Outgoing UN Secretary-General Ban Ki-moon is emerging as the de facto frontrunner for South Korea's December 2017 presidential election, as the conservative ruling Saenuri and centre-left liberal parties are struggling to find plausible candidates amid severe internal rifts. Meanwhile, President Park Geun-hye's deteriorating relationship with Saenuri is accelerating her descent to lame duck status, which will impede her ability to pass economic reforms and host the US's THAAD missile defence system.
We are downgrading South Korea's 2016 real GDP forecast slightly to 2.6% from 2.8% previously despite the economy's stronger than expected expansion of 3.0% in H116. This is to reflect mounting headwinds from the restructuring of the shipbuilding industry and the spillover effect this will have on the broader economy. In addition, ongoing weakness in the Chinese economy and high levels of youth unemployment will continue to weigh on growth.
South Korea's supplementary budget aimed at supporting growth and ongoing restructuring efforts of the country's main shipbuilders will be unable to sufficiently mitigate the broader economic slowdown. With downside risks to growth rising, we expect the central bank to cut interest rates to support the government's initiatives, and now forecast a 25bps cut to 1.00% for its base rate over the coming months. At the same time, we note that the stimulus is unlikely to have an impact on the government's 2016 headline fiscal deficit, with funding being provided by state-owned institutions.
The BoK kept its base rate steady at 1.25% following its August 11 monetary policy meeting, but we retain our forecast for the central bank to cut its base rate by 25bps to 1.00% over the coming months to support government fiscal measures and exports against a backdrop of low inflation.
We are revising our average 2016 forecast for the KRW to average KRW1,180/USD from KRW1,200/USD previously to reflect US dollar weakness since late-February, but note that short-term techncials do not bode well for the currency. Over the long-term, South Korea's strong fundamentals such as a high current account surplus, modest inflation, and relatively robust growth will support the won, allowing gradual appreciation.
Major Forecast Changes
We have upgraded our 2016 average KRW forecast to KRW1,180/USD from KRW1,200/USD previously to reflect KRW strength.
We have downgraded our 2016 real GDP growth forecast to 2.6% from 2.8% to reflect mounting headwinds.
We now expect the BoK to cut its base rate by an additional 25bps to 1.00%, versus our previous forecast for the central bank to hold rates at 1.25%.
Downside Risks To Economic Growth Forecast: Should we see a sharper-than-expected downturn in the global economy or even an implosion in South Korea's household debt market, we would certainly expect to see a substantial weakening in its exports sector, which, in turn may push the economy into a pronounced recession.
Political Risks Rising: An increasingly belligerent North Korea poses a latent security threat, and any nuclear test could lead to a flare up of tensions on the Korean peninsula.
|Nominal GDP, USDbn||1,410.3||1,377.7||1,371.0||1,447.0|
|Real GDP growth, % y-o-y||3.3||2.6||2.6||3.0|
|Consumer price inflation, % y-o-y, eop||0.8||1.3||1.5||1.6|
|Exchange rate KRW/USD, eop||1,090.98||1,175.06||1,200.00||1,180.00|
|Budget balance, % of GDP||0.6||0.0||-1.2||-0.8|
|Current account balance, % of GDP||6.4||7.9||8.2||8.0|
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