BMI On The Ground: Seoul Searching In South Korea
BMI View: BMI visited South Korea in late February to discuss the country's growth outlook and key economic challenges with a host of corporations, financial institutions and government agencies. Our visit also coincided with the inauguration of President Park Geun-hye, whose rise to the Blue House drew a mixed reception from our clients. On the macro front, the consensus view on 2013 real GDP growth appeared a little on the optimistic side to us given our view that China's rebound will prove fleeting over the coming months. Meanwhile, a perceived focus on boosting welfare spending over developing infrastructure is a particular source of concern for the construction sector.
BMI journeyed to Seoul in late February to discuss the country's growth prospects with a host of major corporations, financial institutions and government agencies. Our visit also coincided with the inauguration of President Park Geun-hye, South Korea's first female head of state and daughter of former dictator Park Chung-hee (who ruled the country from 1961 to 1979). Park's ascent to the Blue House provoked a mixed response from our clients, as we discuss below, which is consistent with her slim majority at the ballot box (winning 51.6% of popular votes) in the December 2012 general elections.
Before turning our head to politics and policies, we start by taking a look at the prevailing mood on economic activity. While few of those we spoke to expected a return to the plus-5% growth clip seen before 2008, the general sentiment appeared quite upbeat, with most encouraged by the recent dataflow (such as PMI numbers) and the improvement in external demand. In this regard, parallels can be drawn with the early part of 2012, when mainstream expectations were comparatively bullish versus our own (see 'Expecting Growth Weakness In H213', January 24 2013). The divergence this time around is less intense - we are forecasting a firm first half of 2013 and our full-year forecast of 3.0% is not miles away from the Bloomberg consensus projection of 3.3%. Still, Corporate Korea does not appear overly concerned about an H213 relapse in China's economic rebound, which is of course our baseline view, suggesting that growth expectations across South Korea will be tempered in the coming months.
The major risk to headline growth, which was expressed particularly amongst financial institutions, was the magnitude of South Korea's household debt burden. This is a concern that we have raised repeatedly in recent quarters (see ' Debt Deleveraging Still In Nascent Stages', February 18 2013). Total household debt stood at a record KRW937.5trn (US$860.9bn) in January, and was equivalent to roughly 90% of GDP in 2012. What is more, loan defaults have started to tick up. The government is looking to address such concerns by assuming mortgage debt from distressed households, but this would come at the cost of a worsening fiscal position and would open the door to moral hazard risks. Overall, we believe that debt deleveraging is a necessary process over the coming years, which will impact the country's short- and long-term growth prospects. In our baseline scenario, we see South Korea's consumers paying off their debts in an orderly fashion, which would crimp private consumption growth. In a worst-case scenario, we could see a major spike in default rates which would pose existential risks for several of South Korea's smaller banking players, despite their reasonably healthy capital buffers at present.
Wary Of Park's Pledges
We met with a number of major infrastructure players and industry associations, and our main takeaway was that of widespread unease on the outlook for new projects in 2013, not least due to the change of political guard and likely implications for policy agenda. Park's election campaign was centred upon pledges to ramp up social welfare expenditure and, while few details on such policies have been unveiled as of yet, the new leader reiterated the 'fair society' rhetoric in her inauguration speech. With regards to construction, the concern shared by many in the sector is that increased welfare spending will come at the expense of public sector outlay on infrastructure and civil engineering works. The public sector accounts for roughly 35% of all construction orders in the country and is thus integral to the health of the industry. For our part, we believe that 2013 will be a decent year for Korean construction. Park is unlikely to re-allocate spending toward welfare payments aggressively, there remains scope for further monetary easing (25bps to 2.50% by end-2013, according to our forecasts), and the base effects of a weak 2012 should all come into play.
That said, our growing caution towards South Korea's renewable energy sector was validated by our on-the-ground discussions. In mid February, we toned down our outlook for non-hydropower renewables generation growth due to a lack of progress on existing projects and a shift back towards traditional thermal power. From our discussions, there is agreement that, while investment in renewables remains a long-term objective, the degree of public support for the sector will remain relatively subdued - particularly versus that of Japan, for example - making it difficult to generate sustainable profits.
Chaebols And North Korea
Turning back to the political story, we saw some disagreement over the government's ability and willingness to break up South Korea's giant conglomerates, known locally as the chaebol . Strong anti-chaebol rhetoric was another cornerstone of Park's presidential campaign, but there has been a lack of specifics with regards to the administration's policy prescription. Our core view is that much of this can be put down to electioneering and that it will be difficult for Park to push through reform given the potential impact that this could have on the country's economy coupled with the considerable influence that major corporations wield (see ' What To Expect From Park's First Term', February 22 2013). While most agreed with us, others believed that Park would still try to curb the power of chaebol activity in non-core sectors. The jury on this matter is still out.
The North Korea threat was not seen as a major issue for Korean business leaders from both a political and financial market perspective. Despite heightened tensions on the Korean peninsula following the North's third nuclear test in early February 2013, local firms have learnt to shrug off routine threats of violence. To be sure, Pyongyang has on a number of occasions provoked incoming South Korean leaders in a bid to rationalise military spending, and this time should prove no different. The condemnation from Beijing for the recent nuclear test means that North Korea is even less likely than before to follow up its threats with military action. As such, for those we saw in Seoul, the North Korean threat is not high up the priority list in terms of threats to business activity.