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South Korea shows recovery skills

The South Korean economy continues to show its ability to bounce back rapidly from crisis, this time due mainly to the combined impact of a domestic stimulus and restocking of global inventories.

The recovery has been sufficiently strong for central bank governor Lee Seong-tae, whose term ends next March, to surprise observers by announcing his readiness to raise rates, if necessary even in the near future, to tamp down inflationary expectations arising from growing optimism and the existing loose monetary policy.

On Thursday, the central bank kept its key interest rate unchanged at 2% for the seventh month running, meeting analysts' expectations after having cut the rate by 3.25 percentage points between October and February.

A rate increase would go against the preferences of the new cabinet led by Chung Un-Chan, a Princeton-trained economist and former president of Seoul National University, who was named as prime minister two months ago. It would prefer the central bank to continue a looser monetary policy.

The economy, which also showed fast regenerative ability in the wake of the 1997-98 Asia financial crisis, grew 2.6% in the second quarter compared with three months earlier, outperforming an earlier 2.3% estimate. July saw the first increase in industrial production in 10 months, following the second quarter's phenomenal 8.2% growth over the first quarter in manufacturing production.

Other good news comes from the Purchasing Managers' Index, which reached 53.6 in August as export orders increased; any value over 50 represents improving business conditions. On Tuesday, the Korea Development Institute, a state agency, said the economy would likely contract by 0.7% during the present calendar year, a significant improvement over its previous prediction of a 2.3% decline.

The Asian Development Bank opined in July that the Korean economy bottomed in the first quarter of the present calendar year, while the International Monetary Fund expects the country's recovery to lose some momentum but nevertheless continue.

Global inventory restocking is coming to an end, but consensus expectations for a US economic recovery are expected to drive manufacturing export. At the same time, domestic consumption in Korea may fall if the government does not renew tax relief that is part of its stimulus program.

A weaker national currency will allow global market share of South Korean production to increase while remaining a downside risk for the stock index. To be sure, the continuing standoff of the international community with North Korea weighs upon political risk on the peninsula, but it is unused capacity and the contingency of the recovery rather than political risk that keeps firms from laying out capital expenditure for new investments.

Bloomberg News reports that Fitch Ratings, impressed with how resilient the country's banking system has shows itself, has raised South Korea's credit-rating outlook from "negative" to "stable".

Seoul's benchmark KOSPI stock index, of which the banking sector represents fully two-fifths, closed Thursday at 1,645, up 56% from its low at the end of October last year. Other key sectors are shipbuilding, steel, electronics, and also automobiles. The last two of these provided a significant part of the boost in exports in July.

Almost all major financial houses expect the KOSPI to continue to the upside in the near and medium if not also the longer term, rising as much as another 10% by the end of the calendar year and peaking sometime in the second or third quarter of next year. This timing is uncannily consonant with the fearful prediction in some circles of a worldwide "double-dip" or "W-shaped" recession, although it is not an explicit aspect of analysts' projections for the KOSPI in particular.

At its present level, the KOSPI is maintaining its up-channel initiated six months ago and still showing good strength in the near term that is, however, also influenced by such "conjunctural" factors as commodity and oil prices. It is not generally expected to get easily through the 1,700s and low 1,800s; but if it does, then it should show good strength afterwards to the upside.

Political analysts rank South Korea among the most risky of financial and stock markets because of the situation in North Korea, but this does not appear to be bothering financial and economic analysts whose decisions are governed by less imponderable considerations. The South Korean economy therefore has among the best economic prospects in Asia for the foreseeable future: with the emphasis on the adjective "foreseeable".

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First published in Asia Times Online, 11 September 2009.

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