Cablegate: Korean Economy Slowing -- Outlook Weak for First

VZCZCXYZ0000
PP RUEHWEB

DE RUEHUL #0002/01 0012219
ZNR UUUUU ZZH
P 012219Z JAN 09
FM AMEMBASSY SEOUL
TO RUEHC/SECSTATE WASHDC PRIORITY 2795
INFO RUEHBJ/AMEMBASSY BEIJING 5123
RUEHGP/AMEMBASSY SINGAPORE 6165
RUEHKO/AMEMBASSY TOKYO 5229
RUEHHK/AMCONSUL HONG KONG 3761
RUEHIN/AIT TAIPEI 2910
RUEHRC/DEPT OF AGRICULTURE USD FAS WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHDC 1862
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/NSC WASHINGTON DC

UNCLAS SEOUL 000002

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV KS
SUBJECT: KOREAN ECONOMY SLOWING -- OUTLOOK WEAK FOR FIRST
HALF OF 2009

1. (U) This cable is sensitive but unclassified and not/not
intended for internet distribution.

2. (SBU) Summary: Korean economic growth slowed in 2008 from
the 5 percent pace of 2007 to below 4 percent. Growth was
already slowing before the impact of the global financial
turmoil, but has been further impeded by it. The benchmark
KOSPI index fell by more than 40 percent and the won fell by
more than 30 percent for the year. GDP growth is expected to
reach a maximum of 1.4 percent in the fourth quarter. Export
growth is waning rapidly, recording an 18 percent decline in
November from a year ago. Industrial output fell by 14
percent in November from the November before. The silver
lining is that falling oil and commodity prices have lead to
reduced inflationary pressure and improvement in the current
account. Looking ahead into 2009, the Korean economy, which
depends heavily on the export sector, will be buffeted by the
global slowdown and continuing credit crunch until global
recovery begins and demand starts to increase. Investment
houses, think tanks, and international institutions have
presented a wide array of forecasts for ROK GDP growth in
2009 with the majority falling between one and two percent.
End Summary.

Korean Economic Performance and Prospects
-----------------------------------------

3. (SBU) The Korean economy had already begun to slow in the
third quarter of the year, well before financial turmoil in
New York precipitated the global liquidity squeeze that began
in late September. Korea's GDP growth in the third quarter
was 3.8 percent, more than a percentage point below the
economy's 2007 performance. Sluggish domestic demand
combined late in the quarter with the impact of the global
financial turmoil and pushed growth below all but the most
pessimistic forecasts. Private consumption grew by just 1.1
percent in the quarter while government expenditure and
domestic investment growth were higher at 4.5 percent and and
5.2 percent, respectively. Export growth was 10.7 percent
higher than the third quarter of 2007, but low in contrast
with the 21.8 percent growth of the preceding four quarters.

4. (SBU) While final statistics for the year are not yet
available, it is clear that growth in the fourth quarter will
be considerably weaker at around 1.4 percent and will drag
GDP growth, which stands at 4.7 percent through the first
three quarters, to below 4 percent for 2008 as a whole.
Increasing government expenditure growth in the fourth
quarter is attributable to earlier spending lags and USD 3.2
billion in supplementary budget spending. Growth in private
consumption, gross capital formation, and exports are
expected to show sharp declines in the quarter.

5. (SBU) Korea's equity market was hit hard in late September
through November by the global economic turbulence. The
Korean economy's declining performance in the third quarter,
its thin capital markets, and a large increase in foreign
short-term debt left it exposed to the external shock posed
by the global financial turmoil. The benchmark KOSPI index
ended the year at 1,124, down 40.7 percent (most acutely in
October and November). This was the third worst showing ever
recorded for the index. The Korean won ends the year at 1260
per U.S. dollar, down by about 28 percent over the last five
months. The picture could have been far worse, but the won
recovered by 16.6 percent during December. Despite the
December recovery, this was the worst performance by the won
since the economic collapse in 1997 during the Asian
Financial Crisis. Interest rates remain above pre-crisis
levels, despite intensive efforts by the BOK to reduce them.

