Currency Forecast - KRW: Long-Term Appreciatory Trajectory Still Intact - NOV 2017

Spot 2017 2018
Source: BMI, Bloomberg, August 30 2017
KRW/US$, ave 1122 1160 1110
KRW/EUR, ave 1344 1276 1188
Base Rate, % eop 1.25 1.25 1.25

BMI View: We remain neutral on the KRW in the near term as the currency continues to test key technical resistance while geopolitical tensions remain high. Over the longer term, we expect the currency to appreciate slightly as it remains supported by positive growth-inflation dynamics, a still-undervalued real effective exchange rate, and a strong external position.

Short-Term Outlook (three-to-six months)

The Korean won has appreciated by 7.8% since January and is testing long-term technical resistance. We remain neutral on the currency as we expect two factors to present upside and downside pressures.

From a technical perspective, a break of resistance at around KRW1,100/USD would be a bullish signal potentially triggering a run at KRW1,000/USD. This could be triggered by perceptions of an improvement in the still-slow reform momentum. In our view, investors could view the sentencing of Samsung heir Jay Y Lee on August 25 on corruption charges as a sign of South Korean President Moon Jae-in's commitment to reforming the chaebol. Lee's five-year corruption sentence marks a shift from the typical three-year jail term that was given to chaebol leaders convicted of corruption.

Break Of Resistance Would Be Reason To Turn Bullish
South Korea - Exchange Rate, KRW/USD
Source: BMI, Bloomberg

On the other hand, geopolitical tensions and an increase in risk premiums could weigh on the KRW, with tensions on the Korean peninsula remaining high. Korean 5 year CDS yields jumped following the launch of an intercontinental ballistic missile by North Korea on July 28 and spiked again after the launch of a presumed intermediate-range ballistic missile over northern Japan on August 25. We expect tensions to persist in the run up to key anniversaries in North Korea (when Pyongyang typically launches missiles), acting as a downward force on the won (see ' Guam Missile Launch Threat Is Credible ' , August 11).

Geopolitical Tensions Weighing On KRW
South Korea - 5-Year CDS (%) & KRW REER
Source: BMI, Bloomberg

Long-Term Outlook (six-to-24 months)

We forecast the currency to remain on a slight appreciatory trend, averaging KRW1,160/USD in 2017 and KRW1,100/USD in 2018 as we expect positive growth-inflation dynamics relative to the US, an undervalued exchange rate, and strong external position to be supportive of the currency. However, the Bank of Korea (BoK) is likely to seek to keep South Korea's exports competitive, acting as a slight drag on the currency.

Positive Growth-Inflation Dynamics To Lend Support

South Korea's positive growth-inflation outlook compared to the US is likely to be positive for the KRW over the coming quarters. We forecast real GDP in Korea to average 2.9% from 2017-2019 amid strong demand from the electronics sector, which will be supportive of the country's semiconductor and manufacturing sector. In addition, continued demand for electronics will be positive for fixed asset investment as the various South Korean chip makers seek to both expand production for existing lines as well as move up the value chain by investing in foundries capable of producing the next generation of chips. This is in contrast to our forecast for real GDP in the US to average 2.0% over the same period.

Strong External Position To Lend Support
South Korea - Foreign Reserves, USDbn
Source: BMI, Bloomberg

In addition, inflation in South Korea is likely to remain below that of the US, suggesting that the real interest rate differential between the countries will remain in favour of the former. We forecast inflation in Korea to average 1.9% from 2017-2019, compared with our forecast for inflation in the US to average 2.1% over the same period.

Despite recent strength, South Korea's REER remains cheap from a historical perspective compared to that of the US and we expect this to be slightly supportive of the won. In addition, the currency remains attractively valued when comparing against the current level of GDP per capita in purchasing power parity (PPP) terms. We expect this to be supportive of Korea's external competitiveness over the medium term. Furthermore, Korea has continued to accumulate reserves of approximately USD383bn (or 27% of GDP). We expect these large reserves to place appreciatory pressures on the KRW over the long term as interest payments feed through into a strong income surplus.

