South Korea has faced continuing economic headwinds during the first half of 2023, due to the impact of weak exports and the cumulative transmission effects of monetary policy tightening by the Bank of Korea during 2022.

Weak economic growth in the US and the European Union (EU) remain a key downside risk for South Korea's manufacturing export sector in the second half of 2023 and into 2024. Despite improving economic growth in mainland China during the first half of 2023, South Korean exports to this key market have remained weak due to declining exports of semiconductors and mobile phones. However South Korea's tourism sector is expected to show improving momentum during the second half of 2023 and in 2024, with the recent lifting of COVID-19 related restrictions for tourism arrivals.

GDP resumes positive growth in first quarter of 2023

South Korea's real GDP grew at a pace of 0.3% quarter-on-quarter (q/q) in the first quarter of 2023, showing a return to moderate positive growth after contracting by 0.4% q/q in the fourth quarter of 2022. On a year-over-year (y/y) basis, real GDP growth slowed to an increase of 0.8% year over year in the first quarter of 2023, compared with 1.4% y/y in the fourth quarter of 2022.

The resumption of positive growth was helped by a rebound in private consumption, which grew by 0.5% q/q, after having declined by 0.6% q/q in the fourth quarter of 2022. Private consumption was up 4.5% y/y in the first quarter of 2023, while government consumption rose by 3.9% y/y.

Monthly industrial production statistics for April showed continued weakness in South Korean manufacturing output, which fell by 9.0% y/y, similar to the 10.0% y/y decline recorded in the first quarter of 2023.

The seasonally adjusted South Korea Manufacturing Purchasing Managers' Index (PMI) ticked up from 48.1 in April to 48.4 in May but remained below the 50.0 neutral mark. This indicated the eleventh consecutive monthly contraction in the South Korean manufacturing sector, albeit still showing a moderate pace of decline overall.

The strongest downward contribution to the headline PMI came from a further sharp reduction in new orders, which was reflective of weak demand conditions in both domestic and external markets.

South Korea's merchandise exports have remained weak in the first half of 2023, declining by 15.2% y/y in May 2023, mainly as a result of continued contraction in exports of semiconductors and displays.

However, the value of automobile exports hit a new historic high of USD 6.2 billion in May, helped by strong growth in exports of eco-friendly cars. Exports of electric vehicles and fuel cell electric vehicles rose by 98.5% to USD 1.2 billion in May. Exports of hybrid electric vehicles grew by 44.5% to USD 0.7 billion.

As the US and EU are among South Korea's largest export markets, weak economic growth in the US and EU since mid-2022 have been a negative factor for South Korea's manufacturing export sector, notably as the Eurozone has entered a technical recession in the first quarter of 2023. In May, South Korean exports to the US were down 1.5% y/y, while exports to the EU were down by 3.0% y/y.

During the second half of 2022, moderating economic growth in mainland China due to the impact of pandemic-related restrictive measures on domestic demand had been an important factor contributing to weaker external demand for South Korean exports, since mainland China is South Korea's largest export market. In calendar year 2022, South Korean exports to mainland China fell by 4.4% y/y, having deteriorated considerably in late 2022 and early 2023.

South Korean exports to mainland China have remained weak in the first half of 2023, with May trade data showing a 20.8% y/y decline in exports to mainland China due to falling demand for semiconductors and mobile phones.

Due to the importance of Vietnam as a hub for South Korean manufacturing, total South Korean exports to Vietnam reached USD 61 billion in 2022. However, with the downturn in Vietnam's manufacturing exports during the first half of 2023, South Korean exports to Vietnam have also been declining. Reflecting the downturn in exports to Vietnam, total South Korean exports to ASEAN fell by 21.2% y/y in May.

However, an important factor that will help to mitigate the impact of weak goods exports will be the upturn in international tourism during 2023-24. International tourist arrivals reached 884,000 in April 2023 and visitor arrivals are expected to be further boosted due to the recent removal of COVID-19 related restrictions for foreign tourist arrivals. Prior to the COVID-19 pandemic, tourism accounted for around 4.7% of South Korea's GDP, with mainland China and Japan being key tourism source markets. Total international tourist visitor arrivals reached a record high of 17.5 million in 2019, averaging around 1.46 million arrivals per month.

South Korean CPI inflation had risen significantly during 2022, largely reflecting the impact of the Russia-Ukraine war on global commodity prices, particularly for oil and gas. The annual average CPI inflation rate of 5.1% for 2022 compared with an average CPI inflation rate of 2.5% in 2021. The 2022 average CPI inflation rate was the highest annual average since 2011.

Due to the upturn in inflation pressures during 2022, the Bank of Korea (BOK), South Korea's central bank, tightened monetary policy seven times in 2022, lifting the Base Rate to 3.25%. At its January meeting, the Monetary Policy Board of the BOK decided to raise the Base Rate by a further 25 basis points (bps), raising the Base Rate to 3.50%. This has brought total cumulative tightening to 300 bps since August 2021. This has impacted domestic demand, with household lending having continued to decrease owing to rising interest rates and falling prices in the residential property market.

In the first half of 2023, there have been signs of easing inflation pressures. South Korea's headline CPI inflation rate moderated to 3.3% y/y in May 2023, compared with 3.7% y/y in April and a recent peak of 6.3% y/y in July 2022. The Monetary Policy Board of the BOK decided at its April and May meetings to leave the Base Rate unchanged at 3.50%. In its May Monetary Policy Decision, the Monetary Policy Board assessed that consumer price inflation for 2023 is expected to be consistent with their February forecast of 3.5%. Core inflation for 2023 is projected to be 3.3%.

