Published on 01 Aug 2019.
Growing trade friction between South Korea and Japan coupled with a prolonged China-US standoff will, in RAM Ratings’ view, constrain South Korea’s external trade and economic performance. “Despite the increasing macroeconomic uncertainties faced by South Korea, its economic resilience, backed by accommodative policy measures, will alleviate downside risks to GDP growth, underlining the stable outlook on the country’s ratings,” notes Esther Lai, RAM’s Head of Sovereign Ratings. South Korea is currently rated gAA3(pi)/Stable and seaAAA(pi)/Stable on RAM’s global and ASEAN scales, respectively.
Japan had tightened restrictions on the export of key industrial materials – critical to the manufacture of semiconductors and display panels – to South Korea in July and is considering removing the latter from a list of countries to which it has accorded preferential trade status. Limited access to vital raw materials and potentially more onerous trade administrative procedures will dampen South Korea’s production and export of semiconductors and display panels (comprising around 25% of total manufacturing output and exports), of which the country commands a respectable global market share. The impact of Japan’s export curb is amplified by its global dominance in the production of such industrial materials, rendering South Korea highly reliant on materials sourced from the former. The trade dispute between the two countries has been escalated to the World Trade Organization, but a resolution is unlikely in the near term.
While South Korea’s y-o-y GDP growth picked up slightly to 2.1% in 2Q 2019 (1Q 2019: 1.7%) due to stronger public consumption and investment in line with its expansionary fiscal stance, downside risks to growth are greater given increasing trade protectionism and softer global growth that have weighed on private investments. The country’s technology-related output could register a decline in the near term should trade relations with Japan deteriorate. South Korea’s external trade contracted in 1H 2019, with exports and imports falling a respective 8.5% and 5.1% (1H 2018: +6.3% and +13.4%). Exports to China, its largest trading partner, were noticeably set back during the period amid the prolonged battle between China and the US. In view of growing macroeconomic uncertainties, the Bank of Korea has revised its forecast for the country’s GDP growth downwards to 2.2% from 2.5%.
The central bank had pre-emptively cut the benchmark interest rate by 25 bps to 1.50% in July and is likely to maintain its accommodative monetary policy going forward, owing to the unfavourable outlook on private investment and exports. While legislative approval for the government’s proposed supplementary budget (KRW6.7 tril or 0.3% of GDP) announced in April is still pending due to wider differences between lawmakers, intensifying economic challenges will, in our view, hasten the passage of the additional budget to support the economy. South Korea’s commendable government finances – highlighted by consistent fiscal surpluses and a substantially lower debt level of 39.8% of GDP as at end-2018 compared to similarly rated peers such as China and Japan (50.5% and 235.0%, respectively) – underpin ample policy space and flexibility for the implementation of further stimulus measures to buffer the adverse effects of trade barriers on the economy.
Cheong Kah Weng
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