Contributions to GDP Growth by Major Component
--------------------------------------------- -

6. (SBU) Looking more closely at the components of GDP
growth, the steep decline in net export growth will allow
exports to yield only a 0.6 percent contribution to GDP
growth in the fourth quarter. Weak fourth quarter investment
(gross capital formation in the table above) will yield only
a 0.3 percent boost to GDP growth in the fourth quarter.
Increased government spending is expected to be the biggest

factor in sustaining GDP growth in the fourth quarter,
providing a boost of 0.7 percent. The Bank of Korea has
slashed its key interest rates by 2 percent since early
October and taken other steps to help ease the liquidity
crunch. While it is difficult to measure the impact of the
monetary loosening in a financial crisis, it should have a
stimulatory effect on the economy as the credit crunch
gradually eases in 2009. The ROKG plans an aggressive fiscal
stimulus for 2009 to make up for the anticipated low levels
of private sector economic activity and to complement the
monetary action. Since Korea imports almost all of its
energy needs, the silver lining in the global financial
turmoil has been the collapse of oil prices. This has
dramatically reduced import expenditures in the fourth
quarter and reversed the current account deficit, thus easing
one source of pressure on the won.

7. (SBU) Private consumption has been weakening throughout
2008, recording just 1.1 percent growth in the third quarter.
Increasing prices, low employment growth, falling asset
values, and rising household debt have all contributed to
this weakness. Despite the easing of oil and gas prices,
core inflation and the weak won are still limiting demand for
non-necessities. The negative wealth effect is a relatively
new factor in the picture as equity and real estate values
fell most heavily in the fourth quarter. The impact on Korea
of the global credit crunch has also reduced consumer credit
and furthers limits demand. These new developments in an
already weak environment lead to the expectation that private
consumption growth will reach only 0.1 percent in the fourth
quarter. Consumer confidence survey scores in December fell
to the lowest level in ten years. Demand is expected to
remain weak through at least the first and second quarters of
2009.

8. (SBU) Investment growth is expected to fall by 1.4 percent
in the fourth quarter of 2008 in comparison with the third
quarter. This will bring the annual investment growth figure
for 2008 to around 2.4 percent, slightly lower than in 2007.
The poor overall economic environment is also likely to lower
investment in new plant and equipment in at least the first
two quarters of 2009. The BOK announced in late December
that facility investment in the fourth quarter was 7.2
percent lower than in 2007. The BOK anticipates declining
facility investment in 2009. Increasing ROKG construction
spending will not have a significant impact on the economy
until the first and second quarters of 2009, although the
supplementary budget measure in September did boost spending
modestly in the fourth quarter. In any case, increasing
government construction spending is only likely to offset
partially otherwise declining private sector construction
activity in the first half of 2009. While President Lee
Myung-bak had promised increased infrastructure spending
during his campaign in 2007, these plans did not get off the
drawing board in 2008 as the Administration was bogged down
by other issues.

9. (SBU) The real estate and housing market is moribund with
large stocks of finished but unsold apartments accumulating
in the fourth quarter. This problem is particularly
pronounced in the regions beyond Seoul where the previous Roh
Administration had promoted development and construction.
Construction firms and mutual savings banks heavily invested
in these regional projects are clearly among those most
likely to be put out of business as the government is
expected to move forward with restructuring in these and
other sectors in 2009. The Lee Myung-bak Administration is
pushing forward a number of real estate reforms that had been
stalled in order to stimulate the market. While these
measures may yield positive results, the effect is unlikely
to be substantial at the outset of 2009.

10. (SBU) Government expenditure growth was only 4.2 percent
through the first three quarters of this year. This in part
was the result of the budget austerity stance at the start of
the Lee Myung-bak Administration. Total government spending
through the first ten months of 2008 was 197.7 trillion won
(USD 141.2 billion), only 75.9 percent of the annual budget.
The supplementary budget of 4.5 trillion won (USD 3.2
billion) passed in September was insufficient to reverse the
low spending growth trajectory established through the first
9 months. The expected increase in spending in the fourth

quarter will boost the annual rate of government spending
growth to 4.5 percent. Government spending is expected to
grow significantly in 2009 as the budget already contains a
fiscal stimulus and an additional stimulus package is
expected.

