South Korea in the eye of a cross-Pacific economic storm
The US-China trade war has ramped up uncertainties, the Bank of Korea governor has said an understated way; indeed, Korea has the dubious honor of showing investors what may lay ahead with exports flattening and corporates getting very jittery
In his four years heading South Korea’s central bank Lee Ju-yeol has withstood many a challenge: 10% youth unemployment, record household debt, the impeachment of a president, Pyongyang’s antics spooking markets, you name it. But none holds a candle to Donald Trump.
Like most skilled policymakers in Asia, Governor Lee figured Trump’s trade-war talk was all bluster and no follow-through. So much so that Lee felt comfortable hiking interest rates in November, fully 313 days after the US president took office.
But that confidence hasn’t aged well – something on graphic display today as the Bank of Korea left its base rate at 1.5%. It is the eighth straight month of steady policy.
“In the beginning, many thought that the US-China trade row would not escalate,” Lee said in what sounded suspiciously like a mea culpa. “But now, it is spreading rapidly and heightening uncertainties in the global economy. It is hard to predict the future. But we are well aware that the clash between the two powerhouses will affect the South Korean economy and its exports.”
Clash, indeed. It’s hard not to view today’s drama through the lens of one of those “Avengers” films that Marvel churns out every few months. As Trump takes on his nemeses, this epic battle between superpowers is laying waste to entire economies. Korea has the dubious honor of showing investors what might lay ahead.
An ominous trend takes shape
The downshift could be pretty epic in its own right. After a 13.2% surge in May, exports fell 0.1% in June from a year earlier. That’s a terrible omen for a trade-reliant economy struggling to remain competitive amid the rise of China, India and other emerging superstars.
It also could be a problem for stock markets from Tokyo to New York. In a recent report, Bank of America Merrill Lynch strategist Michael Hartnett flagged the 25-year correlation between Korean exports and earnings at listed global companies. Trump’s escalating tariffs are fast changing the calculus for stock punters. Hence the “Apocalypse Dow” headline on the report.
Before Trump began firing artillery at trade flows, Hartnett’s team had been eyeing a healthy 15.5% earnings per share on average for 2018. As of late June, they had a 9.4% target for 2019. That, however, will surely prove optimistic as Trump adds zeros to levies he began imposing on July 6.
The $34 billion worth of tariffs on Chinese imports the White House unveiled that day could be followed in short order by another $200 billion. Trump’s tariff wishlist could go to $500 billion, the amount of Chinese imports that entered America last year. Trump has already slapped levies on steel and aluminum – 25% and 15%, respectively – and is threatening a 25% one on car imports.
The fallout from these actions, and others to come, are having a chilling effect on Korea Inc. The above-mentioned unemployment and debt challenges are compounded by a corporate sector that’s unwilling to fatten paychecks or invest in increased innovation and productivity. Trump’s trade war has Korea Inc. more worried than it’s been since the 2008 global crisis.
President Moon Jae-in has pivoted away from economic retooling to engage Kim Jong-un. Denuclearization and Korean peninsula peace are worthy goals, but Moon’s neglect of reform – and that of predecessor Park Geun-hye in her four years in office – has come back to haunt Korea.
Now, the BOK is on the front lines of headwinds emanating from Washington. Korea doesn’t matter just because it’s a top-12 economy. It also has predictive value.
Korea: Weather vane for trade-reliant economies
Think of Korea as the global economy’s rosebush. Winemakers often surround their vines with shrubbery that tends to be acutely vulnerable to disease – a kind of early-warning mechanism to protect the grapes. Korea’s sizable and open financial system can play a similar role for the globe’s major economies. And at the moment, Korea is flashing red.
Korea, remember, contracted in the fourth quarter, taking investors by surprise. That mild 0.2% slide, the first in nine years, came just as Trump was ramping up his trade war rhetoric. Today, Lee downgraded his 3% annual growth target to 2.9%, and the Bank of Korea revised down its estimation of the current account surplus for 2018 to US$65 billion from $70.5 billion amid trade tensions.
Elsewhere, Trump’s trade gambit recently handed Japan its first contraction in nine quarters. And the odds of China’s export engine sputtering as the year progresses are rising fast.
Additional BOK rate hikes that markets expected are off the table. Economists at Fitch’s BMI Research expect the BOK to stand pat this year, citing “the central bank’s cautious tone, rising uncertainty around growth caused by escalating trade tensions, and still below-target inflation.”
Rather than tending to policy rate changes, the BOK is shifting into crisis mode. “Uncertainty and volatility in the global financial market have risen highly and can affect the South Korean financial market as well,” Lee said today. “Against this backdrop, the rate difference between Korea and the US may accelerate the foreign outflux.”
Those outflows are partly a strength. One reason sellers often target Korea is that its liquid markets offer easier access to cash than less-developed Asian economies. Too many, though, and Lee’s team could have a mini-crisis on its hands. Not to mention lots of troubled rosebushes.