[Public Trade Deficit] China, South Korea's Largest Trading Partner, Stuck in a Quagmire... High Dependency Korean Companies on Alert

Direct Hit to Consumption Contraction from China Regional Lockdowns
Invasion of Korean Market by Chinese Products Backed by 'Technology'
Dependence on Chinese Raw Materials Expands in Secondary Batteries and Petrochemicals
Corporate Profitability Inevitably Worsens if Trade Deficit Persists

South Korea's Trade Balance by Country in May
Source: Korea International Trade Association, Unit: Million USD

[Asia Economy Reporters Park Sun-mi, Choi Dae-yeol, Jung Dong-hoon]South Korea's trade balance with China is likely to continue running a deficit in July, following deficits of $1.1 billion in May and $1.21 billion in June. This is because if the global consumption downturn persists, global manufacturers in China will inevitably reduce their orders for intermediate goods imported from South Korea. Among all countries, China ranks first in terms of the share of total exports. Within this, the proportion of intermediate goods is absolute.

Despite the declining export trend, dependence on China for raw materials needed to produce semiconductors and petroleum products is actually increasing. The higher the dependence, the more a drop in exports can worsen corporate profitability. Companies are seeking solutions such as diversifying their clients, but finding a solution is difficult. Even if they try to diversify import sources to other regions, it is not easy considering logistics costs and other factors. Some voices express concern that the trade deficit with China, caused by export decreases and import increases, could become prolonged.

Consumption Contraction Hits Hard Due to Lockdowns in China

LG Display, with 97% of its sales overseas, was unable to properly deliver products to global clients such as Apple, HP, and Dell, which have production plants in China, due to lockdowns in regions like Shanghai caused by the 'Zero COVID' policy in Q2 this year. On top of that, rising prices, interest rate hikes, and consumption slowdown combined to weaken sales of TVs and IT products. As Chinese clients reduced their order volumes, a return to deficit in Q2 became inevitable.

An industry insider expressed concern, saying, "Chinese companies in the display market continue aggressive LCD panel price cuts to expand their global market share, weakening the competitiveness of Korean companies. Coupled with the dual challenges of inflation-induced demand slowdown for TVs and PCs, it is practically difficult to find a turning point to improve LCD panel supply and price declines." Another insider said, "Many global set manufacturers have production plants in China, so global consumption contraction immediately translates into reduced exports to China. Companies must endure by cutting costs and strengthening competitiveness focused on high value-added products to improve profitability."

The slowdown in China's economic growth and Chinese companies' efforts to localize key components to overcome this pose threats to Korean companies that export many intermediate goods. Kim Cheon-gu, SGI Research Fellow at the Korea Chamber of Commerce and Industry, advised, "Companies should pursue diversification of overseas markets such as ASEAN and advanced countries to replace exports to China. In export strategies toward China, it is necessary to shift from an intermediate goods-centered export structure to strengthening Korea's supply capacity focused on consumer goods such as bio, life sciences, beauty, and food." Kim added, "About one-quarter of South Korea's total exports depend on China, so a slowdown in the Chinese economy is highly likely to lead to domestic growth slowdown. If South Korea's exports to China decrease by 10%, the domestic economic growth rate will fall by 0.56 percentage points, and a 20% decrease will cause a 1.13 percentage point decline."

However, regarding the sharp export decline in the semiconductor sector, which accounts for a large portion of South Korea's exports to China and is causing the trade balance to shrink, some opinions suggest that this phenomenon is due to increased local production rather than deterioration in corporate competitiveness or market supply-demand changes, so there is no need for major concern. Kim Ah-rin, Research Fellow at the Korea International Trade Association, diagnosed, "One reason for the trade deficit turning negative with China is that domestic companies, which used to export intermediate goods directly to China, have recently increased local production by establishing factories in China." She added, "Although this may be negative from a trade balance perspective, it is not a concern from an individual business perspective. It is an area where the government needs to prepare a new trade strategy toward China."

Chinese Products Invade South Korea Backed by 'Technological Strength'

Not only are finished cars made in Chinese factories of overseas brands such as those from Europe imported into South Korea, but recently, imports of Chinese brand electric vehicles have also increased significantly. China has long focused on electric vehicle development and production, rapidly increasing exports of various electric vehicles including passenger cars and commercial vehicles. For commercial vehicles, price competitiveness is crucial, so demand for inexpensive Chinese buses and trucks is rising.

According to Kaizyu Data Research Institute, among newly registered commercial vehicle brands (buses, trucks, special vehicles) in South Korea in the first half of this year, Dongfeng Sokon (2nd), Higer Bus (8th), Changan Automobile (9th), CHTC (11th), China National Heavy Duty Truck Group (12th), and King Long (13th) all ranked. Until the first half of last year, sales per brand were in the tens or less than ten units, but this year, sales have increased to triple digits across the board. Until 2019, before COVID-19, China was outside the top 10 countries exporting cars to South Korea, but last year it ranked 9th, and as of June this year, it rose to 3rd place behind Germany and the United States for the first time, surpassing traditional top importers like Japan.

Automotive parts, once a representative foreign currency earning item in trade with China, turned to a deficit from 2020. This year, exports to China until May amounted to $598 million, about 20% less than the same period last year, while imports increased by 5% to $979 million.

For these reasons, trade in automobiles with China reversed several years ago. According to Korea International Trade Association statistics, the trade surplus peaked at $2.31 billion in 2011 (exports $2.342 billion, imports $32 million) and has gradually declined, turning into a steady deficit since 2017. Especially, exports have shrunk significantly, while imports from China have increased by double digits annually, but Korean automobile companies have no sharp solutions to reverse this trend.

Dependence on China for Raw Materials Such as Secondary Batteries and Petrochemicals is Increasing

Due to energy and raw material inflation, the high import growth rate continues, with significant increases in imports of petroleum products such as crude oil, natural gas, coal, and raw materials needed for semiconductor production. The trade deficit in sectors heavily dependent on Chinese imports for raw materials such as secondary batteries and petrochemicals is growing.

Imports of non-ferrous metals, including lithium, nickel, and cobalt, which are raw materials for secondary batteries considered future growth engines, increased from $6.52 billion (about 8.53 trillion KRW) in 2020 to $9.78 billion (about 12.8 trillion KRW) last year, and $12.73 billion (about 16.65 trillion KRW) this year as of the first half. Most non-ferrous metals are imported from China.

Key raw materials for making electric vehicle batteries include lithium, nickel, cobalt, graphite, manganese, and copper. Although reserves vary by material, most undergo intermediate processing in China. China not only holds large reserves of rare metals and minerals but also serves as the world's 'processing factory,' so purchasing key raw materials requires reliance on China. For example, graphite is mined in Africa and South America, but most refining and intermediate processing occur in China, making 70-80% of graphite used by major countries Chinese-made. Such high dependence on China poses risks to the industry itself. Amid US-China tensions and raw material supply difficulties, incidents like the 'second urea solution crisis' could occur.

Battery and material companies are making efforts to diversify the highly concentrated raw material supply. POSCO is a representative example domestically. Since starting lithium extraction technology development in 2010 and launching anode and cathode material businesses, POSCO Group has acquired lithium salt lakes in Argentina, invested in lithium and nickel mines in Australia, and graphite mines in Tanzania to secure secondary battery raw materials.

Additionally, battery material companies such as LG Chem, POSCO Chemical, and EcoPro BM have consecutively established response teams to secure raw material supply amid supply chain crises. The intention is to diversify raw material supply chains to spread risks. They are also developing new battery technologies based on more abundant raw materials such as manganese and sodium.