NABO Economic Trends & Issues (No. 85)
Date of Publication : Nov. 20, 2019
Competent Office : Macro-Economic Analysis Division of Economic Analysis Department
I. Economic Trends
Recently, the Korean economy has continued to suffer from an economic downturn, with exports and investments still on the decline. Exports continued to record a double digit drop YoY in October, as both unit prices and volume declined, and construction and facility investments remained sluggish as well. However, the Composite Consumer Sentiment Index rose in the last two consecutive months, and the Cyclical Component of Coincident Composite Index and the Cyclical Component of Leading Composite Index have stayed either flat or elevated MoM, signalling that the economic slowdown will not worsen. Consumer prices increased by 0.0% (YoY, monthly) as the price decline of agricultural products eased and personal service prices rose, outperforming the previous month when negative growth was registered. The the won-to-dollar exchange rate fell for two straight months stemming from expectations of US-China trade negotiations, rising US stock prices, and the weak dollar, while the treasury bond yield increased.
Ⅱ. Impact of Prolonged Hong Kong Demonstrations on Korean Exports
Recent protests in Hong Kong triggered by the Anti-Extradition Law Amendment Bill (Anti-ELAB) move, intensifying the conflict between China and Hong Kong relations, are quickly becoming a major geopolitical risk to the global economy. Hong Kong has seen its role strengthened as a hub of trade and finance connecting China and the world since the Handover. Korea's exports to Hong Kong increased rapidly after the Asian financial crisis, and as an export base to China, over 80% of Korean imports in Hong Kong are re-exported to China. As of 2018, Hong Kong was Korea's fourth-largest export destination and Korea’s semiconductor exports to Hong Kong were USD 33.6 billion accounting for 26.5% of Korea's total semiconductor exports (USD 126.7 billion). If deteriorating China-Hong Kong relations lead to a sharp drop in Hong Kong's exports to China, Korea's exports to Hong Kong will also decrease, which in turn is likely to have a negative impact on Korea’s overall exports in the short term. In the event of a structural shock exhibited in decline in exports from Hong Kong to China, Korea's exports to Hong Kong are estimated to fall for four quarters in a statistically significant manner, while total exports are expected to decline for five quarters due to the drop in exports to Hong Kong. Thus, it is necessary to closely analyze and prepare for the risk factors and economic ripple effects of the rapid changes in China-Hong Kong relations.
Ⅲ. Analysis of Factors in the Won-to-Dollar Exchange Rate Fluctuations Based on Capital Inflow and Outflow
Exchange rate fluctuations are on the rise as capital outflow from emerging economies is growing as a result of the US-China trade dispute and a global economic slow-down. Korea, a small open economy with considerable capital inflow and outflow, witnessed the won-to-dollar exchange rate increase by 8.7% in August of this year from the end of December, 2018 partly due to recent trade disputes between the US and China. Analysis of the factors behind the won-to-dollar exchange rate fluctuations involving mainly capital inflow and outflow illustrates that when USD 1 billion in value increases in capital inflow/outflow, exchange rate fluctuations are affected most by stock investments by foreign investors (-0.439%), followed by other investments by foreign investors (-0.396%) and other investments by Korean investors (0.355%). Investments in securities by foreign investors seem to be sensitive to exchange rate fluctuations when the exchange rates are expected to fall, because these investments are made with short-term gains and losses in mind. For other investments with a high proportion of short-term funds, arbitrage gains from spreads between internal and external interest rates contributed to the exchange rate fluctuations. Since capital inflow/outflow can negatively affect macroeconomics such as inflation through won-to-dollar exchange rate fluctuations, enhanced monitoring activities of investors and investment types, as well as increased policy interests seem to be needed to mitigate seesaw fluctuations in exchange rates.