South Korea’s Economy Shrinks After Surge at Start of 2024

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(Bloomberg) — South Korea’s economy flipped back into reverse last quarter after hotter-than-expected growth at the start of the year, adding to challenges for policymakers as they struggle to stimulate investment and consumption.

Gross domestic product shrank by 0.2% in the three months through June from the previous quarter, the Bank of Korea said Thursday. The figure was weaker than economists’ consensus estimate of a 0.1% expansion.

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From a year earlier, the economy expanded 2.3%, slower than the 2.5% average forecast.

The unexpected contraction may increase calls for the central bank to cut interest rates even if the weakness may have been exaggerated by the hot pace of growth that preceded it in the January-March quarter. 

The government and the central bank have already raised their growth forecasts for 2024, an indication that they view the second quarter outcome more as a speedbump on the way toward a continued expansion, rather than a warning signal that the tide is turning.

Still, the continued sluggishness of consumer spending suggests that robust external demand isn’t feeding into broader strength across the economy.

A global boom for artificial intelligence development has been a boost for South Korea, home to two of the world’s biggest semiconductor manufacturers, Samsung Electronics Co. and SK Hynix Inc. Memory chips in particular have led growth in South Korea’s exports, fueling the 1.3% economic expansion in the first quarter that was more than twice the size forecast by economists.

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Trade data indicate the export rally led by technology continued through the April-June period and may be persisting into this quarter. Semiconductor shipments jumped more than 50% from a year earlier in the first 20 days of July, supporting the expectation by the central bank that the chip rally may continue as long as through the first half of next year.

Consumption is key for the economy in the second half of the year as private spending remains lackluster under elevated interest rates and lingering consumer inflation. The Bank of Korea is keeping its benchmark interest rate restrictive for now as it is worried that signaling a cut too early could feed the appetite for housing purchases and inflate a real estate bubble.

Economists are mostly split on whether the BOK is likely to cut rates in August or October. Authorities have kept the policy rate at a restrictive 3.5% for a year and a half. The local currency’s weakness against the dollar is a factor that has kept the central bank cautious about cutting too early, as further currency weakness would increase the costs of food and energy imports.

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Stronger-than-forecast economic momentum at the start of the year gave the BOK another reason to extend its cautious approach toward adjusting policy. It also prompted both government and monetary policymakers to revise their growth forecasts to the mid-2% range as they took heart from a semiconductor boom, which the nation increasingly relies on to ride out economic challenges, including the coronavirus pandemic.

“Strong AI-driven export growth should buttress economic growth in the meantime and give the Bank more room to take a more measured approach in policy pivots,” Kelvin Lam, a Pantheon Economics researcher, said in a note before the GDP release.

South Korea finds itself plagued by another risk to long-term economic vitality as the nation continues to renew the record for the world’s lowest fertility rate. With each South Korean woman expected to have just 0.72 child over her lifetime, the country faces the prospect of its working population shrinking at one of the fastest paces in the world and is turning more aggressively to automation and AI to buffer the impact of aging demographics.

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“We see AI could continue to fuel Korea’s long-term growth without hurting the existing labor market,” Bank of America economists, including Benson Wu, said in a report. “The overall productivity gain brought by AI development could be the potential driver of Korea economic growth in coming years.”

In the near term, South Korea needs to resolve persistent concerns over credit risks overshadowing the construction industry, a pivotal component of the GDP. On top of mounting costs of raw materials, developers are struggling to repay debt as rates stay elevated.

The industry saw a surprise uptick in output in the first quarter after a warm winter helped encourage investment. That may no longer be the case in coming quarters, according to Chong Hoon Park, an economist at Standard Chartered Bank Korea Limited, who predicted the quarter-on-quarter contraction in the second quarter.

With an economy that is reliant on China and security supported by American troops, South Korea also faces the prospect of policy implications should Donald Trump win the US election in November, potentially reversing some of the measures pursued by the Biden administration, including tax incentives for foreign electric vehicle manufacturers.

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South Korean President Yoon Suk Yeol has routinely met with his US counterpart Joe Biden, at times involving Japanese Prime Minsiter Fumio Kishida, as they sought to strengthen strategic and technology ties. Washington has been driving closer coordination with its Asian allies as it seeks to reduce Beijing’s influence in the region both politically and economically.

The Asia-Pacific region still relies heavily on China for economic growth and there are signs the property slump in China is improving. South Korea’s exports to the world’s second-largest economy rose 20% from a year earlier for the first 20 days of July, according to customs office data. That’s a little more than the 17.6% gain in the value of shipments to the US.

What Bloomberg Economics Says…

“We expect surging global demand for computer chips to drive a faster expansion in the quarters ahead, allowing full-year growth to reach 2.5% in 2024.”

— Hyosung Kwon, economist

For the full report, click here

From the previous quarter, private consumption fell 0.2% while government spending was up 0.7%. Exports in real terms increased 0.9% and facilities investment dropped 2.1%.

Machinery including chipmaking equipment led the decrease in investment, the BOK said in its statement. Construction investment contracted 1.1% following a surprise 3.3% expansion in the previous quarter.

(Updates with added details)

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