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Global Research

Macro Korea Economics

Korea central bank watch

Not so bouncy
Koreas growth entered 3Q 2013 on a soft note; exports fell as the HSBC PMI recorded its lowest reading in nine months Pressure on the Bank of Korea to support growth would rise if activity slows further as government spending was frontloaded But uncertainty, high inflation expectations and already low lending rates mean rates will likely stay at 2.50% on 8 August

Growth concerns linger

The Bank of Korea recently raised its 2013 GDP forecast to 2.8%. But downside risks persist. Growth in China and Japan may prove weaker than what the central bank expects and weigh on Koreas export-led recovery. Indeed, the latest HSBC PMI readings showed that new orders have contracted sharply and was matched by a decline in manufacturing employment. Exports, too, fell over the month. This will likely keep growth under pressure over 3Q 2013 and supports our below-consensus GDP forecast of 2.4% for 2013. A weaker growth outlook strengthens the case for further stimulus measures to be taken by policymakers in Seoul. But given government spending is set to diminish over 2H 2013 and the likelihood of a second supplementary budget being implemented this year remains low, pressure on the Bank of Korea to cut its policy rate again may build. The central bank has already cut rates three times by a cumulative 75bp since July 2012. But we highlight three reasons for why the Bank of Korea will stay on hold for now. First, uncertainty is high and the Bank of Korea will likely wait for more forward guidance by the US Federal Reserve before it makes its next move. Second, inflation expectations are deemed elevated by the central bank in its latest biannual report, which may make the Bank of Korea cautious about over-stimulating the economy. Finally, interest rates on household debt have already fallen below post-2008 global financial crisis lows, which suggests that the potential impact of additional rate cuts may be limited. The Bank of Korea still has a delicate balance to strike. On the one hand, weaker growth prospects support the case for more monetary easing. On the other hand, the prospect of a reduction in asset purchases by the US Federal Reserve may pressure the Bank of Korea to tighten its own policy to ease pressure on local markets. Taken together, we expect the Bank of Korea to keep rates at 2.50% on 8 August and a hike to come in 3Q 2014.
Table 1. HSBCs Bank of Korea policy rate forecasts 3Q 12 Official policy rate (% end)
Source: Bank of Korea, HSBC forecasts

5 August 2013
Ronald Man Economist The Hongkong and Shanghai Banking Corporation Limited +852 2996 6743 ronaldman@hsbc.com.hk View HSBC Global Research at: http://www.research.hsbc.com

Issuer of report: The Hongkong and Shanghai Banking Corporation Limited

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

4Q 12 2.75

1Q 13 2.75

2Q 13 2.50

3Q 13f 2.50

4Q 13f 2.50

1Q 14f 2.50

2Q 14f 2.50

3Q 14f 2.75

4Q 14f 3.00

3.00

Macro Korea Economics 5 August 2013

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Rebound not imminent

If markets were expecting Koreas economy to bounce back in 2H 2013, it certainly hasnt started yet. Economic data in July indicated that the slowdown in economic activity persisted. The sharp rebound in imports had narrowed the trade surplus and would weigh on the direct boost of net exports to GDP growth. More worrying is the sharp decline in new orders received by manufacturers according to the HSBC Korea PMI, which indicates demand should remain low. As such, this supports our view that growth will stay under downward pressure for now.
1. Weaker external growth outlook weighs on our Korea growth projections
8 7 6 5 4 3 2 1 0 2004 2005 2006 2007 Korea
Source: HSBC estimates, Bank of Korea, CEIC

% y-o-y

Bank of Korea HSBC Bank of Korea HSBC

2008

2009

2010

2011

2012

2013f

2014f

Top 4 export markets (export weighted)

Note: rolling weights based on export size, 2013 and 2014 weights are taken from 2012 figures

The Bank of Korea may become more cautious on its growth outlook. Sure, the advance 2Q GDP reading beat expectations with a 1.1% q-o-q sa rise. But the weak June industrial production figures raise the likelihood of a downward revision to the final print (to be released on 5 September). Furthermore, growth in key external markets may surprise the central bank on the downside. Chart 1 above plots our and the Bank of Koreas expectations of GDP growth in Korea and the trade-weighted average in Koreas top four export markets. We make two key points. First, there is a tight correlation between the two lines, reflecting the trade-dependent nature of the Korean economy. Second, the central bank is more bullish on the external outlook: the grey line is higher than the black line, which partly supports their more upbeat

Table 1. HSBC and the Bank of Koreas latest economic growth outlook _____________________2013 _____________________ _____________________ 2014 _____________________ HSBC ________ Bank of Korea __________ HSBC ________ Bank of Korea _________ New (Jul-2013) Old (Apr-2013) New (Jul-2013) Old (Apr-2013) China US Euro area Japan Korea GDP Private consumption Exports Imports
Source: HSBC estimates, Bank of Korea

7.4 1.8 -0.6 1.6

7.8 1.8 -0.6 1.9

8.2 1.8 -0.4 1.5

7.4 2.4 0.6 0.9

8.0 2.8 1.0 1.4

8.2 2.8 1.2 1.3

2.4 1.4 5.5 3.5

2.8 2.1 5.2 3.9

2.6 2.5 5.2 3.7

3.2 2.7 8.7 7.9

4.0 3.5 8.0 7.8

3.8 3.3 8.3 8.0

Macro Korea Economics 5 August 2013

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forecasts. But should external demand prove weaker than expected, this may weigh on domestic demand as production and employment growth weakens: the Bank of Korea expects private consumption to be particularly strong in 2013 at 2.1%, compared to our expectations of 1.4% (see Table 1 for more details).

