Solid but uneven recovery
With South Korea’s GDP set to exceed its pre-pandemic level in 2021, growth momentum in 2022 is expected to moderate as the economic gain from normalising business conditions begins to fade. Exports (about 40% of GDP), which have been the main driver of growth, will continue to be a key pillar of support for the economy, especially as Korean high-tech products remain in great demand. Strong global demand for electronics and semiconductors is expected to sustain through the year, although a prolonged supply chain disruption may constrain export growth. The continued export upturn should spur further investment in construction and facilities (23% of GDP in 2019). In this environment, the manufacturing sector (26% of GDP in 2019) will continue to benefit.
The recovery in private consumption (48% of GDP in 2019) should continue over 2022 as the country seeks to transition into a “living with COVID” approach for the long-term and reopen the economy amid rising vaccination. By early January 2022, South Korea had over 80% of its population fully vaccinated, with over 40% receiving booster shots. Improving labour market conditions will provide a further boost to household spending, especially if the labour participation rate starts to pick up amid strengthening growth prospects. The unemployment rate (not adjusted for seasonality) dropped to an eight-year low of 2.6% in August 2021, but the participation rate remained below its pre-pandemic level, indicating a net outflow of workers from the labour force. The downside risk to the outlook of private spending will come from high household indebtedness (household debt-to-disposal income ratio at a record 92.8% in Q2 2021) in a rising interest rate environment.
Inflation exceeded the Bank of Korea’s (BOK) target of 2% in 2021, and we expect growth in consumer prices to intensify in 2022. A further increase in energy prices and a stronger-than-expected strengthening of domestic demand are significant upside risks to our inflation forecast. Following two rate hikes in 2021, rising inflationary pressures and financial imbalances should push the BOK to increase its policy rate further in 2022. Nevertheless, the interest rate environment remains accommodative and, together with an expansionary fiscal policy, will provide support to growth.
Budget deficit to narrow
The government will continue to face a fiscal shortfall in 2022, though the budget deficit is expected to shrink from an estimated 4.4% of GDP in 2021 to 2.6% in 2022 despite aggressive spending plans. The government proposed an expansionary budget of 604.4 trillion won (USD 530 billion and 31% of 2020 GDP) for 2022. However, projections of higher revenue collection explain the lower budget deficit, while spending will be similar to the initial 2021 budget plus additional expenditures. The public debt is set to increase further in 2022 (50.2% of GDP), and should continue rising through to 2025 (58.8%). The rise in national debt will be partially financed through government bond issuances, with the finance ministry planning to sell 167.4 trillion won of bonds in 2022 (176.4 trillion in 2021).
South Korea’s external position remains solid, supported by a sustained current account surplus, net external assets and ample official reserves. While the expected easing of border restrictions worldwide could contribute to a rise in the services trade deficit, it should be more than offset by strong merchandise trade growth.
The presidential election on 9 March 2022 is shaping up to be closely contested amid a shift towards conservative. The ruling Democratic Party (DP) is in control of the parliament (57%) until the next legislative elections due April 2024, with the main opposition party, People Power Party (PPP), holding about one-third of parliamentary seats (34.8%). However, the left-leaning DP has been losing more moderate support amid public frustrations with the Moon administration’s struggles in responding effectively to emerging coronavirus strains despite early successes, and a failure to rein in rapidly rising home prices. Consequently, the DP lost in the April by-elections for the Seoul and Busan mayoral posts, which were claimed by the conservative PPP. In a scenario where PPP wins in the presidential election, policymaking would be complicated with a DP-majority National Assembly. Furthermore, the PPP is likely to take a harder stance against China, the largest trade partner. Meanwhile, Japan-South Korea relations remain terse, with Japan adamant about South Korea backing down from its wartime compensation demand. Tensions between the two Koreas eased slightly after bilateral communication lines were restored in October 2021, but any meaningful improvement is difficult.