[Ask IB]④Nomura "Korea, Low Growth Entrenched... Not Necessarily Pessimistic"

Interview with Park Jung-woo, Nomura Chief Economist

Jungwoo Park, Senior Economist at Nomura

"Until now, even though South Korea's growth rate has been declining, it has followed a trend similar to the global economic growth rate. However, going forward, it will not be able to keep up as much. Nevertheless, from the perspective of the global competitiveness of key industries, low growth should not necessarily be viewed pessimistically."

Jungwoo Park, Senior Economist at Nomura, a Japanese investment bank (IB), said in a phone interview with Asia Economy on the 16th that he forecasts South Korea's economic growth rate at 0.9% this year and 1.5% next year. Park, part of Nomura's global economic team, is currently based in Singapore and primarily responsible for the South Korean economy.

Nomura attracted attention at the end of last year by being the only institution to forecast a pessimistic economic growth rate of -0.6% for South Korea this year. Although it has revised its forecast upward to 0.9% after several adjustments, it still projects a growth rate in the '0% range,' which is lower than the Bank of Korea (1.4%), International Monetary Fund (IMF, 1.4%), Organisation for Economic Co-operation and Development (OECD, 1.5%), and the average of other global IBs.

Park explained, "The reason our growth forecast is lower than the Bank of Korea's is that we believe households have limited consumption capacity. Since summer, households' ability to withstand high interest rates has been largely depleted, and spending on overseas travel has increased." He added, "South Korea's potential growth rate is around 2%, and it is inevitable that it will decline going forward."

While he views South Korea's consumption and domestic demand negatively, he evaluates key industries and exports positively. Park emphasized, "More important than low growth itself is whether key industries have global competitiveness. Although South Korea's growth rate is falling, from an industrial portfolio perspective, it has a very good structure, second only to the United States."

Regarding South Korea's high household debt ratio, he noted that while it could constrain household consumption due to high interest rates, there is no need to be overly pessimistic. Park said, "Although household debt is high, delinquency rates are relatively low. Since loans are not recklessly spent but invested in assets like housing, the risk to the financial system is small."

Below is a Q&A with Senior Economist Jungwoo Park.

(Photo by Bloomberg)

- The Bank of Korea forecasts South Korea's growth at 1.4% this year (2.2% next year), but Nomura sees it lower.

▲ Nomura forecasts South Korea's economic growth at 0.9% this year and 1.5% next year. The reason for the lower forecast compared to the Bank of Korea is the view that households have limited consumption capacity. Other than the difference in consumption outlook, there is no major difference. Until the first half of this year, households seemed to have the capacity to withstand high interest rates, but this capacity was largely depleted from summer onward. As a result, consumption in July and August was quite weak. It revived in September, but the Chuseok holiday must be taken into account. Also, if we limit domestic consumption, spending on overseas travel has increased. In Japan, Koreans are the largest group of inbound visitors.

- Nomura forecasted South Korea's growth at -0.6% at the end of last year but raised it to 0.9%. Why?

▲ Because domestic demand was weak, the trade balance increased more than we expected. This is a so-called 'recession-type surplus' caused by imports decreasing much more than exports. Imports of capital goods and consumer goods have sharply declined in recent months. Consequently, the contribution of net exports to growth naturally increased significantly. However, this year remains difficult and unfavorable. Consumption contracted more than expected in Q2, and Q3 and Q4 are unlikely to be generous. Overall, consumption and domestic demand are concerning, but key industries and manufacturing exports are viewed positively.

- Will South Korea's low growth continue beyond next year?

▲ Simply put, potential growth can be calculated by adding the labor force growth rate to productivity growth. South Korea's total population has started to decline, and the growth rate of the economically active population is only about 0.5%. To achieve 2% growth, productivity must increase by more than 1.5%. However, that is difficult. South Korea's potential growth rate is around 2%, and its decline is inevitable. Until now, even though South Korea's growth rate has been falling, it was similar to or slightly higher than global growth rates, but going forward, it will not be able to keep up.

However, compared to advanced economies, this is not so bad. As the economic scale grows, a decline in growth rate is natural. More important is whether key industries have global competitiveness. South Korea has had key industries leading growth during past critical periods. In the distant past, these included shoes and wigs, then construction, shipbuilding, heavy industry, and recently semiconductors, pharmaceuticals, secondary batteries, and now the content industry. Although growth rates are falling, from an industrial portfolio perspective, South Korea has a very good industrial structure, second only to the United States. There is no need to view low growth pessimistically.

- What impact does South Korea's high household debt ratio have on the economy?

▲ Research shows that when the household debt service ratio (DSR) exceeds 36%, households start reducing consumption. That is why the government sets 40% as a guideline. In South Korea, according to the Bank of Korea's calculations, the DSR for indebted households is about 40%, and there are over 4 million multiple debtors. Because the DSR is high, it increases households' interest burden and constrains consumption.

However, we should not overemphasize household debt ourselves. Despite high household debt, bank delinquency rates are only 0.4%, and multiple debtors' delinquency rates are in the 1% range (1.4% in Q2). South Koreans are very diligent. Problems arise if money is borrowed and recklessly spent, but in South Korea, housing is viewed as a kind of investment. Household savings go into housing assets rather than deposits or stocks. Externally, high household debt is often linked to financial system risks or fiscal crises, but from a financial system perspective, the risk is small.

