Construction/Infrastructure: Signs Of 2014 Underperformance Surfacing
BMI View: The South Korean construction sector has exhibited signs of a growth deceleration in Q413 and we believe this slowdown will continue into 2014 - we are forecasting construction real growth forecast at just 0.5% for 2014, compared to 3.6% in 2013. This is primarily because of our downbeat outlook towards all of South Korea's construction sector drivers - namely, weak macro fundamentals for residential buildings, a poor export outlook for non-residential buildings and declining government spending on infrastructure.
The recovery in South Korea's construction sector has started to show signs of slowing down. Latest data from the Bank of Korea (Bok) showed that in seasonally adjusted terms, the construction industry grew by 3.9% year-on-year (y-o-y) in Q413. Although this was higher than the contraction of 3.9% y-o-y in Q412, this growth rate was lower than the 5.1% y-o-y in Q313 (We highlight that since the start of 2014, the BoK has made revisions to its dataset and real economic data is now based on 2010, and not 2005 prices).
|South Korea - Quarterly Construction Real Industry Value Data (At 2010 Prices, Seasonally Adjusted)|
This slowdown in Q413 construction growth was due to a sharp slowdown in infrastructure activity. Real growth in the infrastructure sector contracted by 0.7% y-o-y in Q413, compared to a growth of 6.9% y-o-y in Q313. Conversely, real growth for the residential and non-residential building sectors accelerated in Q413. Real growth for the residential building sector accelerated from 9.6% y-o-y in Q313 to 10.6% y-o-y in Q413, while real growth for the non-residential sector accelerated from 3.0% y-o-y in Q313 to 7.8% y-o-y in Q413.
|Can It Last?|
|South Korea - Construction Real Industry Value, By Sum-Components (At 2010 Prices, Seasonally Adjusted), KRWbn|
Overall, the sector's performance in Q413 brought real growth for the South Korea construction sector to 3.6% in 2013, marking the first time the sector experienced full-year growth since 2009.
However, the growth slowdown in Q413 also supports our view that this recovery in South Korea's construction sector is unlikely to last and that construction growth is set to decelerate further in 2014. This outlook is reflected in our 2014 full-year forecasts. Due to higher base effects (we had previously expected construction real growth to reach 2.9% in 2013), we have revised down our growth forecasts for 2014 to from 1.1% to 0.5%.
Our bearish outlook for South Korea construction sector is consistent across all of its sub-sectors. We maintain our view that real growth for the building sector (consisting of residential and non-residential) will be dragged down by the residential sector over the coming years. Since 2012, the government has launched several rounds of stimulus measures to reignite housing demand, with the most recent measures, launched at the end of December 2013, including a permanent reduction in capital gains and acquisition taxes as well as the right to build three additional stories on apartment buildings that are 15 years or order, effective from April 2014.
|Recovery Not To Last|
|South Korea Construction (And Sum-components) Industry Value Real Growth Forecasts|
These measures have been relatively effective as we have not only seen a pick-up in housing demand (the pace of contraction for housing prices, an indicator of demand, has decelerated markedly since mid-2013), but also an increase in residential building activity since the start of 2013 (highlighted above). However, we do not believe that the recovery in the residential building sector is sustainable. This is because:
The macro fundamentals in South Korea (ie, declining population growth, stagnant wage growth and static unemployment rate) do not support robust demand for housing over the long-term.
Household debt in South Korea is also very high, at an estimated 90% of GDP in 2012, and this could act as a cap on the ability of consumers to finance new housing.
There is still a considerable supply glut within the South Korean housing market, with the country's housing supply ratio - an indicator that measures the total housing supply to the number of households - at record highs in 2012. Data from the South Korea Land Ministry also showed that there were 52,387 unsold apartments in South Korea at the end of February 2014.
Lastly, as part of the April 2013 stimulus package, the government decided to cut the number of new public housing units from the current 70,000 per annum to 20,000. This was followed by an announcement from the government in May 2013 that housing expenditure would be cut by KRW9.5trn over the next four years. These measures are likely to result in lower residential building activity from the public housing sector.
|Real Estate On The Mend|
|South Korea - Housing Supply Ratio, % (LHS); And Housing Prices, % chg y-o-y (RHS)|
Poor Exports Outlook Hurt Non-Residential
In the non-residential building sector, we expect near-term activity to be held back by a lack of demand for South Korea's manufacturing products (a key driver of non-residential building investment). Even though we have seen a resurgence in export growth over 2013, we believe that this has more to do with one-off factors than a sustained recovery in the demand for South Korea's manufacturing products. To be sure, outbound shipments from South Korea only grew by 0.7% y-o-y in the first two months of 2014.
