08 September 2003 00:00 [Source: ACN]
There is no getting away from the fact that the second quarter of the calendar financial year was pretty awful for South Korea's petrochemical players.
One chemicals analyst, for instance, estimates that the sector's operating profit was down by an average 40% in Q2 compared with the same quarter of last year.
The second-quarter numbers ACN could obtain make pretty grim reading for some of the producers, although it must be borne in mind that the downturn was not uniform. For those fortunate to be in booming products, such as monoethylene glycol producer Honam Petrochemical, the second quarter was in fact very good, although not as good as Q1.
But the broader issue now as the Q2 numbers are digested and brooded over (see p15), is what's going to happen in the second half of the year, regardless of your product slate.
The problem with the second quarter was that the South Korean players were hit by the triple whammy of the Iraq War, Sars (severe acute respiratory syndrome) and the downturn in the domestic economy that officially became a recession in mid-August when the government announced the Q2 GDP (gross domestic product) number. South Korea had suffered its first two quarters of consecutive declining growth - the technical definition of a recession - since 1998, when it was entangled in the Asian financial crisis.
Provided Sars doesn't raise its ugly head again and the US and the UK don't decide to bomb another country that theoretically might threaten their security at some point in the distant future, the external macro-environment should provide some boost to the South Korean companies. All the indications are that the long-awaited sustained recovery in the US has finally arrived with growth in China very strong following the slight blip caused by Sars.
A statistic to support this view is the 19.3% year-on-year increase in South Korea's exports in July over a 17.5% rise experienced the month before, when automobiles are not included.
However, when automobiles are included, July export growth dipped to an increase of 16% from a rise of 21.9% in June. The reason was the strike at Hyundai Motor from 20 June to 8 August, costing US$1.2bn in lost production and resulting in an overall contraction in industrial output in Q2.
Labour unrest and how it's handled by the Roh Moo-hyun administration is one of the big threats to the South Korean economy in H2.
The resolution of the Hyundai strike has raised major concerns in many quarters over how tough, or perhaps how consistently tough, Roh, the former civil rights lawyer who was elected on a socialist agenda, will be towards the trade unions.
The strike was brought to end through the chaebol accepting all the union's demands, including an 8.6% pay rise (double the inflation rate), and labour involvement in management decisions. The government could have used its influence to persuade Hyundai not to yield, some critics argue.
The same could be said of two other more recent big pay awards in the automobile sector - 8.8% to Kia Motors workers and 14.8% to GM Daewoo employees.
The critics add that Roh is also going soft on the chaebols.
His socialist election platform included both redistribution of wealth and decisive action on the reform of the conglomerates.
But the start of the accounting scandal at the SK Group and the beginning of the investigation into another financial scandal at Hyundai Merchant Marine led to a change in government direction in February of this year, as the Korea Composite Stock Price Index fell to a 17-month low.
Finance minister Kim Jin-pyo announced that the emphasis in future would be on 'market rather than chaebol reform' and that 'we will fix illicit practices by the chaebol over time.'
And the Fair Trade Commission, at the government's bidding, said it would 'flexibly adjust specific investigation dates to take into account specific situations (such as) Iraq and the North Korean nuclear issues.' In other words, let the chaebol off the hook?
To return to the issue of labour unrest and what is being seen as another example of inconsistency, Roh has taken a very hard line against the strike by 30 000 unionised truckers which began on 21 August.
Several union leaders have been arrested and demonstrations broken up, with efforts made to discourage non-union truckers from joining a dispute triggered by demands for a 30% increase in fees for cement bulk trailers and containers. The hardline approach seemed to be working as ACN went to press as operations at two of South Korea's major ports were almost back to normal.
Does this represent a renewed determination to take on the trade unions?
'Not really,' says a political scientist from a university in Seoul. 'It's just that the truckers have much less political muscle than the car workers and less popular support. Roh has been given the opportunity to impress both domestic critics and foreign investors by walking down a path of not much resistance.'
There is likely to be further clashes with trade unions in the coming months following the passing of legislation to introduce the five-day working week from 1 July 2004. The unions are concerned that its introduction will result in lower pay and worse working conditions.
President Roh faces a difficult balancing act. He needs to keep the overseas investors happy and retake the National Assembly from the Grand National Party in elections due to next year.
