Bank of Korea: "Domestic demand will improve moderately, but strong recovery is difficult" [Q&A]

Q2 Real Gross Domestic Product (GDP) Press Briefing
Domestic Demand Expected to Improve Gradually but Strong Recovery Difficult
Net Export Contribution to Remain Positive in Second Half

The Bank of Korea diagnosed that domestic demand will gradually improve in the second half of this year as high inflation and high interest rates ease. However, it drew a line, stating that a transition to a strong recovery would be difficult.

On the 25th, Shin Seung-cheol, Director of the Economic Statistics Bureau at the Bank of Korea, said at a press briefing on the "Q2 Real Gross Domestic Product (Preliminary)" that "the factors of high inflation and high interest rates that constrained domestic demand in the first half of this year are expected to gradually ease," and "in the second half, domestic demand is expected to show a moderate improvement centered on private consumption and facility investment." He added, "However, it will be difficult for domestic demand to completely overcome sluggishness and shift to a strong recovery."

Regarding the negative contribution of net exports, which was a major factor in the surprise growth in Q1, he explained, "Since Korea has an export-led economy, it is normal for imports to increase when exports increase. Recently, imports did not increase as much as exports," and "the normalization of energy demand in Q2 increased the import growth rate."

He expected the contribution of net exports to remain positive in the second half. He evaluated, "Overall export growth will continue due to the favorable IT and automobile markets, although the growth rate will slow," and "imports are also expected to increase in the second half, but since they will not surpass export growth, the contribution of net exports will generally remain positive in the second half."

Director Shin urged not to interpret the negative economic growth rate in Q2 as a sign of recession. He explained, "It is not appropriate to overinterpret the negative growth rate due to the base effect of Q1 GDP as a sign that exports are deteriorating or the economy is collapsing," and "when quarter-on-quarter growth shows large fluctuations, it is necessary to look at the year-on-year growth rate and the growth rate for the first half together."

Below is a Q&A with Director Shin.

- The growth rate for the first half of this year was 2.8%, slightly below the May forecast of 2.9%. Is achieving an annual economic growth rate of 2.5% possible?

▲ There is not much difference from the Research Department's forecast. If growth reaches 2.2% in the second half as forecasted, the annual growth rate will arithmetically come out to 2.5%, so under the current circumstances, the growth rate is judged to be in line with the annual growth rate forecast.

- Private consumption and facility investment are lower than the May forecast. Is domestic demand recovery possible?

▲ Domestic demand saw a temporary improvement in Q1, eliminating sluggishness in private and construction investment sectors, leading to an adjustment in domestic demand. Domestic demand has shown a poor trend since last year, with a brief rebound in Q1. This trend adjusted again in Q2, continuing sluggishness. Comparing the second half of last year and the first half of this year, sluggishness continues but shows slight improvement. Looking ahead to Q3 and the second half, factors constraining domestic demand such as high inflation and high interest rates are expected to ease. Particularly, construction investment is expected to remain sluggish, but facility investment is anticipated to improve due to the recovery of the global manufacturing sector, favorable IT market conditions, export growth, and improved corporate business performance. In the second half, domestic demand centered on private consumption and facility investment is expected to show a moderate improvement, though it will be difficult to completely overcome sluggishness and achieve strong recovery.

- The contribution of net exports recorded a negative value. What caused net exports to be negative? What is the outlook for net export contribution in the second half?

▲ A negative contribution of net exports does not mean that external trade or export conditions have worsened or that the export market has declined. After four consecutive quarters of positive net export contribution, a slight negative was recorded this time because while exports were increasing, the import growth rate exceeded the export growth rate, resulting in a negative contribution.

▲ Exports have continued to increase, so the export growth rate may decline slightly, but this does not mean the export market has weakened. During the early recovery phase of exports, growth rates are high but gradually slow down. Since Korea has an export-led economy, it is normal for imports to increase as exports increase. Recently, imports did not increase as much as exports. Until Q1, imports of energy products such as crude oil and natural gas were lower than last year. Related petrochemical industry conditions were poor, and heating demand was low last winter. The normalization of energy demand in Q2 increased the import growth rate.

- Why was the 'change in inventories and net acquisition of valuables' the only positive contributor to growth?

▲ Last year, the semiconductor market deteriorated from the second half of 2022, and major manufacturers reduced production early last year, leading to inventory reduction. The increase in inventories in Q2 this year is partly due to increased energy imports being held as inventory. Imported energy is not immediately used in production but accumulated as reserves for production. These inventories are expected to be used later in power generation and petrochemical sectors.