While a pickup in trade momentum in the US and Europe could help bolster Korean exports in the near term, we believe that declining trade activity with the ASEAN region ( see 'Northeast Asia: Changing Export Trends', December 9 2013) and a renewed downturn in China's economy ( see 'Slowdown In Full Effect', March 24 2014) could eventually weigh on South Korea's export activity once support from the developed markets starts to ebb. The domestic economy is also unlikely to provide much support, with the government doing little to address the country's mountain of household debt. This debt, when coupled with a floundering real estate market, will inadvertently crimp consumption spending on goods. Given this poor business climate, companies are likely to maintain a cautious outlook towards fixed investment.
|Export Growth Slowing|
|South Korea - Total Exports Growth, By Principal Country, % y-o-y; And Non-Residential Building Construction Real Growth (At 2010 Prices, Seasonally Adjusted), % y-o-y|
We do however, highlight that non-residential building activity could pick-up slightly over the medium term due to the 2018 Winter Olympics. This is reflected in our forecasts, with real growth for the buildings sector expected to rise from 1.1% in 2016 to 1.9% in 2017. The sporting event is expected to trigger an estimated US$8.4bn construction boom in South Korea over the coming years, with most of the activity originating in the commercial construction sector. Not only are there plans to build and refurbish several stadiums, but hotels, retail and leisure developments are also expected to be developed to cater for the increase in tourist arrivals and to house Olympic participants.
Tourist arrivals to South Korea also remain relatively elevated at present, and this will drive demand for tourism-related facilities. Tourist arrivals in the 2013 reached a record-high of 12.1mn, indicating that the rise in purchasing power among Asia's consumer class is having a material impact on South Korea's tourism sector.
|Achieving New Highs|
|South Korea - Tourism Arrivals, By Month|
Infrastructure Activity To Remain Muted
Most importantly, we believe that infrastructure growth will be muted over the coming years. We are forecasting real growth for the sector to average 1.5% per annum between 2014 and 2016, lower than the 3.3% seen in 2013. This is despite a sharp increase in activity in the airport infrastructure sector ( see 'Incheon Expansion A Major Tailwind To Airport Growth', October 7 2013) and a restart of South Korea's nuclear power generation plans ( see 'New Nuclear Approval Provide Relief', February 3 2014). This muted outlook is primarily due to the government's lack of progress with previously announced infrastructure plans and its recent decision to scale down on infrastructure spending.
In 2011, the South Korean transport ministry announced a US$170bn plan to upgrade the entire country's transport infrastructure by 2020 - which included building or expanding roads, railways (high- and normal- speeds), airports and seaports - but we have not seen this translate into increased project opportunities. Data from the Korean Statistical Information Service showed that domestic civil engineering orders (which is termed infrastructure by BMI) have been declining since 2009, with orders in 2013 the lowest since 2009.
|Domestic Orders Falling|
|South Korea - Value Of Domestic Construction Orders Received (At Current Prices), By Sector, KRWtrn|
Meanwhile, the Park Geun-hye government announced in May 2013 that it would cut social overhead capital expenditures (which include spending on transportation and electricity) by KRW11.6trn over the next four years and use the funds for its social welfare programmes under its five-year (2013-17) budget plan. In addition, in February 2014, the government unveiled an economic reform plan (dubbed the '474 Vision') that aims to reorient the South Korean economy from manufacturing to services, and reduce the public sector's involvement within the economy by 2017 ( see 'Reforms Ambitious, But Bode Well For Growth', February 28 2014).
In our opinion, these moves by the government mean that there is little scope for a sharp pick-up in domestic infrastructure orders over the coming years. This is because the majority of domestic infrastructure orders are from the public sector and a reduction in the government's capital spending or role in the economy would likely translate to a decline in domestic infrastructure orders. In addition, initial details on the government's plan to develop the country's service sectors - namely, finance, education, healthcare, tourism and software - are geared more towards the deregulation of these sectors and subsidies for research and development, as opposed to fixed asset investment.
Not All Doom And Gloom
Despite the muted outlook, we note that our construction growth forecast for 2014 is still significantly higher than the historical ten-year average (the sector contracted by an average of 0.26% per annum between 2004 and 2013 [based on 2010 prices]). This is because monetary conditions in South Korea remain relatively conducive for construction activity. The Bank of Korea has maintained the benchmark base rate at 2.50% since May 2013. This rate is a four-year low and in our opinion, is unlikely to change over 2014, with monetary tightening to only take place in 2015 at the earliest. This is because the South Korea economy is still relatively fragile due to poor external conditions, while inflationary pressures in South Korea remain relatively well contained ( see 'Pause In Rates Expected Through 2014', February 14 2014). Domestic borrowing costs could therefore remain attractive for construction companies to take up new projects or carry out capital-intensive construction works.
|Monetary Conditions Growing Conducive|
|South Korea - BoK Base Rate, % & Headline Consumer Price Index (CPI), % y-o-y|