He needs a majority in the assembly to avoid having to water down - or even abandon - proposed legislation, the fate of his predecessor Kim Dae-jung who lost control of the South Korean parliament during his tenure.
Roh will need the support of one of the big interest groups that backed his presidential campaign, most probably organised labour, if he is to retake the assembly.
Should he risk a further decline in foreign direct investment (FDI) by taking it easy on the unions in order to regain the assembly?
But if he does regain the assembly, might he have to pay back his trade union supporters by being permanently soft on labour reform?
An example of how he is attempting to balance the demands of the foreign investors and the unions emerged last week. The Labour Ministry disclosed that the government is considering increasing the speed and ease of lay-offs by reducing the redundancy notification period for employees and unions, which is currently 30 days. In addition, the ministry said that the government may remove the requirement that unions negotiate with management before going on strike.
The fall in FDI has already been bad enough, down by 41% in Q2 2003 to US$1.55bn against the same quarter of last year, partly because of labour disputes.
This is hardly progress towards Roh's goal of increasing FDI in parallel with making South Korea Northeast Asia's financial hub.
But should he bother listening to the foreign investors? Do they know what's best for the South Korean economy?
The investors, and also some of the foreign media which gives voice to the views of the investors, are obviously convinced they are right. A concern is that their opinions appear to be founded on a shaky understanding of history.
For instance, one particular wire service recently wrote: 'A major problem [talking about the reason why South Korea was dragged into the Asian financial crisis] was their [talking about the chaebol] bloated workforces and excess production capacity.'
It adds in another article that 'Korea, simply put, stands at a crossroads. One road will make companies more competitive and give them bigger market capitalisations; the other has labor unions blocking economic progress to enrich thousands of workers at the expense of tens of millions.'
The wire service also praises the International Monetary Fund (IMF) for dragging South Korea out of the crisis.
The western banks were all too willing to lend to South Korea to build up their 'bloated workforces and 'excess production capacity' before 1997. Also, words such as 'bloated' are not particularly helpful. It might be better to replace 'bloated' with 'levels of employment essential to rebuild the country after the Korean War, and to later on achieve rapid economic growth, making South Korea one of the strongest economies in Asia.'
True, there is excess capacity, but the same could be said of the US steel industry, already benefiting from safeguard duties, and the country's textile industry, which is lobbying for protectionism.
And returning to the subject of trade unions, America's United Auto Workers Union recently sent 115 pages of demands to General Motors (GM) as a new wages-and-conditions round of talks opened. The demands include free chiropractic care and a seat on the GM board.
Another point worth making is the argument that the IMF made the impact of the Asian financial crisis worse, not better, for countries such as Thailand, which precisely followed its prescriptions.
South Korea followed the IMF's advice by raising interest rates to economically damaging levels. However, it ignored the fund by going slow on privatisation and, in effect, nationalising banks, enabling a rapid and very successful restructuring of the financial sector. This helped its economy recover much more quickly than Thailand's, say critics of the IMF.
Also, it cannot be disputed that the cause of the crisis was not just excess capacity. There was also the 'hot money' that poured out of South Korea and other Asian countries as currency speculators made their fortunes.
Another example of what could be viewed as historical ignorance. An American investor was recently reported as saying: 'You can't expect us to invest in South Korea when you keep seeing trade unionists clashing with riot police on CNN.'
For goodness sake, this has been the norm in South Korea for decades, ever since the trade-union movement helped fight against the Japanese occupation. And, anyway, it's summer now. Come winter and minus 10oC, and the workers and riot police might not be as willing to entertain CNN viewers.
Plus, the cameras only ever focus on the part of a demonstration where there is a scuffle, and not on the 90% of a protest that's usually taking place very peacefully. I should know, I'm a journalist.
A myopic view of history might not necessarily mean that the foreign (meaning US or US-centric) investors, and the press, are wrong about what South Korea should do to reform its economy. At the very least, though, it would be nice if they were better informed.
But there could be a danger that Roh will have to follow what could be wrong overseas advice if he wants to raise FDI, assuming that ignorance about the past adds up to a lack of understanding of the present.
During its rapid economic growth between 1953 and 1997, South Korea was to a large extent able to do its own thing because it relied on its own funding.
What's not in dispute, though, is that South Korea has some serious labour-cost disadvantages.
A recently released survey by the Korea International Trade Association (KITA), for instance, found that the country's average monthly wage was 11 times higher than China's in 2002.
