SERI Economic Forecasts

2011 Outlook for the Domestic Economy

LEE Chan-Young Dec. 15, 2010

Welcome to SERI's 2011 Outlook. I'm Chan-Young Lee from the Macroeconomics Department. The Korean economy in 2010 can be compared to a train passing through a dark tunnel, heading for an exit. What path will be ahead for the Korean economy in 2011? Summarizing 2010 briefly, the Korean economy performed well, rebounding rapidly and effectively from the global financial crisis. In the first half of 2010, it grew 7.6% year-on-year. The main catalysts were strong exports and investment by the IT and automobile industries. This has activated a virtuous cycle, increasing company's hiring, which, in turn, improves private consumption. This has made the Korean economy into a model case of successful recovery from the global financial crisis. In the second half, however, this trend has changed. Signs of a global economic slowdown have emerged, while exports and investment, the main drivers of the domestic economy in the first half, have begun to lose steam. Waning government stimulus has also weighed down on the economy. Despite the slowdown in the second half, however, the Korean economy is expected to end 2010 with annual average growth of 5.9%. Can such growth momentum continue into 2011? Domestic economic growth will slow to 3.8% with tepid growth in facilities investment and consumption. Exports, one of the main economic engines, will sputter in 2011, growing only by 9.0%. This major slump in exports is a result of an expected slowdown in emerging economies, including China, and fiercer worldwide competition in the global market. Growth in private consumption will slow to 3.6% in 2011 with weakened growth momentum, dampened consumer sentiment amid protracted sluggishness in the real estate market, and increased strain from household debt because of interest rate hikes. Facilities investment is expected to grow 5.1% in 2011 as production capability has already been significantly reinforced in the IT and automobile industries, which represent more than half of the total facilities investment in the nation's manufacturing sector. Though construction investment should finally return to positive growth in 2011, the sluggishness will likely continue due to government fiscal constraints and the delayed recovery of the real estate market. In sum, next year, growth in exports, consumption and investment will all slow down. Slow exports and facilities investment will significantly lower job creation capacity in the manufacturing sector in 2011. Service sector job creation will also be tepid due to the sluggish domestic economy. The unemployment rate is expected to fall to 3.5% in 2011 even as new hiring in the public sector decreases. This is because the higher jobless rate in 2010 was due to more middle-aged and elderly people looking for jobs rather than the new jobs created by the government in the public sector. Consumer inflation will remain stable in 2011, growing 2.8%. Demand-side pressure will subside due to slower economic growth while inflationary pressure

stemming from rising international oil prices will ease as the won appreciates. Interest rates will likely rise slightly to 5.1% in 2011. The slowdown in the domestic economy and continued inflow of foreign investments may restrain interest rate increases. The annual average won/dollar exchange rate is expected to fall to 1,080 in 2011. Forces boosting the won's value will come from continued quantitative easing by the US Federal Reserve, a low interest rate policy in major advanced economies and gradual appreciation of the Chinese yuan. Internally, Korea's current account surplus and overly depreciated won will boost the won's value in 2011. The real estate market is unlikely to recover in the near future. Lending regulations such as LTV and DTI and increased household repayment burdens due to rate hikes will have negative impact on the housing market. Lastly, government efforts will likely be stepped up to reach FTAs with emerging countries, including BRICs. Free Trade Agreements (FTA) have become a viable method to offset decreasing exports in the changed global trade order. In sum, the road for the Korean economy will not be smooth in 2011. Exports, investment and consumption are expected to weaken. Uncertainties will still be lingering at home as well as abroad. Thus, government, businesses, and individuals should join forces in putting the Korean economy into a stable growth phase for the next year. Thank you for watching. I'm Chan-Young Lee.

Copyright 2009 Samsung Economic Research Institute. All rights reserved.

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