The Korean economy is showing signs of stabilizing as the effects of fiscal stimulus kick in. Although the worst is probably over for the Korean economy, real GDP growth likely will remain sluggish for some time as consumers de-lever.

Real GDP Stabilized in the First Quarter

Data released today showed that real GDP in South Korea edged up at an annualized rate of 0.2 percent in the first quarter of 2009 relative to the previous quarter (see top chart). Not only was the outturn a bit stronger than the consensus forecast had anticipated, but the relative stability of the first quarter was a welcome relief in light of the 18.8 percent nosedive that occurred during the fourth quarter.

The freefall in Korean GDP in the fourth quarter reflected, at least in part, the collapse in exports that occurred at the end of last year (see middle chart). Although exports continued to decline in the first quarter, the rate of contraction eased off somewhat. The Chinese economy is showing incipient signs of growing again, which should eventually help Korea given the extensive trade ties between the two economies.

In addition, stabilization in real GDP in the first quarter reflects the effects of fiscal stimulus. Not only did government consumption expenditures rise at an annualized rate of 15.2 percent in the first quarter, but the 1.9 percent increase in consumer spending may reflect the tax cuts that went into effect earlier this year. And there is more stimulus in the pipeline as well. The government is awaiting parliamentary approval for a second stimulus package worth an additional 2 percent of GDP. The Bank of Korea cut its main policy rate by 325 basis points between October and February. Lower rates should translate to stronger growth in the next few quarters.

Barring another global financial meltdown, the worst is probably over for the Korean economy. That said, growth in Korean real GDP will probably not go back to the 5 percent per annum rate that characterized the 2006-07 time period. For starters, our forecast calls for global growth to remain sub-par through 2010, which should constrain growth in Korean exports. In addition, household debt has shot up nearly fourfold over the past decade, and the debt-to-income ratio is closing in on 160 percent. In other words, Korean households are quite leveraged at present. Therefore, growth in consumer spending probably will remain sluggish for some time as households de-lever.

The Korean won dropped sharply last autumn as credit markets locked up and as Korean banks scrambled for dollar liquidity (see bottom chart). However, the won has recouped some of its losses recently as tensions in financial markets have eased. Unless capital markets lock up again, which is not our expectation, the won/dollar exchange rate probably won’t approach the highs set earlier this year. That said, we project that the won will drift lower versus the dollar over the next few quarters as the upturn in Korea remains frustratingly slow.