But Cautious BoK To Limit Strength

That said, we expect the central bank to actively intervene to control the rate of appreciation as it has displayed a historical reluctance to allow the currency to appreciate excessively. Indeed, the KRW's strength in H117 was likely due to a combination of factors, with the most important one being a desire to avoid being labelled as a currency manipulator by the incoming Donald Trump administration. South Korea remains an export-dependent economy and excessive KRW strength would undermine the competitiveness of Korean exports. As such, the central bank is unlikely to allow the currency to strengthen significantly as it would have a negative impact on exports.

Risks To Outlook

Risks to our South Korean forecast are weighted to the downside. The rise in global protectionist measures could lead to a slowdown in global trade, will be negative for the externally focussed South Korean economy. Also, while the outlook for the Chinese yuan has improved significantly, there remains a risk of this reversing given the huge problems facing the financial sector.

Macroeconomic Forecasts (South Korea 2013-2019)
Indicator 2013 2014 2015 2016e 2017f 2018f 2019f
e/f = BMI estimate/forecast. Source: National sources, BMI
Population, mn 50.17 50.39 50.59 50.79 50.98 51.16 51.34
Nominal GDP, USDbn 1,305.9 1,410.3 1,377.7 1,410.6 1,479.0 1,636.3 1,732.6
GDP per capita, USD 26,029 27,990 27,229 27,772 29,009 31,980 33,747
Real GDP growth, % y-o-y 2.9 3.3 2.6 2.8 2.8 2.9 3.2
Industrial production, % y-o-y, ave -19.4 1.4 1.6 2.8 14.4 3.3 3.8
Consumer price inflation, % y-o-y, ave 1.3 1.3 0.7 1.0 1.5 1.9 2.0
Consumer price inflation, % y-o-y, eop 1.1 0.8 1.1 1.3 1.7 2.0 2.0
Central bank policy rate, % eop 2.50 2.00 1.50 1.25 1.25 1.25 1.75
Exchange rate KRW/USD, ave 1,094.62 1,053.02 1,131.34 1,160.77 1,160.00 1,100.00 1,095.00
Exchange rate KRW/USD, eop 1,049.80 1,090.98 1,175.06 1,205.83 1,120.00 1,100.00 1,090.00
Budget balance, KRWbn 14,200.0 8,500.0 -166.0 16,911.0 -324.4 -1,553.6 244.4
Budget balance, % of GDP 1.0 0.6 0.0 1.0 0.0 -0.1 0.0
Goods and services exports, USDbn 683.9 724.8 648.1 604.6 652.5 690.9 732.9
Goods and services imports, USDbn 617.2 641.3 542.6 539.7 553.9 586.8 622.7
Current account balance, USDbn 70.7 89.5 108.7 97.4 94.7 100.2 106.2
Current account balance, % of GDP 5.4 6.3 7.9 6.9 6.4 6.1 6.1
Foreign reserves ex gold, USDbn 341.7 358.8 368.0 366.3 465.8 566.0 672.2
Import cover, months 6.6 6.7 8.1 8.1 10.1 11.6 13.0
Total external debt stock, USDbn 408.3 408.6 383.2 402.4 406.3 412.7 420.6
Total external debt stock, % of GDP 31.3 29.0 27.8 28.5 27.5 25.2 24.3
Crude, NGPL & other liquids prod, 000b/d 20.0 20.0 21.6 13.0 7.8 3.9 1.9
Total net oil exports (crude & products), 000b/d -2,249.4 -2,407.9 -2,524.5 -2,668.9 -2,729.0 -2,788.8 -2,819.2
Dry natural gas production, bcm 0.5 0.3 0.2 0.1 0.1 0.0 0.0
Dry natural gas consumption, bcm 54.7 51.1 45.7 45.6 45.6 46.1 46.5