South Korea: A post-election update

We discuss the implications of the upcoming new government’s policies, as well as the monetary policy outlook.
Group Research19 Apr 2022
  • We discuss the implications of the upcoming new government’s policies,...
  • ...covering the fiscal, business, and external aspects
  • We also explore the known and unknown factors affecting monetary policy outlook ahead
Photo credit: Unsplash

New government, new policies
South Korea’s president-elect Yoon Suk-yeol is set to take office on May 10. As a member of the conservative People Power Party, Yoon adopts a different stance compared to the incumbent President Moon Jae-in on some key domestic and external issues. His inauguration probably marks a shift in the country’s economic and foreign policies in the next five years. Having said that, the Democratic Party will continue to control the majority of the National Assembly till April 2024. Yoon’s ability to enact some of his policies that require the legislation process could be constrained, at least in the early part of his five-year term.

The centerpiece of Yoon’s economic policies is pro-business, market-based reforms. He plans to scale back corporate regulations, promote the growth of start-ups, SMEs and high-tech ventures, and create more job opportunities in the private sector. He also plans to ease the excessive curbs imposed in the property market, such as lowering the capital gains and property ownership taxes to boost housing transactions. Another proposal is to deregulate the digital asset industry, raising the tax threshold for cryptocurrency investment from the current KRW2.5mn to KRW50mn. These market-friendly measures should be welcome by the business sector and bolster the country’s medium- to long-term investment outlook. But the efficiency and effectiveness of policy implementation remain a question mark. The KOSPI has not reacted strongly after the March 9 election, showing that investors still adopt a wait-and-see attitude on the new government’s business reform agenda for the time being.

On fiscal policy, Yoon pledges to curb government spending and reduce budget deficit in the medium term, but expand stimulus in the short term to consolidate economic recovery. He has proposed to allocate KRW50tn funds (2.4% of GDP) to aid the small merchants and self-employed hit by the Omicron outbreak. This will likely require the passage of a second supplementary budget for this year, the size of which will likely far exceed the KRW16.9tn of the first one approved in February. A persistently expansionary fiscal policy would increase public debt burdens and exert upward pressure on bond yields, at a time when monetary stimulus is gradually withdrawn. The 2-10Y KTB yields have climbed upward notably by 50-100bps over the past one month after the March 9 election. The rise was driven by the combination of external and domestic factors – the Fed’s kickstart of rate hikes and the mounting concerns about KTB supply increase.

On the external front, Yoon pledges to strengthen alliance with the US and repair relations with Japan. Possible moves include applying to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) and expanding cooperation with the US and Japan on semiconductor supply chains. Some of these issues may be discussed during US President Joe Biden’s upcoming Asia trip in late May. Both the US and Japan are important trade and investment partners for South Korea. The US ranked as South Korea’s largest source of inward FDI in 2021. Thanks to Samsung’s investment to build advanced chip facilities in Texas, the US also emerged as South Korea’s largest outward FDI destination last year. 

Whether the possible shift in Yoon’s foreign policies will harm Seoul’s relations with Beijing and Pyongyang will need to be closely watched going forward. Seoul’s deployment of the US-made missile shield system THAAD trigged a negative response from Beijing in 2016, including the bans on Chinese tour groups traveling to South Korea and broadcasting of Korean entertainment content in China. Today, China remains as South Korea’s largest trade partner, accounting for 25% of its total exports and 23% of its total imports. The potential impact of souring ties with China could be significant for the South Korean economy.

Monetary policy outlook

The Bank of Korea (BOK) has continued to push for gradual monetary policy normalisation during the leadership transition period, raising the benchmark repo rate by another 25bps to 1.50% at the April 14 meeting. This is the fourth hike in the current normalisation cycle, which started in August 2021. While the first few hikes targeted at containing housing prices and household debt, the latest move largely aimed to curb consumer prices inflation. Headline CPI jumped to a 11-year high of 4.1% YoY in March, driven by the surge in oil import prices as a result of the Russia-Ukraine conflicts.

Due to the change of BOK leadership, there is some uncertainty as to the future pace of rate hikes. From May onwards, rate setting will be under the new governor nominee Rhee Chang-yong. His policy bias is not very clear for the time being. As an ex-IMF official, Rhee said recently that he will adopt a balanced policy approach – “focus on how to lead monetary policy while taking into account ways to balance growth, inflation and financial stability”.

President-elect Yoon has refrained from making comments on interest rates. But given his pro-business, pro-growth stance on general economic policies, speculation exists that Yoon’s government may prefer a less hawkish monetary policy going forward.

Judging from the underlying trend of growth and inflation data, rate hike pressure will remain strong till 3Q. CPI numbers are likely to stay above the 4% mark till July/August. Growth data are also likely to continue to hold up well in the near term. As Omicron infections have passed the peak, South Korea has scrapped most of the pandemic-related restriction measures starting from April 18. This should help to lift consumption demand in 2Q.
Data trend also suggests that rate hike pressure will ease towards the end of this year. Barring further shocks to global oil prices and supply chains, inflation numbers should be able to retreat to the 3% level in 4Q. Growth data, meanwhile, may show some signs of softening in 2H. Export sector is likely to gradually feel the repercussions of global slowdown, in the aftermath of the Russia-Ukraine conflicts, oil price surge, and DM monetary policy tightening.

We are maintaining the view that the BOK will continue to normalise rate towards the neutral 2-3% level under the new leadership in the rest of this year and next year. But we expect the pace of hikes to slow in 2H22-2023. The benchmark repo rate is expected to be lifted to 1.75% by end-2022 and 2.25% by end-2023.

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Ma Tieying 馬鐵英, CFA

Senior Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣
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