- There was an evaluation that growth in Q1 was led by the private sector. Is this still valid?

▲ In Q1, private consumption and construction investment showed high growth due to temporary factors, resulting in a significant contribution from the private sector. The Q1 growth contribution emphasized both domestic demand and export sectors.

▲ The private sector contribution in Q2 (-0.3 percentage points) turned negative due to a lower net export contribution compared to the previous quarter. Adjustments in private consumption and construction investment were reflected. Since the second half of last year, the economic growth trend and outlook have been described as "domestic demand is sluggish, but growth continues centered on exports." The outlook that domestic demand constraints will ease and domestic demand will improve while exports maintain growth in the second half still holds. The government sector has been steadily contributing. The private sector should be viewed separately as private exports and private domestic demand.

- Facility investment in the first half fell significantly compared to the May forecast, while construction investment rose sharply. What caused this difference?

▲ Compared to the May forecast, facility investment in the first half was worse than expected, while construction investment was higher. At the time of the May forecast, semiconductor manufacturers planned significant domestic investment this year, and many aircraft deliveries were scheduled. In the first half, semiconductor manufacturing equipment investment was delayed by manufacturers, affecting the figures. Aircraft deliveries were also delayed due to defects in the aircraft, resulting in facility investment being lower than the Research Department's forecast.

▲ Construction investment had been sluggish due to poor construction market conditions and real estate project financing (PF) issues, which dampened construction investment sentiment. The recent improvement is not due to a recovery in the construction market but reflects an increase in recent housing transactions. Besides construction output, housing sales and transactions were reflected, and the recent increase in residential building transactions was not accounted for in the May forecast, causing some discrepancy. The outlook that construction market will continue to be sluggish and negative in the second half remains valid.

- You mentioned semiconductor facilities and aircraft as reasons for weaker-than-expected facility investment. Will these be postponed and executed in the second half?

▲ The reasons for weaker facility investment than the Research Department's forecast were the postponement of semiconductor investment and delayed aircraft deliveries. These are expected to improve in the second half. Major semiconductor companies announced plans for significant investment in July, and customs data up to the 20th shows increased imports. These effects will appear in Q3.

▲ Aircraft deliveries were expected to be many this year, but the timing of arrivals in the second half remains uncertain. If delivered, they will contribute to facility investment.

▲ The positive outlook for facility investment is due to improving global large corporation market conditions and better corporate business performance, enhancing overall corporate investment capacity. These improving investment conditions are reasons to expect good facility investment in the second half. Overall, since facility investment in the first half was worse than the May forecast, the forecast for facility investment may need adjustment in the next outlook.

- Construction investment turned positive from negative in the first half. You cited increased housing transactions as the reason. How much did housing transactions affect construction investment? If transactions increase in the second half, could construction investment improve?

▲ Housing transactions influenced construction investment. Real estate-related output components are combined and reflected in construction investment. It is difficult to specify exact proportions, but the recent increase in housing transactions after a period of weakness is a fact.

▲ However, this is not expected to significantly affect the construction investment forecast for the second half. Although residential building transactions and prices have increased mainly in the metropolitan area, it is not seen as overheating. The recent increase is viewed as a recovery from previous weakness. The real estate market includes subscription, sales market, construction starts, and social overhead capital (SOC). Overall, the construction market remains sluggish, but housing transactions have recently increased mainly in the metropolitan area. It is not yet at a stage to interpret this as overheating or to expect construction investment to exceed forecasts in the second half.

- You said private consumption will recover. The May forecast for the first half was 1.4%, but the actual was 1.5%. What is the outlook for demand-side inflationary pressure?

▲ There is no special factor; overall, high inflation and high interest rates continue to affect private consumption, and although inflation is decreasing, instability in agricultural product prices also influences it. The Research Department reflects overseas consumption in the private sector, but overseas consumption in Q2 was not as high as in Q1. There may be differences in overseas performance.

▲ Since domestic demand recovery is not expected to be strong, demand-side pressure is not significant. Even if domestic demand improves in the second half, the extent of demand-side pressure will need to be reflected in the next Research Department forecast considering GDP and domestic demand performance.

- You said domestic demand sluggishness will ease in the second half. Does this mean private consumption will improve only if high interest rates ease?

