Growth likely to prevail despite headwinds

By Park Chong-hoon

Economic news has been pretty grim lately. The Omicron variant has been seen to be more contagious than the Delta variant, necessitating restrictions and leading to lockdowns globally. Inflation remains high on the back of fiscal expansion, high commodity prices and global supply bottlenecks. The Fed is likely to hike interest rates in March on inflation concerns, which is expected to hurt equity markets, and especially technology stocks.

Furthermore, geopolitical tensions between the U.S., China and Russia are worsening, affecting export-oriented and China-dependent economies, as well as energy importers. Given all these factors, we think Korea faces more downside than upside risks in 2022.

We forecast GDP growth of less than 3 percent for Korea, one percentage point lower than in 2021. However, as 3 percent is a strong growth level ― higher than "potential GDP" ― we think Korea can achieve this rate even with the headwinds it potentially faces. Exports will continue to support growth, and domestic consumption, which has been depressed due to the pandemic, will pick up in 2022 in our view. Moreover, we see monetary and fiscal policy supporting growth.

Korea's exports have shown resiliency, though moderate, growth, due to low base effects. December exports grew strongly on a year-on-year basis, by 18.3 percent to $60.74 billion. The three-month export growth average (ended December 2021) trended up in significant sectors such as semiconductors, autos and petrochemicals.

Exports of 15 essential items, including semiconductors, increased evenly in 2021, comparable to 2018, when exports hit an all-time high. This situation suggests that overall exports will not drop suddenly this year due to base effects. Exports may in fact expand further, with China expected to boost its economy through monetary and fiscal policy.

Domestic consumption has room to improve; it dropped 5 percent in 2020 on the COVID-19 impact, but we expect it to have bounced back by 3.5 percent in 2021, despite the strict social distancing measures. While the economy has returned to pre-COVID-19 growth levels, consumption continues to lag, as social activity has been limited. When the social distancing measures are relaxed, we think consumption will drive growth again.

Fiscal policy will support domestic consumption and growth this year, in our view. In addition to an already expansionary 2022 budget, the government is discussing a supplementary budget to support SMEs and service sector industries.

Government spending has played a crucial role in supporting Korea's recovery from the pandemic so far, and we think fiscal policy will continue to boost the economy with expanded and additional budgets. Both candidates for the upcoming presidential election in March are proposing a sizeable fiscal stimulus, suggesting that fiscal policy will be expansive no matter who becomes the president.

Interest rate normalization is likely to be slow in Korea. Last year, the Bank of Korea (BOK) hiked rates twice, faster than any Asian emerging markets (EM), and we expect it to hike them again this week at its policy meeting. Since the BOK has been ahead of global central banks in rate normalization, it has room for flexibility even if the Fed hikes rates faster than expected in 2022.

Generally speaking, EM economies need to follow the Fed's rate-hiking path to avoid capital outflows. However, as Korea already has a significant rate gap, even after the Fed's expected rate hikes, capital outflows are less of a risk. As a result, we think the BOK will be in no hurry to make a hike this year, which is supportive to growth.

The key driver of monetary policy will be the inflation path in 2022. CPI inflation remained high at around 3 percent (3.7 percent) in December and ended 2021 at 2.5 percent, the highest level since recording 4 percent in 2011. Despite vehicle gas price and tax cuts, CPI inflation ranged around 3 percent for three consecutive months from October-December.

Going forward, fiscal policy may continue to drive inflation, as we saw happen in the U.S. last year. If the BOK hikes the base rate faster than we expect, investment and consumption could be adversely affected.

While we don't believe the current high inflation is transient, we don't expect it to increase faster than it did in 2021 either. The main inflation drivers last year were high commodity prices, supply bottlenecks and low workforce participation. We think these pressures will dissipate in 2022 as the global economy returns to "living with COVID" even under new infection waves. The BOK's two rate hikes last year, and another likely hike this week, will also put downward pressure on the inflation trajectory in 2022.

While the downside risks to Korea's growth look bigger than its upside potential, we still expect resilient growth this year. The economy is likely to maintain the growth momentum of 2021 with the global economy resuming the recovery trend. Korea's competitiveness in technology gives it a leading edge in growth.

Geopolitical tensions will probably remain a threat, but there are also opportunities to benefit from China's expected expansive fiscal and monetary policy, and the Beijing Winter Olympics. While we need to be mindful of the uncertainty and risks, we also should not disregard the opportunities that lie ahead.

Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and the head of telecommunications policy at the Korea Information Society Development Institute (KISDI).