FocusS Korea interest rate hits record low, recession looms

12 February 2009 03:46  [Source: ICIS news]

By Pearl Bantillo

SINGAPORE (ICIS news)--South Korea’s export-driven economy, the fourth largest in Asia, is headed for a severe downturn in the next six months despite aggressive interest rate cuts, economists said on Thursday.

The Bank of Korea’s 50 basis point rate cut today, which brought the central bank’s policy rate to a record low of 2.0%, was widely expected but may no longer prevent a looming recession, they said.

Since October 2008, the central bank had slashed its key interest rates six times to pump prime the economy given the unexpected speed of deterioration in fundamentals.

“The question is how much more can they cut? The global economy is slowing and it may be too late to avert a sharp deceleration,” said Daniel Soh, a Singapore-based economist at consultancy firm Forecast.

The country’s Finance minister Yoon Jeung-hyun predicted a 2.0% contraction in the South Korean economy, according to media reports, admitting for the first time that the economy will end more than a decade of consistent growth this year.

It was a sharp reversal from the government’s target of a 3.0% expansion.

Yoon, who officially took the post as South Korea’s finance minister on Tuesday, said in his inaugural speech that “dark clouds … hang over the Korean economy” as the global financial crisis that started in the US had pushed the global economy on the brink of recession.

He cited the “sluggishness in both domestic demand and exports” as principal reasons for the 5.6% quarter-on-quarter decline in the country’s GDP in the October-to-December period.

The combination of monetary and fiscal measures the government had implemented will take time to work their way through the economy and will largely depend on the recovery of the country's major trading partners, economists said.

The most optimistic assumption so far for the economy is a 0.7% year-on-year growth from consultancy firm Forecast.

Based on Forecast’s estimates, the country’s GDP will shrink by as much as 4% in the January-to-June period but this will be followed by a sharp rebound in the second half on hopes that the fiscal stimulus package introduced by the government last year would start to work.

“Normally economic performance will tend to undershoot fundamentals because of a confidence crisis,” he said. But once the issue of confidence was addressed, recovery would likely be very strong, he added.

“It is going to be a V-shape recovery,” Soh said. “I am still confident South Korea will be able to post marginal growth.”

Research company Action Economics holds a bleaker outlook of a 3.5% GDP contraction for South Korea while investment bank UBS had projected in November 2008 a 3.0% fall in GDP for 2009.

This has translated into weaker demand for petrochemicals, such as polyvinyl chloride (PVC) in South Korea, which may shrink 5% this year, in line with the overall weakness of the economy, said a major producer.

“The dip in demand will be felt mainly in construction-related products such as PVC profiles, where domestic consumption is likely to shrink the most,” the producer said.

The company was looking at increasing exports to markets such as India and the Middle East where demand was more bullish, it said.

“Last year exports accounted for 50% of our sales, but this year we hope to raise our export level,” it added.

But demand elsewhere was also contracting.

“We are experiencing the steepest fall in global activities that we have not experienced in several decades,” said David Cohen, chief economist at Action Economics.

“In the longer-term, maybe the governments will greater appreciate the risks of depending on exports,” he added, citing Asia’s strong trade links with western economies made it extremely vulnerable to economic downturn.

South Korea’s exports in January tumbled a record 32.8% year-on-year amid the unprecedented weakness in global demand.

With the slump in the global economy likely to drag on for the whole of 2009, the country’s export-oriented companies may not get a reprieve.

“Export is a key driver of industrial production. If we don’t see some pick up there, the economy will remain relatively soft,” said Action Economics’ Cohen.

Prema Viswanathan contributed to this story

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By: Pearl Bantillo
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