South Korea

AI-driven growth outperformance

South Korea's GDP grew 3.8% in H1 2026, supported by a memory chip-led export boom and a recovery in facilities investment. The supplementary budget (worth at around 0.9% of GDP) enacted from April also helped cushion Middle East impact. The Bank of Korea raised its 2026 growth forecast to 3.3% in August, well above its estimated potential growth rate of slightly less than 2.0%. Goods exports rose 44% y/y in the first eight months of the year, driven primarily by tech-related products. In particular, semiconductor exports, accounting for 40% of total exports, surged by more than 170% y/y amid strong AI server demand, tight memory supply, and rising prices. Within non-tech exports, ship exports were a bright spot thanks to solid demand for LNG carriers and dual-fuel tankers. However, overall non-tech exports underperformed, growing by just 9.6% y/y, dragged by muted steel exports. Strong semiconductor exports have also lifted facilities investment, which accounted for 9.5% of GDP and expanded by 5.4% y/y in H1. Meanwhile, construction investment remained a drag on overall capex, declining 1.5% y/y in H1 amid elevated construction costs. Private consumption, accounting for 47.8% of GDP, continued its gradual recovery. This was supported by the government's consumption coupon program, which has partly offset the erosion of purchasing power caused by higher inflation. Rising equity prices have also boosted consumer sentiment and spending on durable goods such as automobiles.

Headline inflation accelerated sharply to around 3% following the Middle East conflict, while core inflation also rose into the mid-2% range. Further pass-through of accumulated cost pressures, coupled with demand-side pressures from improving labour market conditions, could keep domestic inflation above the 2% target. Against this backdrop, the Bank of Korea has delivered two consecutive rate hikes in July and August and has signalled another 25bp increase over the next six months. Sectors with weaker interest coverage, notably construction and transport, will face a heavier debt-servicing burden as interest expense rise. On the positive side, tighter monetary policy has helped support the Korean won recently and could alleviate import cost pressures. However, the sustainability of the recent KRW appreciation will depend on exporters' willingness to convert forex earnings and fund flow conditions, which in turn hinge on the appetite of retail and foreign investors.

We expect the growth momentum to carry into 2027 as robust capex guidance from hyperscalers should continue to underpin semiconductor export growth, particularly for high-bandwidth memory (HBM) chips. Meanwhile, rising investment by Samsung Electronics and SK Hynix should further support the recovery in facilities investment. That said, this optimistic outlook remains contingent on the sustainability of the AI boom, which presents both upside and downside risks to Korea's growth outlook. A moderation in global demand for Korea's high-end chips could weigh on growth and exports, while a correction in AI-driven equity valuations may tighten domestic financial conditions. Recent market developments suggest that investors have already started to reassess some of the optimism embedded in AI-related assets. The KOSPI has corrected by as much as 40% from its mid-June peak, although it still doubles from a year earlier and has yet to exert significant pressure on consumption through wealth effects.

Both fiscal and current accounts improved

South Korea’s current account surplus has improved markedly, reaching an all time high of around 20% of GDP amid the AI-driven technology upcycle. The improvement has been driven primarily by a widening goods trade surplus, as the memory chip-led export boom has more than offset a larger energy import bill. The primary income balance has also strengthened, supported by rising investment income. Together, stronger goods and primary income balances have more than compensated for a modest widening in the services deficit – while both information and communication services and cultural and leisure services, including K-pop, recorded surpluses in H1, these gains were insufficient to offset larger deficits in intellectual property royalties and professional and business services tied to increasing reliance on foreign cloud infrastructure and AI platforms.

Supported by AI-related tax windfalls, the government plans to raise spending by 12.8% in 2027. Additional expenditure will be directed toward strategic, forward-looking sectors, particularly AI, youth support, and other future growth engines, including small modular reactors, nuclear fusion, renewable energy. Despite the sizeable increase in spending, net government bond issuance is expected to be lower than government's medium-term projection, aided by stronger revenue collection. As a precaution against any reversal in AI-driven tax windfalls, the government plans to spend only around 30% of the additional revenue generated above its long-term growth trend. The remaining 70% is earmarked for a Future Response Fund to help finance expenditures over 2028-30.

Stronger mandate for governing party

The June 2026 local elections delivered a landslide victory for the governing Democratic Party, widely seen as a public endorsement of President Lee Jae-myung's first year in office. The party won 12 of the 16 races for metropolitan mayors and provincial governors. In contrast, the main opposition People Power Party (PPP) won only 4 of the 16 races, although it retained the Seoul mayorship, one of its traditional strongholds. The PPP's failure to decisively distance itself from former President Yoon, who was impeached following his declaration of martial law in December 2024, has left the party divided and struggling to regain public support.

The local election result, combined with the Democratic Party's near-supermajority in the National Assembly, strengthens the Lee administration's political mandate to advance its policy agenda, including AI investment, industrial policy, regional development, and fiscal expansion. On the foreign policy front, Lee has emphasized a pragmatic approach. He seeks to maintain the alliance with the United States, but Trump’s transactional approach may increase uncertainty regarding the scope of alliance activities and place greater pressure on Seoul on its own defence capabilities. He also aims to maintain constructive ties with China and Japan, but mostly through bilateral interactions, as progress on a trilateral FTA stall. He also expresses willingness to selectively engage with North Korea through humanitarian initiatives like family reunions and basic correspondence. With the next legislative election not due until April 2028, the administration has a relatively long policy runway to implement its priorities.

2024

2026

Croissance du PIB (%)

1.0

2.6

Last updated: October 2026