Prepare for the worst, but no need for pessimism

By Park Chong-hoon

South Korea's trade deficit has been a cause for concern for the past 12 months due to a decline in semiconductor exports and exports to China. A widening trade deficit could impact the Korean won and monetary policy, prompting the Bank of Korea (BOK) to hike the base rate further to stabilize the currency. Moreover, the trade deficit may negatively affect economic growth by reducing imports and decreasing investment and economic activity.

Some market participants believe that Korea's export slump is structural, caused by prolonged U.S.-China tensions and by U.S. pressure on Korean firms exporting semiconductors to China. Investors are concerned about the potentially negative impact of the U.S. CHIPS and Science Act on Korea's semiconductor industry. Specifically, they are worried that the Act's conditions for subsidies may infringe on management rights and trade secrets and that it may be overreaching by demanding excessive technology transfer and production increases. The upcoming 10-year restriction on subsidized companies' investments in semiconductor facilities in China could disrupt the operations of Korean semiconductor companies in China.

Therefore, there is increasing demand for the government to actively take measures to promote Korean exports and protect the interests of domestic firms.

Despite these concerns, we see reasons for cautious optimism about Korea's trade balance and the competitiveness of its semiconductor industry.

First, Korea's crude oil and petroleum product imports have room to shrink significantly, which would reduce the overall import bill. The decline in imports so far has come from the non-energy sector, but energy imports should also decline with the onset of spring.

Second, Korean automobile exports rose 47.1 percent year on year to a record high of $5.6 billion in February. The increase in automobile-related products and general machinery exports have increased Korea's exports to key regions, including the U.S., the euro area and the Middle East.

Third, while a decline in Korea's imports would narrow the trade deficit, we see a possibility of a rebound in the trade balance with China as exports may pick up on the back of China's reopening and a potential increase in China demand. We think the recent decline in Korea's exports to China was not geopolitically or structurally driven, but rather due to China's economic slowdown. We expect Korean exports to China to increase in the second half of the year, improving the trade balance with China and, therefore, the overall trade balance.

Finally, Korea has a competitive global advantage in semiconductor chip production, which should support its exports. The current semiconductor chip down-cycle is hurting its semiconductor exports to key markets such as the U.S. and China, down 37.1 percent and 47.9 percent year on year, respectively, in February. However, we think this down-cycle is driven by oversupply, and Korea's high-level semiconductor chips are not easily replaceable.

There is a growing demand for chips for electric vehicles (EVs) and renewable energy technology, where Korean chips have a competitive advantage, as well as an increasing need for semiconductors in the healthcare sector. All of this should drive semiconductor exports higher. Furthermore, we expect the global semiconductor cycle to turn around in the second half, which would support Korea's export prospects.

The U.S. dollar has strengthened by 0.6 percent since the start of February, which returns the pair toward our first quarter forecast of 1,300, after its sharp decline between November 2022 and January 2023. We do not attribute the February rebound to the trade deficit, given that the Korean won appreciated in January despite a wider trade deficit of $12.65 billion, versus a $5.3 billion trade deficit in February when the Korean won depreciated. Current dollar strength is likely to be driven by concerns over a continued rise in U.S. interest rates due to resilient inflation, rather than by softening Korean exports. That said, weak exports and the semiconductor down-cycle could limit Korean won upside in the short term.

We find it worthwhile to look at the past correlation between Japan's semiconductor exports and its overall exports. A key reason Japan's exports failed to recover after the global financial crisis was the slump in its semiconductor sector. Japan lost its competitiveness due to increasing competition from Taiwan and South Korea due to a technological shift, which required massive investment and consolidation.

We wonder if the recent U.S. Act will similarly change the dynamics of the global semiconductor industry going forward. Perhaps Korea will lose significant export market share and need to compensate investors with higher dividends; this would be a challenging scenario, considering the potential withdrawal of 75 percent of profit due to lost exports. This theme is a long way from playing out, but we think it is a compelling reason for the government to negotiate with the U.S. to revise the act in order to protect the interests of Korean semiconductor companies.

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 head of telecommunication policy at the Korea Information Society Development Institute (KISDI).