▲ Many factors affect private consumption. Globally, monetary tightening has led to high interest rates and high inflation, which have been interpreted as major influences. Korea is also affected by high inflation and high interest rates. Private consumption is influenced by income and interest rates, but consumer sentiment is more affected by inflation. The weak recovery in private consumption is more due to inflation than interest rates. Naturally, lower interest rates increase disposable income and consumption capacity, while higher rates encourage saving over consumption. Interest rates do have an effect, but currently, high inflation has a greater impact on private consumption. A major reason for expecting private consumption improvement in the second half is the decline in inflation rate. Price stability is a prerequisite.

- Inventory changes turned positive for the first time in five quarters. Is inventory adjustment complete or is this temporary?

▲ The IT market was weak in the first half of last year but recovered in the second half. Major companies adjusted production in the first half, and inventory was significantly depleted from the second half of last year as recovery progressed. Currently, semiconductor factories are in the expansion phase. Although investment timing was delayed in the first half, production adjustments by semiconductor manufacturers early last year have ended, and the IT market is expected to improve. The increase in inventories in Q2 is due to increased imported raw materials being held as inventory.

- Why did imports exceed exports despite negative investment?

▲ Imports are generally classified into raw materials, consumer goods, and capital goods. The increase in imports was mainly due to raw materials. Capital goods are counted as facility investment. Semiconductor manufacturing equipment did not increase significantly in Q2, but from July, customs data shows increased capital goods and consumer goods imports as semiconductor manufacturers resumed investment. This will be reflected in Q3 GDP as increased capital goods imports and facility investment. Although imports increased mainly in raw materials this time, they were not reflected in investment but went largely into inventory, resulting in negative investment.

- Was the Q2 growth rate largely affected by the base effect of Q1 growth?

▲ Q2 declined as temporary factors from Q1 disappeared and domestic demand adjusted. The decline due to the base effect in the next quarter is a technical phenomenon. Although Q1 grew significantly and Q2 contracted, it is difficult to interpret this as economic deterioration. When quarter-on-quarter growth shows large fluctuations due to base effects, year-on-year growth and the first half should be considered together. That is why the first half growth rate was mentioned. It is inappropriate to overinterpret negative growth due to base effects as worsening exports or economic collapse.

- When Q1 growth rate was announced, early smartphone releases were cited as a reason for increased private consumption. Does this effect apply this time as well?

▲ In Q1, factors such as early smartphone releases, mild weather, and strong overseas consumption were explained as reasons for increased private consumption. Korea’s representative smartphones are usually released in March, with foldable phones released mostly in the second half. New products are released in March, pre-ordered, and sold around April. Sales peak for one or two months after release and then decline. If released in March as usual, sales would have been reflected in Q2 private consumption, but this time sales occurred in February, so the smartphone release effect was already reflected in Q1. The early release, one month ahead, caused sales to peak in March and then decline, explaining the high private consumption in Q1 due to the early release effect.

- What is the outlook for energy prices and net export contribution in the second half?

▲ Exports will continue to increase, but the growth rate will slow. However, export growth is expected to exceed import growth. Although export growth rate will decline, the IT market and automobile market are favorable, so overall exports will be good. A lower export growth rate does not mean deterioration.

▲ Imports are also expected to increase in the second half but will not surpass export growth. Net export contribution is expected to remain generally positive in the second half, though the margin may narrow.

- The last negative growth was in Q4 2022. What are the differences between then and now?

▲ In Q4 2022, the IT market sharply contracted, causing exports to decline significantly. There were concerns that the economy might enter a recession phase after a downturn. Generally, two or more consecutive quarters of negative quarter-on-quarter growth indicate a recession.

▲ This time, the negative growth is due to the base effect from the large increase in Q1 GDP, so the meaning of the negative growth now differs from that in Q4 2022.

- Could domestic demand improvement in the second half lead to improved economic sentiment?

▲ Economic sentiment is generally influenced by construction consumption, private consumption, and self-employed business conditions. Private consumption recovery is slow, construction showed a brief growth in Q1 but is expected to remain weak in the second half, and facility investment is not closely related to economic sentiment. Therefore, even if domestic demand improves in the second half, it may not immediately translate into improved economic sentiment. For economic sentiment to improve, export growth needs to spill over into domestic demand. A time lag may be necessary for economic sentiment to improve.

This content was produced with the assistance of AI translation services.