But you're not measuring like with like when comparing South Korea with China.
A fairer comparison would be with countries such as Japan, Singapore and Taiwan because South Korea has moved very effectively up the value chain away from being only a basic commodity supplier.
The KITA also discovered that South Korea's average monthly salary was US$1524 in 2002 against Japan's US$3210 and Singapore's US$1759. However, South Korea was US$400/month more expensive than Taiwan.
What's also worrying is that South Korea's average monthly wage rose by 11.2% during the first five months of this year against January-May 2002, concluded the Ministry of Labor in another survey. This supports the view that the unions are getting too much of their own way.
Enough said about labour issues other than to add that they are not going to go away and are likely to continue to dog the economy, even if the protestors and riot police pack up for the winter.
South Korea has several other economic issues that could cause problems in the second half of this year.
Consumer spending declined by 2.2% in Q2 over the first quarter, the worst fall - yes, you've guessed it - since 1998.
One reason for the decline is the credit-card spending binge which lasted for two years until the government introduced restrictions in 2002. At one stage, you could walk down any High Street and be accosted by very pretty salesgirls who would offer you large cash gifts for signing up for credit cards, with hardly any questions asked and hardly any credit checks.
The root causes of the boom were the successfully restructured banking sector desperate to lend, corporates unwilling to borrow enough to keep the banks happy because they were too embroiled in their own restructuring, and gadget-crazy, credit-flushed consumers.
Economists point out that personal bad debt is still nowhere near the levels of other developed countries such as the US, and so there is no real danger of another financial sector crisis such as the one provoked by all the bad corporate debt in 1997-98.
Nevertheless, consumer spending could remain depressed in H2 because of both the credit-card clampdown and the other negative - North Korea. As long as the nuclear crisis remains unresolved, some consumers will remain reluctant to spend, say economists.
However, in early August, the government announced a Won4200bn (US$3.49bn) stimulus package which should boost private consumption in H2. It has also cut special excise taxes on luxury goods, such as cars, and has twice lowered interest rates so far this year.
Some economists and the government, therefore, believe that the economy bottomed out in Q2 when it contracted by 0.7% over the first quarter.
But to repeat, this assumes that there will be no major external shocks during what's left of this year.
And whatever happens in the second half, the Bank of Korea has cut its full-year GDP (gross domestic product) forecast to 3.1% from 4.1%. This compares with actual 2002 GDP growth of 6.2%.
However, a recent poll of economists came to the consensus that the economy would grow by 3.3% in 2003, with a strong rebound to 5.4% growth next year.
The downward GDP revision is reflected in reductions by the Korea Petrochemical Industry Association (KPIA) in most of its 2003 sales and demand forecasts.
KPIA's forecast for the industry's total sales volume growth is now 4.6%. This would be the same as last year's and is down from the 5.9% growth prediction that it had made in the first quarter of this year.
As for domestic demand growth, it currently expects 1.3% compared with its earlier expectation of a 4.5% expansion and last year's 7.3% growth.
But the association expects 4.2% volume growth in synthetic-resin exports against its earlier prediction of a 1.4% increase. In 2002, exports grew by 1.2%.
In the case of local synthetic-resin sales volume, though, the KPIA forecasts a contraction of 0.3%. Earlier, it was a predicting a rise of 4.9%. Domestic sales volume grew by 9.4% in 2002.
All of this is likely to add up to a dis-appointing year for the South Korean petrochemical industry as a whole.
But the producers are in a much better state than they were during the Asian financial crisis which makes the first-half recession pale in comparison.
In addition, the prospects look a great deal better for 2004.
To end on another note of caution, though, if Roh handles the labour issue badly, may be by listening to the advice of the ill-informed, the economy will surely suffer. Perhaps a few free history books should be handed out.
LG Chem saw a 32% decline in operating profit in Q2 2003 to Won98bn (US$8.32m) from Won143bn in the same period last year.
The decline, attributed to weak global demand and the impact of Sars (severe acute respiratory syndrome), occurred despite a 13% year-on-year rise in sales to Won1430bn.
As for the first half, sales increased by 14% year-on-year to Won2810bn, although operating profit fell by 12% to Won255bn.
LGChem's industrial materials division - the most profitable of the company's four divisions in 2002 - saw its Q2 operating profit fall by 24% to Won49bn.
