(Bloomberg) -- South Korea’s economy flipped back into reverse last quarter after hotter-than-expected growth at the start of the year, adding to challenges for policymakers as they struggle to stimulate investment and consumption.
Gross domestic product shrank by 0.2% in the three months through June from the previous quarter, the Bank of Korea said Thursday. The figure was weaker than economists’ consensus estimate of a 0.1% expansion.
The unexpected contraction may increase calls for the central bank to cut interest rates but isn’t likely to trigger an immediate move. The weakness was exaggerated by the hot pace of growth that preceded it in the January-March quarter, and for now the BOK is focused on ensuring that it doesn’t inadvertently spur a further increase in household debt by signaling a near-term policy easing.
“The trajectory toward a rate cut is as good as confirmed, but the BOK wants to scrutinize financial stability issues,” said Kwon Young Sun, chief economist at Woori Finance Research Institute. “GDP isn’t the only factor for the central bank. Everything else from debt to currency will matter for the timing of a cut.”
The government and the central bank have already raised their growth forecasts for 2024, an indication that they view the second quarter outcome more as a speedbump on the way toward a continued expansion, rather than a warning signal that the tide is turning.
Still, the report underscored the weakness of domestic demand. From the previous quarter, private consumption fell 0.2% while government spending was up 0.7%. Exports in real terms increased 0.9% and facilities investment dropped 2.1%.
“The real worry here is the shrinking investment that bodes ill for longer-term growth potential,” Kwon said. Plans for investment may be delayed further if companies wait until after the US election in November, he said.
Machinery including chipmaking equipment led the decrease in investment, the BOK said in its statement. Construction investment contracted 1.1% following a surprise 3.3% expansion in the previous quarter.
The continued sluggishness of consumer spending suggests that robust external demand isn’t feeding into broader strength across the economy.
“We expect the weakness to be temporary,” Betty Wang, an economist at Oxford Economics, said. “Particularly, investment should pick up gradually in following quarters largely due to the still-intact stocking process in the technology sector.”
Separately on Thursday, SK Hynix said its quarterly revenue more than doubled and its capex outlays this year would likely top earlier plans.
A global boom for artificial intelligence development has been a boost for South Korea, home to two of the world’s biggest semiconductor manufacturers, Samsung Electronics Co. and SK Hynix Inc. Memory chips in particular have led growth in South Korea’s exports, fueling the 1.3% economic expansion in the first quarter that was more than twice the size forecast by economists.
Trade data indicate the export rally led by technology continued through the April-June period and may be persisting into this quarter. Semiconductor shipments jumped more than 50% from a year earlier in the first 20 days of July, supporting the expectation by the central bank that the chip rally may continue as long as through the first half of next year.
South Korea will now need to grow about 0.8% in the second half from the previous six-month period in order to achieve the mid-2% target for 2024, according to a Bloomberg Economics model.
Consumption is key for the economy in the second half of the year as private spending remains lackluster under elevated interest rates and lingering consumer inflation.
Economists are mostly split on whether the BOK is likely to cut rates in August or October. Authorities have kept the policy rate at a restrictive 3.5% for a year and a half. The local currency’s weakness against the dollar is a factor that has kept the central bank cautious about cutting too early, as further currency weakness would increase the costs of food and energy imports.
Stronger-than-forecast economic momentum at the start of the year gave the BOK another reason to maintain a cautious approach toward adjusting policy as authorities took heart from a semiconductor boom, which the nation increasingly relies on to ride out economic challenges, including the coronavirus pandemic.
“Strong AI-driven export growth should buttress economic growth in the meantime and give the Bank more room to take a more measured approach in policy pivots,” Kelvin Lam, a Pantheon Economics researcher, said in a note before the GDP release.
South Korea finds itself plagued by another risk to long-term economic vitality as the nation continues to renew the record for the world’s lowest fertility rate. With each South Korean woman expected to have just 0.72 child over her lifetime, the country faces the prospect of its working population shrinking at one of the fastest paces in the world and is turning more aggressively to automation and AI to buffer the impact of aging demographics.
“We see AI could continue to fuel Korea’s long-term growth without hurting the existing labor market,” Bank of America economists, including Benson Wu, said in a report. “The overall productivity gain brought by AI development could be the potential driver of Korea economic growth in coming years.”
In the near term, South Korea needs to resolve persistent concerns over credit risks overshadowing the construction industry, a pivotal component of GDP. On top of mounting costs of raw materials, developers are struggling to repay debt as rates stay elevated.
The industry saw a surprise uptick in output in the first quarter after a warm winter helped encourage investment. That may no longer be the case in coming quarters, according to Chong Hoon Park, an economist at Standard Chartered Bank Korea Limited, who predicted the quarter-on-quarter contraction in the second quarter.
What Bloomberg Economics Says...
“The GDP data make it clear that risks to growth lurk on both the domestic and external sides. There is high uncertainty about how restructuring will play out in the troubled property market. Meanwhile, a cooling US economy could slow demand for computer chips, which we have envisioned as Korea’s main growth driver this year.”
— Hyosung Kwon, economist
For the full report, click here
With an economy that is reliant on China and security supported by American troops, South Korea also faces the prospect of policy implications should Donald Trump win the US election in November, potentially reversing some of the measures pursued by the Biden administration, including tax incentives for foreign electric vehicle manufacturers.
(Updates with economist’s comment)
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