In April 11, South Korea’s currency Korean Won (KRW) hit its record low exchange rate at 1,035 KRW per dollar, largest appreciation to reach the highest level since 2008. Although Korea’s economy is slowly gaining international recognition, but there are still obstacles for Korea to reach stability and still rag for higher growth.
According to South Korea Finance Minister Hyun Oh Seok, interest rate rise might pose great threat at home. South Korea have generally fared well despite 2008 financial crisis and Euro zone debt crisis. Just to see few data on inflation control and interest rate see charts:
We see that there was a huge drop in nominal interest rate from above 5% down to 2%, and at the same time inflation dropped at about the same rate. As a result, the real interest had little influence. This abled Korea to control capital in/outflow and eventually the export quantity. Because it lacks natural resource endowments in its territory, Korea is quite dependent on its exports in order to buy necessary goods from foreign country. One characteristic of Korean exports is that it is focused on technological value added items . To name a few, cell phones, TV’s, naval engineering goods and automobiles are some of more known items.
As a result, in order for South Korea to be really stay on its competitive edge requires favorable financial conditions, especially those regarding exchange rates and interest rates. So, what happened to Korea in the past few months? There has been a huge appreciation in KRW and some economists in Korea worry that this will be a head wind against its growth in coming years.
Another big concern for Korea right now is climbing household debt level reaching its record high (see graph below) at a wrong time. The Fed is continuing to taper quantitative easing programs, and the talk of whether interest rate will increase sooner than anticipated will also play a role in markets other than that of US. Why Korea should really be worried is that most of household debt is tied to mortgage in floating interest rate. Not to mentioned the housing prices rising due to cultural flux of real estate as a popular investment options, the trend of borrowing to finance these houses drive the prices up. Consequently, if interest rate hike around the world raises interest rates in Korea, burden on household could cause a series of default, which would in turn drive down the housing prices as well.
High debt level and high interest rate are something that Korea is not so fond of with harsh memory of defaulting less than two decades ago. There has been government measures to mitigate mortgage loan by directly bailing out some of highly distressed households, but this has not been so popular for many people on the ground of moral hazard. Also, such high spending is a good vulnerable points for either political parties. Although current level of debt is of course not as bad as the level during the Asian financial crisis in 1996, but it is something to keep in mind over time. Considering that it is the large bandwidth of middle class in Korea that holds mortgage debt, this could arise as a serious problem.
Another thing I would like to point out briefly is the trends of disinflation, and elongated times of inflation rate. With target band between 2.5% and 3.5%, the 1.3% Korea has right now may be not so satisfying. With inflation rate going down, monetary policy instrument may be eroding its power, at least less than it could fully have. I don’t think it is at a worrisome level just yet at nominal interest rate still at 2.5%, but this is another sensitive spot for Korea.
Although Korea is number four economy in its geographical region of East Asia, it should be still considered as a “small economy.” Yes, it experienced very high growth and despite hardships in the past had came out of its crises at a record speed, the economy is still very vulnerable to financial market around the world. After having such a bitter experience in 1996, Korea’s financial market is one of the most heavily regulated market in East Asia. I personally think in order for Korea to truly grow, it should allow financial sector to grow as a stronghold for the entire economy to fare well.