Republic of Korea

Growth in the Republic of Korea moderated, from 5.0% in 2007 to 2.5% in 2008. The economy put up a strong performance in the first half of the year, achieving growth of over 5%. However, as the global financial crisis deepened, the economy was inevitably hit due to its heavy dependence on merchandise exports and high exposure to the financial markets. The economy registered virtually no growth in the second half of the year.
The impact of the global financial crisis has quickly spread from export sector to domestic demand. Consumption slackened noticeably since the third quarter. It only expanded by 1.1% in the third quarter, before falling sharply by 4.4% in the last quarter.
Investment was also very sluggish over the course of 2008. Following marginal growth of 0.7% in the first three quarters of the year, investment plunged by 8.4% in the fourth quarter.
To support the economy in the face of the deepening crisis, the Government announced various forms of fiscal stimulus packages. On top of a bank bail-out package of $130 billion, the country approved a fiscal support plan equivalent to around 4% of GDP in its latest Budget. Added to this was the “Green New Deal Job Creation Plan” established in January 2009.

Inflation peaked in mid-2008, pushed by higher oil and non-oil commodity prices. Sharp depreciation of the currency added further inflationary pressure from imported sources. Yet the inflationary pressure subsided as private consumption weakened and international commodity prices took a sharp drop. The inflation rate stood at 4.7% for 2008 as a whole, still nearly double the 2.5% in 2007.
To counteract rising inflation, the Bank of Korea raised its key policy rate by 25 basis points to a seven-year high of 5.25% in August 2008. As the risk of economic slowdown continued to rise, the Bank cut its key policy interest rate by 25 basis points in early October in a coordinated move with other central banks. As the severe credit freeze deepened, the Bank slashed the interest rate again in late October by 75 basis points. That was followed by cuts of another 25 basis points and 100 basis points in November and December, respectively. With all the cuts, the Bank of Korea base rate was reduced to 3.0% at end-2008, compared with 5.0% at end-2007.

The Korean won, fell significantly against the United States dollar over the course of 2008 due to capital outflows as investors retrieved their portfolio investments in the country. Compared to end-2007, the won had lost its value against the U.S. dollar by over 25% at end-2008.
Exports remained strong until the third quarter of 2008, due partly to a much weaker Korean won, which helped enhance competitiveness of Korean products in overseas market. As the negative impact of the global financial crisis set in, the export sector began to feel the pinch, and export performance retreated notably in the last quarter of the year, falling by around 10% year-on-year. The current account balance turned into a deficit in 2008.
Net capital outflow was recorded in the first three quarters of 2008. Significant net direct investment outflow and portfolio investment outflows were only partly compensated for by net inflows of other investment.

Growth in the Republic of Korea is forecast at -1.5% in 2009, slower than 2.5% in 2008. Inflation is expected to ease to 1.6% in 2009, from 4.7% in 2008.
However, the possibility of a deeper economic setback in the United States and consequently in the EU and Japan cannot be completely ruled out, given the highly fluid financial conditions and the uncertain impact of expansionary monetary policy and fiscal rescue programs. Failure to jumpstart the economy and trigger economic growth is the biggest downside risk for the forecast.
Under this more severe scenario, the Republic of Korea, among others, would feel the pinch most. On top of slower export growth due to curtailment in global demand, their deeper integration with the financial sectors of the developed economies would induce a more negative impact on their investment and consumption sectors.

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