Employment and Wages
--------------------

11. (SBU) Unemployment rates are not expected to increase
substantially in the fourth quarter, despite the slowing of
the economy. Unemployment is expected to be 3.3 percent in
the fourth quarter, only slightly higher than the rate
through 2007. One reason for this is the increasing rate of
economic inactivity within the overall population. Another
factor is the tendency in Korean firms to reduce output and
hours rather than lay off workers. Nonetheless, job losses
are anticipated in 2009 through the coming economic
restructuring in construction, shipbuilding and possibly
other sectors. Temporary and day laborers, along with the
self-employed, are expected to face the toughest conditions.
Many of these are actually foreign migrant workers.

12. (SBU) Even as employment growth has slowed in 2008, so
have real wages slowed and then turned negative. Real wage
growth was 2.3 percent in the first quarter, 1.6 percent in
the second quarter, but minus 2.9 percent in the third
quarter. Real wages are expected to continue to decline in
the fourth quarter as workers are in a weak bargaining
position and inflation remains substantial. This trend could
continue into 2009 unless inflation is brought within the
target zone. Declining real wages will further undercut
consumer demand in the fourth quarter and into at least the
first quarter of 2009.

External Sector
---------------

13. (SBU) Net export growth through the first three quarters
of 2008 was 20.2 percent higher than the same period in 2007.
This growth, however, slowed in the third quarter to 10.7
percent and is expected to deteriorate sharply in the fourth
quarter. Exports in November fell by 18 percent from the
level of November 2007, the sharpest drop in seven years.
Similarly, the National Statistical Office announced a 14
percent decline in industrial production in November (from
the level of Nov 2007) -- the sharpest monthly decline since
1970. Despite slowing export growth, the trade balance swung
into positive territory in October with a USD 2.79 billion
surplus, reflecting the impact of rapidly falling oil and
commodity prices. This change helped propel the current
account into a USD 4.75 billion surplus in October and a USD
2.06 billion surplus in November. For the year, we expect a
surplus of more than USD 5 billion for the goods balance,
while the services balance is expected to be around minus USD
14 billion. The positive movement in the trade and current
account balances late in 2008 has not improved exporter
confidence levels. The Export Business Survey Index, taken
quarterly by the Korean International Trade Association for
the coming quarter, peaked at a level of 128.3 in the first
quarter of 2008. The index fell to 90.6 in the second
quarter, 82.8 in the third quarter, and reached a record-low
of 33.4 in the fourth quarter.

14. (SBU) Prospects for the external sector have directly and
indirectly affected by the financial crisis. The global
credit crunch has made trade financing more difficult for
imports and exports. The Korean government has attempted
with mixed results to ensure adequate trade financing.
Recessionary expectations in the United States and Europe are
darkening global growth expectations and many of Korea's
export industries will feel the pain. The won depreciated
rapidly in October and November, reaching 1508 per U.S.
dollar on November 21, losing more than 50 percent of its
value of just a few months before. The won, along with most
other currencies, has regained value against the dollar in
December with the rate on December 30 closing at 1260 won per
U.S. dollar. Market analysts expect the won to recover
further against the dollar but most expect the rate to
stabilize above 1100 with the currency then 15-25 percent

weaker than in the first half of 2008. This should make
Korean exports more competitive over time, particularly in
comparison to those of Japan, where the yen has appreciated.

Inflation and Monetary Policy
-----------------------------

15. (SBU) Consumer prices in 2008 were propelled upward by
rising energy, commodity and food prices in the first half.
As these prices moderated and then fell in the second half,
consumer price pressures began to ease. Consumer prices for
the year as a whole are expected to rise by 4.7 percent, well
above the target zone of 2.5-3.5 percent. Producer prices
climbed even higher during the year, peaking at 12 percent in
the third quarter. These prices are expected to end the year
with an annual growth rate of 8.6 percent. Inflationary
pressures are generally expected to continue to ease in the
first half of 2009, although upside risks spring from the
weaker won, possible public utility price hikes, and possible
increased labor wage demands.