Fiscal support to diminish

The government has recognised that external demand poses a large risk to Korean growth. On 1 August, Finance Minister Hyun stated that South Koreas economic growth momentum was weak and that export conditions to China were not easy. The government had already frontloaded its original and supplementary budget, which means there is less support to growth from the public sector in the remaining half of this year. Growth will be more dependent on private and external demand. Slow growth may pressure the government to deliver a new stimulus package in order to support growth. But we believe the likelihood of actual implementation will be limited. The government is due to present its 2014 preliminary budget by the end of September, giving it little time to prepare a supplementary budget as well. We note that there have only been two years since 2000 when the government has delivered two supplementary budgets in the same year: in 2001 and 2003 (note that the one delivered in 2003 was delivered in response to a natural crisis, rather than to stimulate the economy).

but the Bank of Korea will unlikely cut again

A weaker growth outlook and the unlikely prospect of a further fiscal stimulus package delivered this year may pressure the Bank of Korea to support growth by cutting its policy rate again. But we highlight three key reasons why the Bank of Korea will be hesitant to cut rate rates again: External uncertainty remains high. The Bank of Korea will likely monitor closely the situation in the US as the potential tapering of asset purchases by the US Federal Reserve may put pressure on the Bank of Korea to tighten monetary policy. The latest US Federal Reserve meeting statement suggests that tapering may start later or proceed more slowly than previously expected by markets, supporting our US economists view that the reduction in asset purchases will begin in December. We believe the Bank of Korea will likely want to maintain a neutral stance on this front until there is more clarity over the exact timing of the scaling back of QE in the US.

2. Elevated inflation still a concern for the Bank of Korea

% y-o-y 6.0 5.0 4.0 3.0 2.0 1.0 Jul-03

3. Interest rates on household debt at record low

% 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 Jun-07

Jul-05 Headline CPI

Jul-07

Jul-09

Jul-11

Jul-13

Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

Expected inflation (over next 12 months)

Source: HSBC, CEIC

Interest rate on bank lending to households

Source: HSBC, CEIC

Macro Korea Economics 5 August 2013

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Biannual report indicates that inflation risks are still on the radar. The central banks latest biannual report suggests that it will remain vigilant on taming price pressures despite the still-low headline CPI reading on the back of three key reasons. First, the central bank expects inflation to rise over the second half of the year from higher agricultural prices. This should narrow the scope for monetary policy to stay accommodative. Second, inflation expectations were deemed elevated. Chart 2 shows that the latest measure printed 2.9%, implying that households expected inflation to be almost twice as high as its current rate over the next twelve months. Third, the Bank of Korea signalled that it is weary of the risks associated with an extended period of excessively low global rates by noting that it must consider the medium-term inflation perspective for policy. Interest on household debt already at historical low. One argument to cut rates is to reduce the interest repayment on existing household debt, which increases disposable income for private consumption: 76.8% of bank loans to households are tied to variable interest rates as of June 2013. But Chart 3 shows that interest rates on bank loans charged to households are now even below that seen following the aftermath of the 2008 global financial crisis, when the policy rate fell to an alltime low of 2.00%. Therefore, additional rate cuts may have a limited effect on alleviating interest repayment on household debt and runs the risk of exacerbating the countrys household debt problem. As we argued in our previous central bank watch, we believe the Bank of Korea will need to maintain a delicate balance. On the one hand, weak growth may pressure the Bank of Korea to support growth by delivering further rate cuts. On the other hand, external considerations, such as the potential tapering of QE by the US Federal Reserve, and the medium-term ramifications of excessively low rates should help the central bank strengthen its case for rates normalisation. On balance, we maintain our view that the central bank will hold rates at 2.50% on 8 August and the next move will likely to be a 25bp hike in 3Q 2014.
Bank of Korea monetary policy committee members and historical voting details Committee member Role Recommended by Tenure ends MPC decision breakdown Month May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Policy rate 3.25% 3.25% 3.00% 3.00% 3.00% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.50% 2.50% 2.50% Unanimous? Yes Yes No Yes Yes No Yes Yes No No No No No Yes Yes Kim Choong-soo Park Won-shik Chung Hae-bang Moon Woo-sik Governor 31-Mar-14 Senior Deputy Governor 7-Apr-15 MPC Member Ministry of Strategy and Finance 20-Apr-16 MPC Member Governor of the BoK 20-Apr-16 Ha Sung-keun MPC Member Financial Services Commission 20-Apr-16 Lim Seung-tae Chung Soon-won MPC Member MPC Member

Korea Federation Korea Chamber of of Banks Commerce and Industry 14-Apr-16 20-Apr-16

Wanted 3.25% Wanted 3.00% Wanted 2.50% Wanted 2.50% Wanted 2.50% Wanted 2.50% Wanted 2.75%

Wanted 2.50%

Wanted 2.50%

Source: Bank of Korea, HSBC

Macro Korea Economics 5 August 2013

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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Ronald Man

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Macro Korea Economics 5 August 2013

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