perpetuated uncertainty in global markets and has had adverse affects on Korea’s economy; for instance, on its shipbuilding industry, which receives around 80 percent of its financing from the EU.

These two factors underscore known vulnerabilities in Korea’s economy which should signal to policymakers the imperative for developing additional measures that hedge against unfavorable external forces. Over the years, analysts have suggested ways to do this; for example, through further diversification of export markets, the improvement and expansion of the financial services sector, and other measures to create a second engine for growth that would make the economy more resilient to external shocks. While some progress has been made, current circumstances stress the importance of more forward-looking developments.

On the domestic level, the growing ratio of household debt to disposable income has resulted in a number of economic concerns with serious implications. For instance, there has been an overall decrease in domestic demand which has translated into slow GDP growth, and has additionally caused worries over meeting inflation targets.  For a country whose households are steeped in debt, unstable prices in either direction would give rise to overly burdensome costs of living on one hand, or decreased asset values in the other; both of which would put strain economic activity. Other important domestic issues include struggling SMEs and stagnant property and construction industries.

A Tiger Poised to Manage

South Korea’s short-to-medium term economic outlook may appear dim, but during times of uncertainty there are few countries in the world as experienced as Korea in successfully navigating through bleak circumstances.  The country has an enviable record of impressive post-crisis recoveries, which have been both broadly lauded and studied as models. And this time around, policymakers and analysts are not underestimating the implications of the economic challenges that Korea faces today.

Suffice to say that the painful, lingering memories of structural readjustments made under the IMF in the wake of the Asian financial crisis are reasons enough to understand why relevant actors in Korea are wasting no time in sizing up the situation and creating policies that take direct aim at each of the economic challenges at hand.

Taking Aim with Targeted Policies

So what practical measures are being taken to overcome the hurdles faced by Korea’s economy?

According to the Ministry of Strategy and Finance, public-private joint meetings chaired by the president are being held each month to closely monitor and find targeted solutions to the challenges that undercut growth and threaten to weaken the overall economy.  On its website, the Ministry also has strategic policies for the second half of 2012 clearly laid out in seven points, each addressing the broad challenges facing the economy.

Among many measures, the policies for the second half of 2012 include:

  • Measures to lower household debt by incentivizing the use of debit cards over credit cards through tax deductions on debit transactions;
  • Measures to support the working class and SMEs through easing of mortgage terms and government financing for young businesses;
  • Measures to minimize unspent budgets and increasing spending on social safety nets;
  • Measures to support SMEs through a facilities investment fund and tax benefits for firms that generate jobs; and,
  • Measures to diversify Korea’s export market by developing specific strategies unique to each market, especially emerging markets and the Middle East.

Consistent with such policies, in recent weeks a few noteworthy actions have been taken by various government/public entities, including:

a)     The Bank of Korea lowered the benchmark interest rate to 3 percent (from 3.25 percent.) While this came as a surprise to many, members of the central bank saw a need for monetary easing in order to counterbalance overall sluggish economic activity.

b)    The Financial Supervisory Service (FSS), Korea’s financial watchdog, began looking into the rapidly growing lending market by non-banking financial institutions, which have a reputation for extending loans to individuals at higher risks of default. The probe could eventually lead to tightened regulations for loans and mortgages and ease concerns over the growing household debt issue.

c)     In an effort to prop up struggling construction firms in Korea, the Financial Services Commission (FSC) announced measures to provide them with around USD 7.07 in liquidity.

Needless to say, policymakers in Korea are not standing idly by simply waiting for their fate to befall them. But whether or not their conceived policies are effective enough to stave off another recession, or crisis, remains in question.  If global economic conditions persist as they are now, the Korean economy will undoubtedly feel the pain; however, with close monitoring and micromanagement the effects can be muted. With presidential elections coming up in December, Koreans can only hope that careful and smooth management of the economy will remain a high priority amidst all the important issues to be considered in the coming months.

Seongjin James Ahn is a Visiting Fellow with the Korea Economic Institute. The views expressed here are his own. 

Photo from Marc Smith’s photo stream on flickr Creative Commons.

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