- Recently, expectations for US interest rate cuts have diminished, leading to forecasts of prolonged high interest rates. Do you think high interest rates could become the new normal?

▲ It depends on the country. In the US, deleveraging of the household sector has been successful since 2008, and most mortgage rates are fixed, so the effects of rate hikes are not strongly felt. Therefore, the US can sustain high interest rates for a long time. In contrast, South Korea has many multiple debtors and a large proportion of variable-rate loans for households and businesses, making it harder to maintain high interest rates compared to the US. High interest rates may become the new normal in the US, but neighboring countries like South Korea will likely show differentiated patterns.

- When does Nomura expect the US Federal Reserve (Fed) and the Bank of Korea to cut interest rates?

▲ Nomura expects the Fed to cut rates in March next year, forecasting a rate of 3.5% by the end of next year (currently the upper bound is 5.5%). However, last week, US super-core inflation (core inflation excluding housing) remained strong, so there is a risk that the timing or magnitude of rate cuts could change. The Bank of Korea is expected to cut rates around April next year, assuming US rate hikes end this year. Since the Fed also expects rates next year to be lower than this year, there is generally little burden regarding the rate cut trend next year, but timing is the issue. With exports recovering and consumption remaining weak, South Korea's policy focus next year will likely be on how to revive the sluggish domestic economy.

- Recently, major countries including the US and South Korea have been struggling with high inflation. Is the 'low inflation era' caused by globalization and cheap Chinese exports in the 2000s ending, leading to a 'high inflation era'?

▲ There were three main reasons for the past low inflation era: first, technological advancement; second, China's low-wage labor as the world's factory; third, central banks' 2% inflation target. These were the three pillars of the low inflation era. Among these, China's low-wage labor has weakened significantly. However, I believe technological advancement and central banks' strong monetary policies to achieve inflation targets are much more important for inflation. Therefore, I do not strongly agree that the low inflation era is ending and a high inflation era is beginning due to rising Chinese labor costs.

- Many analyses suggest South Korea will enter a low growth phase due to aging and other factors. Does this mean inflation will likely fall below 2% in the medium to long term?

▲ It is true that South Korea should worry more about low inflation than high inflation. As a country that imports a lot of oil, inflation tends to move with international oil prices when they rise sharply, but considering aging and limited household consumption capacity, wages and other labor market factors are unlikely to rise significantly.

- The US is strengthening semiconductor and advanced technology regulations against China. What is your outlook on the Chinese economy?

▲ There are three scenarios. Recently, Huawei in China surprised many by unveiling the 'Mate60 Pro' equipped with a mobile processor made with a 7-nanometer (nm; 1 nm = one billionth of a meter) process. It is presumed to be made with deep ultraviolet (DUV) lithography, not extreme ultraviolet (EUV) subject to US export controls. One scenario is that China succeeds in technological advancement in an unexpected way like this. Another is that China imports equipment through backdoor markets such as Hong Kong or Malaysia. A third scenario is a reconciliation phase between the US and China triggered by some event. Currently, markets and experts consider all three scenarios unlikely.

Even if China can produce 7-nm semiconductors, mass production is another matter. Marketability and economic feasibility must be considered. Chinese semiconductor companies receive substantial government subsidies and produce at a loss. There is a 4-5 year (up to 10 years in some fields) technology gap between China and the US, South Korea, etc., in semiconductors, and this gap is expected to be maintained or widen in the long term. The Chinese economy is expected to maintain a 3-4% growth rate long term. Since major cities in China have reached per capita incomes of $20,000 to $30,000, a slowdown in growth is natural.

Chinese President Xi Jinping is greeting at the opening ceremony of the 19th Asian Games held in Hangzhou, Zhejiang Province on the 23rd of last month. [Image source=Yonhap News]

- China's self-sufficiency in intermediate goods is increasing. What impact will this have on the South Korean economy, which has exported many intermediate goods to China?

▲ As China's level rises and its domestic industries develop, it will naturally produce goods it previously imported from South Korea. Twenty years ago, South Korea used Japanese Elephant rice cookers, but now it uses Cuckoo. Products South Korea used to export to China may no longer be sellable. We need to identify products or services where we have comparative advantages that China will need in the future. Fortunately, the US recently extended unlimited approval for US semiconductor equipment imports to Samsung Electronics and SK Hynix's Chinese factories, which should help smooth trade relations with China.

- Japan's economy is regaining vitality. How does Nomura view this?

▲ Japan has suffered from deflation for the past 30 years, but now the culture is shifting toward rising prices. Quantitative easing and zero interest rate policies have been effective, but wages have naturally risen due to a shrinking labor force caused by population decline. Although this increases corporate costs, recent significant foreign investment is coming in. Semiconductor companies like TSMC and Infineon, wanting to leave China, are considering Japan as an alternative. Investment brings vitality to the region. These factors combined seem to be creating a virtuous cycle in Japan.

Senior Economist Jungwoo Park of Nomura is

the senior economist at Nomura, Japan's largest investment bank, currently based in Singapore on the global economic team responsible for the economies of South Korea and Taiwan. He has over 20 years of experience in South Korean economy and economic policy. Before Nomura, he worked at Korea Investment & Securities and Samsung Securities. He holds a master's degree in economics from the London School of Economics and a bachelor's degree in communication from Seoul National University.

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