16. (SBU) The impact of the global financial turmoil
(including easing energy and commodity prices) caused the
Bank of Korea (and the Ministry of Strategy and Finance) to
abandon anti-inflationary policies of the summer months in
favor of monetary easing in the fourth quarter. The BOK cut
the benchmark seven-day repurchase agreement by 75 basis
points on October 27, 25 basis points on November 7, and a
full percentage point on December 11. Analysts generally
expect additional monetary easing in the first half of 2009
and indeed, BOK Governor Lee Seong-tae in New Year remarks
announced that the bank would "manage the base rate with
priority on economic recovery and improving financial markets
because price growth is expected to slow down."

Wide Range of 2009 Forecasts
----------------------------

17. (SBU) The most pessimistic forecast for the Korean
economy in 2009 was released by UBS, which predicted in late
November a 3 percent GDP decline. UBS expects the heavy blow
to export industries coming in early 2009 to burst what it
considers to be a credit bubble. Some other western
investment houses have also predicted negative growth in
2009, but most western and domestic institutional analyses
are more positive.

18. (SBU) The OECD is among the more optimistic of
forecasters and, in its &Economic Outlook 20098 anticipates
GDP growth of 2.7 percent for the coming year. The OECD
suggests a quicker rebound for exports than most other
institutions. The OECD analysis foresees the weak won as a
spur to exports (but the won has recovered considerably in
December). The IMF and World Bank have both announced
expectations of 2 percent for Korean GDP growth in 2009.

19. (SBU) The BOK, which has a reputation for optimism when
forecasting Korean GDP growth, surprised most observers in
December with a forecast of only 2 percent GDP growth for
2009. The BOK was less optimistic than the OECD about a
quick turnaround in demand in export markets as well as
domestically. With the exception of Samsung Economic
Research Institute, which is predicting 2009 GDP growth of
3.2 percent, Korean think tanks are forecasting growth
between 1 and 2 percent. President Lee Myung-bak warned in
late December that growth in the first half of 2009 could be
negative, but was hopeful regarding positive growth for 2009
as a whole.

Comment
-------

20. (SBU) President Lee Myung-bak has made shoring up the
economy his highest domestic priority in late 2008 and is
expected to make it a primary theme in his New Year's
address. Lee and the ruling GNP are trying to move forward
with a wide-ranging set of reforms intended to help the
economy weather the global slowdown as well as create an
environment more conducive to business interests. Lee and

the GNP are, however, at loggerheads with the opposition
Democratic Party, which seized the floor of the National
Assembly in late December to prevent the GNP from using its
majority to pass any legislation. (The GNP's majority was
used to pass the budget and tax cuts earlier in December over
strenuous objections of the DP). The economic crisis offers
Lee a rare opportunity to regain the initiative in his
Presidency and the opposition is using radical tactics to
prevent this outcome. Regardless of the outcome of the
legislative standoff, the government has used the tools
available to it, along with the budget and tax measures, to
adopt expansionary fiscal and monetary policies, ease
regulatory controls, ease the liquidity crisis facing the
financial sector, shore up bank capital adequacy ratios, and
prepare for restructuring in industries such as construction
and shipbuilding.

21. (SBU) The financial crisis appears to have generated the
necessary urgency to spur Korea and its larger neighbors,
China and Japan, to adopt a new set of bilateral national
currency swap mechanisms on the margins of the mid-December
summit in Fukuoka. Nonetheless, the ROKG remains greatly
appreciative of the USD 30 billion currency swap between the
Federal Reserve and the Bank of Korea. This gesture played a
key role in stabilizing Korean markets in late October when
fear and uncertainty were accelerating the decline of the won
and stock indices. The ROKG is also appreciative of the U.S.
role in ensuring a place at the table for Korea at talks on
the global financial system and we can expect the ROKG to
continue to be an ally in these talks.
STEPHENS

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