Reflecting weak demand conditions and lower global backlogs of manufacturing new orders, the May South Korea Manufacturing PMI survey signalled a further improvement in supply chains that was the strongest in just over seven years. Price pressures also eased in May, as panel members surveyed signalled the slowest rise in average cost burdens since September 2020. As a result, output charges were lowered for the first time in 32 months as firms looked to stimulate sales.

The recent rebound of the Korean won against the USD has also helped to somewhat mitigate the upside risks to inflation. The KRW had depreciated from 1,189 against the USD on 1st January 2022 to 1,428 by 12th October 2022, but has since appreciated to 1,310 by 28th June 2023.

Electronics sector downturn hits South Korean exports

The electronics manufacturing industry is an important part of the manufacturing export sector for South Korea which is one of the world's leading exporters of electronics products to key markets such as the US, China and EU. As Vietnam is an important production hub for South Korean electronics multinationals such as Samsung and LG for a wide range of electronics products such as mobile phones, Vietnam is also a key export market for South Korean electronics components.

Exports of South Korea's information and communications technology (ICT) goods for calendar year 2022 amounted to USD 233 billion, up 2.5% y/y and accounting for 34.1% of South Korea's total merchandise exports. However, deteriorating global economic conditions through the course of 2022 resulted in weaker ICT exports in late 2022, with ICT exports in December 2022 down 23.6% y/y.

South Korea's ICT exports have remained weak in the first half of 2023. South Korea's Ministry of Trade, Industry and Energy trade data showed that South Korea's exports of ICT goods in May 2023 were USD 14.5 billion, down 28.5 per cent y/y. Semiconductors exports fell by 35.7 % y/y to USD 7.5 billion, with exports of system chips down 4.9% y/y to USD 3.6 billion and memory chip exports down 53.1% y/y to USD 3.4 billion.

The downturn in South Korea's ICT exports reflects the slowdown in the global electronics industry since mid-2022. The headline seasonally adjusted PMI posted 47.9 in May, down from 48.2 in April, to signal a third consecutive deterioration in operating conditions across the global electronics manufacturing sector. According to survey respondents, lower production was signalled across the wider Asia-Pacific region, Europe and the US. However manufacturers signalled rising output in mainland China to fulfil existing orders.

According to panellists, weak global economic conditions and subdued confidence led to the paring back of new orders. Lower new orders and the easing of supply constraints allowed firms to work through unfinished business, according to panellists.

Near-term economic outlook

South Korean GDP growth is forecast to moderate from 2.6% in 2022 to 1.4% in 2023, according to the latest forecast by S&P Global Market Intelligence. In May, the BOK also revised down its GDP forecast for 2023 to 1.4%.

South Korea's export sector, which accounts for an estimated 38% of GDP, has faced continuing headwinds during the first half of 2023 due weak economic growth momentum in the US and EU and the slowdown in the global electronics cycle. The near-term outlook for South Korean goods exports remains constrained by weak demand conditions in the US and EU, as well as the relatively moderate pace of economic recovery in mainland China.

Due to the upturn in inflation pressures since late 2021, the Bank of Korea has tightened monetary policy by 300 bps since August 2021, which has lifted the Base Rate to 3.50%. Higher policy rates have also resulted in a cooling property market, with South Korean apartment prices estimated to have declined by 4.7% y/y in 2022 according to the Real Estate Board. For the eleven months to April 2023, South Korean housing prices declined by 8.5% y/y.

Medium-term outlook and key risks

Over the medium-term outlook, South Korean exports are expected to resume growing at a rapid pace, helped by the sustained strong growth of intra-regional trade within APAC, as China, India and ASEAN continue to be among the world's fastest-growing emerging markets. South Korea's strong competitive advantage in exporting key electronics products, notably semiconductors and displays, as well as autos and auto parts, are expected to be an important positive factor underpinning export growth.

The rapid growth of South Korean exports is also expected to be strengthened by the APAC regional trade liberalization architecture. This includes the large recent RCEP multilateral trade agreement and major bilateral FTAs. The RCEP trade deal, which South Korea has ratified, entered into effect from 1st January 2022 for the first ten ratifying members, and from 1st February 2022 for South Korea.

An important macroeconomic risk to the South Korean economy over the medium to long-term outlook continues to be from the high level of household debt as a share of GDP. This has risen to 104.5% by mid-2022, according to BOK data. A key factor driving this debt ratio higher has been large mortgage lending flows for residential property purchases. Such a high household debt ratio creates macroeconomic vulnerability to significant monetary policy tightening, with Bank of Korea rate hikes during 2021-23 having increased financial pressures on highly leveraged households.

Managing the energy transition towards renewable energy is also a key policy priority for South Korea. South Korea has already been at the forefront globally in planning initiatives to develop hydrogen as a key future fuel source for domestic power generation.

Among South Korea's greatest economic challenges will be long-term demographic ageing, which will have severe implications for South Korea's economy and society. The number of seniors aged 65 or over has already reached 16.5% of the population and by 2025 is projected to rise to 20% of the population. Meanwhile the working age population (aged 15 to 64) is declining as a share of the total population, from 71.4% in 2021 to a projected 55.7% by 2041.

Demographic ageing has already contributed to the moderation of South Korea's potential GDP growth rate from around 7% per year in the mid-1990s to around 2.5% per year by 2021. South Korea's potential growth rate could drop to a range of around 1% to 1.5% per year by 2050 due to demographic ageing.

Consequently, structural reforms to increase the potential growth rate will be a key policy priority over the medium term. These reforms would include policy changes to lift the labour force participation rate, improve services sector productivity, accelerate digitalization and further boost the adoption of industrial automation.

Rajiv Biswas, Asia Pacific Chief Economist, S&P Global Market Intelligence

Rajiv.biswas@spglobal.com

Purchasing Managers' Index™ (PMI^®) data are compiled by S&P Global for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.