There are increasing signs showing that South Korea’s exports cycle has started to turn down, amid the weakening of global tech demand. This will pose further challenges to the economy in the next six months, through both the growth and external balance channels.

Exports cycle turning down

The latest August trade data were disappointing. Exports growth slowed notably to 6.6% YoY, down from 9.2% in July and the average of 13.0% in 2Q. Importantly, semiconductor exports contracted -7.8%, the first negative reading over more than two years since April 2020. In the global market, memory chip prices have been correcting downward since 2Q, dragged by weakening demand for mobile phones, PCs and other downstream consumer electronics products. According to the latest research by TrendForce, NAND Flash prices will decline by 13~18% QoQ in 3Q, larger than the original forecast of 8~13%. TrendForce expects oversupply and inventory adjustment to continue in the NAND Flash market in the near term, as demand for consumer applications will not improve by the end of this year.

Trade deficit widening

As a result of weakening exports and still expensive energy imports, trade deficit widened sharply to USD9.5bn in August, the largest in recorded history. The current account remained in a small surplus of USD1.1bn as of July. But the seasonally adjusted current account balance already posted a deficit of USD1.8bn, the first red ink seen since April 2020. Given the sharply widening trade deficit, we think the unadjusted C/A balance will also slip into a deficit of ~USD3bn in August.

KRW vulnerability increases

The rapid deterioration in trade/current account balance increases the vulnerability of the KRW, during the strong USD and volatile capital flow environment. The KRW depreciated 3.6% against the USD month to date, the worst performing currency in the Asia region. Year to date, the KRW has lost 14%, the second worst performer in Asia, just after the JPY (20%). USD/KRW hit 1,380 this morning, the highest level over 13 years since March 2009. Our FX strategist has revised up the USD/KRW forecast, expecting it to reach 1390 by end-2022.

Inflation pressure remains high

The weakening of the KRW boosts inflation pressure through the import channel. Thanks to the faster decline in global oil prices, CPI inflation in South Korea has still fallen from the peak, from 6.3% in July to 5.7% YoY in August. Nonetheless, as the inflationary impact of KRW depreciation partly offsets the disinflationary impact of oil price decline, it would still take quite some time for CPI numbers to return to the BOK’s comfort zone of 2%. Our forecast model suggests that headline CPI will stay around 5% till end-2022, ease modestly to 3-4% in 1Q23, and further to 2% from 2Q23 onwards.

Interest rates continue to go up

Between the goal of maintaining price/financial stability and that of supporting economic growth, the Bank of Korea continues to prioritize the former in the near term. At the August policy meeting, the BOK revised the 2023 inflation forecast to 3.7%, sharply higher than 2.9% previously. Governor Rhee also made hawkish remarks during the latest media interviews. He said explicitly that the BOK may not end the tightening cycle earlier than the Fed. He also kept the door open for another outsized 50bps rate hike – if inflation stays well above the 5% level. We now expect the BOK to extend the rate hike cycle into 1Q23, delivering a 25bps hike at each of the October, November and January meetings. Our terminal rate forecast is revised up to 3.25% from 3.00%.

A gloomy growth outlook ahead

The persistent rise in interest rates increases mortgage repayment costs, aggravates households’ debt servicing burdens and weakens their disposable incomes. South Korea’s residential property market has entered a downcycle since last year, as evidenced by the continuous double-digit declines in apartment transaction volumes. The broad consumption indicators have also started to deteriorate recently. Consumer confidence has dropped below the neutral 100 level since June, while retail sales have also begun to contract on both the YoY and MoM basis.

Furthermore, President Yoon’s government plans to shift towards a prudent fiscal policy, prioritizing fiscal soundness over economic growth. During the recently announced budget proposal for 2023, total government spending will amount to KRW639tn next year, a 6% decline from this year’s KRW680tn (including two rounds of supplementary budgets). This will also be the first time since 2010 for total budget spending to decline from the preceding year. Net fiscal deficit will narrow to KRW58.2tn (2.6% of GDP) next year, notably smaller than KRW110.8tn (5.1%) this year.

From exports, domestic private demand, to public spending, growth engine seems to be losing steam on almost all the fronts. As such, we are further downgrading the country’s growth outlook for the next six months. Our GDP growth forecast for 2023 is lowered to 2.0%, from 2.4% previously.

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