Is Korea heading toward deflation?

December 12, 2013
A South Koren trader works at the Korea Exchange Bank's main office in Seoul, South Korea (Yonhap)

A South Koren trader works at the Korea Exchange Bank’s main office in Seoul, South Korea (Yonhap)

By Kim Rahn

Concerns are growing that the Korean economy is drifting toward Japan-style deflation, because it has entered a low-growth, low-price era amid a stagnant economy.

Some experts have expressed concerns that what’s happening in Korea is similar to the start of Japan’s “lost decade.”

According to Statistics Korea, the consumer price index grew 0.9 percent in November from a year before.

The annual growth rate recorded less than 1 percent for three consecutive months ㅡ 0.8 percent in September and 0.7 percent in October. It was the longest period of less-than-1-percent growth in 14 years following the eight months recorded in 1999 after the Asian financial crisis.

Additional data by the Bank of Korea (BOK) showed that the export price index in November was 90.59, the lowest in five years and nine months. It decreased 0.8 percent from the previous month, and this mainly came as the value of the won against the dollar rose 0.4 percent in a month.

Korea’s gross domestic product (GDP) is not regaining its earlier growth pace: while it grew 6.3 percent annually on average in the 1990s, it was lowered to 3.9 percent in the 2000s, and to 3.7 percent in 2011 and 2 percent in 2012, and this year’s estimate is 2.8 percent.

The nation’s potential growth rate also used to be 6.7 percent in the 1990s but dropped to 4 percent in the 2000s and is estimated at lower than 4 percent now.

Experts say the trend here resembles Japan’s case when the country was about to enter its decade-long slump and deflation.

“Korea is seeing signs of low growth and low prices, which Japan experienced before the lost decade,” Kang Joong-koo, researcher at the LG Economic Research Institute, said.

He said the consumer price growth has remained less than 2.5 percent for 18 months, a bottom limit of the price growth range which the BOK aims to maintain, 2.5-3.5 percent.

“In the medium and long term, the low-growth, low-price situation will continue, as the working age population is forecast to begin to decrease in 2016 and employees’ working hours will be cut further. These will lower the nation’s potential growth,” Kang said.

Domestic demand is unlikely to bounce back ㅡ baby boomers are reducing their spending as most are feared to have inadequately prepared for a post-retirement life, while construction investment may be sluggish for a longer period of time as housing prices remain low.

A report of the Hana Institute of Finance said, “Korea resembles Japan in terms that it has limits in domestic demand growth and sees reducing fixed investment. Export is also unlikely to boost the economy as much as it used to.”

The won’s appreciation might also continue like the Japanese yen used to, and it will decrease Korean exporters’ competitiveness, it said.

Economists said that the chance of Korea experiencing deflation is lower than Japan’s previous conditions but the nation needs to take precautions.

The Hana report said the government should understand the nation’s economic situation correctly to prevent this scenario.

“Japan’s long-term depression came from a vicious circle of bubble burst, asset deflation, economic slump and a series of failures in government policies. Not to follow Japan’s suit, the government needs to improve fiscal and financial policies,” it said.

Kang called for more monetary easing. “The consumer price growth has remained lower than the BOK’s target boundary for over a year. It may be the time for the central bank to cut the base rate more. I don’t think a lower rate will cause inflation or asset bubble for now.”