Economic Analysis - Upgrading Growth As External Outlook Improves - DEC 2017


BMI View: South Korea ' s economy grew by 2.7% y-o-y in Q217, bringing H117 growth to 2.8% y-o-y, and we are upgrading our 2017 real GDP forecast to 2.8% from 2.6% previously (the same rate as 2016). Strong demand from the electronics sector is likely to be the main driver of both export growth as well as provide continued support for fixed asset investment in the semiconductor sector. Domestically, while the government ' s supplementary budget will provide a limited measure of support, it will be insufficient to overcome the drag from persistently high youth unemployment, which will undermine efforts to boost domestic consumption.

South Korea's real GDP expanded by 2.7% y-o-y in Q217 and this brought growth to 2.8% y-o-y in H117. On a q-o-q basis, the economy grew by 0.6% in Q217, marking a slowdown from the 1.1% q-o-q rate recorded in the previous quarter due largely to a decline in exports. In light of the economy's better than expected H117 performance, we are upgrading our 2017 real GDP forecast slightly to 2.8% from 2.6% previously. Strong demand from the electronics sector is likely to be one of the main drivers of growth over the coming quarters amid continued global demand for semiconductors. We expect this to be positive for fixed asset investment, with South Korean electronics firms continuing to expand production capacity amid high semiconductor prices. Domestically, we believe that the government's supplementary budget will provide a limited degree of support, but note that this will be insufficient to boost domestic consumption. Instead, we believe that the government's budgetary measures to reduce persistently high youth unemployment are unlikely to be effective as they fail to address the root causes of persistently high youth unemployment. Overall, these factors will keep real GDP growth steady versus the 2.8% expansion registered in 2016.

Export Dip Unlikely To Last
South Korea - GDP By Expenditure, % chg q-o-q
Source: BMI, BoK

Bright Electronics Outlook To Be Supportive Of Exports

Figures from the production approach indicate that the manufacturing sector remains one of the main drivers of growth and we expect this to persist amid continued strong demand for electronics and semiconductors. The manufacturing sector was the second fastest growing component, expanding by 3.3% y-o-y in Q217. While this was a slight slowdown from the 4.5% y-o-y rate recorded in the previous quarter, we believe that manufacturing output is likely to pick up over the coming months (with electronics accounting for approximately 27% of total exports in 2016). Indicators from Taiwan, a bellwether of international semiconductor demand, suggest that demand for electronics and semiconductors is likely to remain strong over the coming months, with Taiwan's export orders and industrial production remaining in expansion.

Although South Korea's industrial production grew at a slower rate of 2.4% y-o-y in May (compared to 3.5% in April), we believe that this figure is likely to pick up over the coming months due to an upswing in the tech cycle in Q317 as key smartphone manufacturers start to release major products. Furthermore, indicators from major semiconductor producing countries such as Singapore and Taiwan suggest that there was a lull in production in May, but picked up in June. Given the key role that South Korea plays in the semiconductor industry, we believe that this pick up will be reflected in the country's high frequency data over the coming months, supporting headline economic growth.

Semiconductor Demand Positive For Domestic Investment

Strong global demand for semiconductors has also resulted in continued investments by various South Korean chip makers as they 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. We expect this to be supportive of fixed capital investment as South Korean firms seek to maintain their technological edge over their close competitor, Taiwan. A report by Semiconductor Equipment and Materials International estimates that South Korean firms will invest a total of USD12.9bn in fabrication equipment, marking a 68.7% y-o-y increase from 2016. Indeed, our Infrastructure team forecasts non-residential construction to expand by 8.4% in 2017 and 8.2% in 2018 (compared to the five-year historical average of 5.2%).

Demand For Electronics Remains On An Uptrend
South Korea - Electronic Exports, % chg y-o-y
BMI, Bloomberg

Leading Korean chip maker Samsung Electronics has announced that it will invest at least USD18.6bn in South Korea over the coming years to extend its lead in memory chips and next-generation smartphone displays. The firm will also expand its existing lines, having announced that it will invest an additional KRW14.4trn in its Pyeongtaek plant to add more semiconductor manufacturing lines. With demand for chips likely to remain strong due to demand for data centre servers, dual cameras, artificial intelligence applications, and new voice-activated devices, we believe that South Korean firms are likely to continue investing as they seek to maintain their edge against rivals such as Taiwan Semiconductor Manufacturing Corporation (TSMC) and Toshiba Corp.

Weak Domestic Demand To Cap Growth

Domestically, we believe that the government's efforts to boost domestic consumption by tackling persistently high youth unemployment (10.5% in June) are likely to fall short despite the passing of a KRW11.3trn supplementary budget aimed at job creation on July 22. Given that the budget includes funds to support drought-hit regions, the disabled, the ailing shipbuilding industry, preparations for the 2018 Pyeongchang Winter Olympics, and the installation of air purifiers at elementary schools, we expect this to provide some degree of support to growth. However, it will not be able to achieve its main aim of helping the economy shift towards one that is driven by domestic demand through boosting youth employment.

No Significant Pick Up In Sight
South Korea - Retail Sales, % chg y-o-y
BMI, Bloomberg

With the supplementary budget seeking to create approximately 2,000 jobs by the end of 2017 by expanding the public sector, we expect high levels of youth unemployment to continue to act as a drag on the economy, weighing on domestic demand and retail sales as the bill fails to address the root of South Korea's problems. We believe that high youth unemployment is a structural issue and likely stems from a skills mismatch between job seekers and employers as well as due to South Korea's seniority wage system and overly rigid labour market. This has resulted in considerable difficulties in firing workers, leading to a preference for corporations to depend on contract staff. Given that these issues are structural, the creation of jobs in the public sector is unlikely to be able to alleviate unemployment significantly and boost spending.