The division is particularly vulnerable to the domestic market as it is the No1 player in South Korea in residential floor coverings, made from PVC, with a strong presence in commercial floor coverings, wall coverings, windows and doors. A slowdown in the property sector could therefore cause more damage in H2.
On the release of these disappointing results in late July, LG Chem revised down its full-year 2003 operating profit forecast to Won518bn from a prediction made only the previous month at an investors' roadshow of an operating profit of Won609bn. The Won518bn would compare with last year's Won517bn.
As for sister company LG Petrochemical, the cracker and hdPE player, its net profit fell by 41% in Q2 2003 over the second quarter of last year to Won16.3bn due to an industry-wide de-stocking.
The industry de-stocking in Q2 2003, the result of the slump in just about all petrochemical prices due to the decline in oil prices and Sars, led to a sharp fall in the ethylene-naphtha spread. A chemicals analyst estimated that the spread fell to US$150/tonne in Q2 over the first quarter's US$250/tonne.
A strong balance sheet and extra earnings from LG Petrochemical's butadiene expansion (it raised capacity to 135 000 tonne/year from 118 000 tonne/year in July) are expected to boost the company in H2.
However, even though ethylene has soared recently on very tight supply, the outlook for polymer margins has been very uncertain.
Early last week as this feature went to press, Chinese polymer buyers were still resisting higher September offers.
All these factors led Daelim Industrial, another hdPE player, to predict lower sales in Q3 and Q4 over the second quarter, although it would not make any forecasts.
And in the second quarter, the 380 000 tonne/year producer said that the domestic injection and blow-moulding segments had been particularly weak because of the recession.
Its petrochemicals division's performance (the company is also a major construction and engineeeing player) was poor in H1.
The division's operating profit fell by 91.2% in the first half to Won0.3bn over H1 2002's Won3.4bn. Sales increased, though, to Won216.6bn from Won200.6bn.
In Q1, petrochemical operating profit fell year-on-year to a loss of Won2.2bn from a profit of Won2.5bn.
In the second quarter, operating profit declined to a loss of Won2.2bn from a loss of Won0.2bn
Cracker, PP, hdPE and moneothylene glycol (MEG) player Honam Petrochemical performed much better. Its Q1 operating profit was Won53.8bn against a forecast of only Won15.5bn. First quarter sales were at Won386.2bn over a forecast of Won312.1bn.
The Q1 performance benefited from the build-up in inventory by just about all the buyers of petrochemicals ahead of the Iraq War.
But perhaps more significantly, in Q2, the company says that its operating profit was Won30.5bn against a forecast of Won24.3bn. Q2 sales were at Won344.5bn against a forecast of Won324.3bn.
Honam going forward will be a beneficiary of tight MEG supply: the fibre intermediate is expected to remain in short supply for the next 18 months.
But the company could suffer from a decline in MEG prices in H2 due to overstocking by polyester producers, the October holidays in China and a seasonal dip in demand in November and December.
Honam's position in MEG has been strengthened through its acquisition, along with LG Chem, of Hyundai Petrochemical (ACN 3 Feb, p9 ).
To return to the impact of the domestic downturn on the South Korean companies, the 530 000 tonne/year non-listed PP producer, PolyMirae said that its net income after tax was in the red in Q1 and Q2 of 2003, but it declined to provide any actual numbers.
However, it added that Q2 was better than Q1.
The joint venture between Daelim and Basell said that it had been very hard hit by Sars as 60 per cent of its earnings are through exports, especially to China.
As for the full year, it said that it has revised down its sales target by 5%.
Hanwha Chemical, the ldPE and lldPE player, faired slightly better in Q2. The company reported a 6% year-on-year increase in operating profit to Won36bn due to what it said were lower ethylene feedstock costs and a rebound in polymer prices.
However, its sales slipped by 10% to Won361bn from Won402bn.
For the full year, the company has forecast a 7% rise in operating profit to Won134bn from Won125bn, despite a project 2.5% fall in sales.
But SK Corp, the refiner and petrochemical major, had a lousy first half at a net profit level, largely because of provisions it had to make for its share of bailing out debt-stressed SK Global, its sister company. SK Corp has agreed to provide SK Global with Won850bn to prevent its bankruptcy.
The slump in petrochemical pricing and margins was also behind the decline in net profit to Won62.1bn against Won374.8bn in the first half of 2002. Sales fell to Won3000bn from Won3300bn.
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