After accelerating throughout the course of 2005, Korea’s economy slowed down this year, principally due to weaker domestic demand.  Real GDP growth moderated to a 4.6 percent year-on-year pace in the third quarter of 2006 from 6.1 percent in the first.  Consumer spending, which has exceeded household income growth for the past two years, started to moderate. Gross fixed investment remained sluggish, in large part due to government measures to restrain speculative investment in real estate.  On the other hand, export growth has been robust despite the hefty 20 percent won appreciation over the last 2-3 years, reflecting strong productivity gains and the high non-price competitiveness of Korean Information Technology-related products.Â
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Inflation has continued subdued, aided by the strengthening of the won. Core inflation has remained below the lower range of the central bank’s medium term target of 2.5-3.5 percent. Given an expected moderation in economic growth and the recent decline in oil prices, inflation is likely to be kept in check though the next year. On the other hand, housing prices have been rebounding since November 2005, after government measures had stabilized the real estate market between August and October 2006. The central bank kept its target for the benchmark call rate (uncollateralized call rate) steady in the last two months after it raised rates by a cumulative 125 basis points. The monetary tightening cycle might come to an end in response to subdued inflation and moderation in growth, although signs of acceleration in real estate prices still remain a concern. Korea’s government will maintain a neutral stance in drafting the budget for 2007, with a greater focus on redistributive and social welfare functions. The fiscal balance excluding the social security fund will continue to be a deficit of less than 1 percent in 2007. On the external front, the current account slipped into a slight deficit for the first eight months in 2006, on the back of a larger oil import bill. On the other hand, the capital account surplus widened substantially during the same period, as banks increased borrowing from overseas on the back of their improved credit worthiness and low Japanese yen interest rates, which helped drive up the country’s short-term debts to a record high. With the small current account deficit more than offset by capital account surpluses, the country’s foreign exchange reserves continued to rise to US$228.2 billion as of September, which is more than enough to cover the short-term external debts. Korean banks have continued to strengthen their financial position. The average non-performing loan ratio of commercial banks fell to 1.0 percent at the end of June 2006. The non-performing loan ratio hit record lows for all categories of loans including corporate loans, household loans and credit card receivables. As a result of a 20 percent increase in net income, the average capital adequacy ratio rose slightly to a record 13.1 percent at the end of June 2006. In addition, the six credit card companies have been improving in financial health. Their average capital adequacy ratio continued to rise sharply, reaching 22.4 percent at the end of March 2006 as a result of increased profit and an additional capital injection. Meanwhile, large Korean commercial banks are moving further into universal banking by acquiring non-bank financial institutions. Shinhan Financial Group is set to acquire LG card, the country’s largest card issuer. A moderation of consumption and export growth is expected to result in overall GDP growth of 4.5 percent in 2007, compared to 5.1 percent in 2006. Private consumption is like to slow moderately, reflecting low consumer confidence and sluggish stock prices. While the firm labor market will help soften this slowdown, still high household debts could weigh on consumer spending in case consumer sentiment deteriorates further. Export growth is also expected to moderate in line with a slowdown in industrial countries. Geopolitical risks associated with North Korea, a sharper-than expected slowdown in the U.S. economy and still volatile oil prices could pose a substantial downside risk to the Korean economy.
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