[Chatham House]③ "Next Year's Economy More L-Shaped than V-Shaped... Preventing the Worst Is the Best"

Is the PF-Induced Financial Crisis Really Coming?

Editor's NoteThe economic and financial think tank of this newspaper, ‘Asia Economy Chatham House,’ has been launched. On the 1st at Lotte Hotel in Sogong-dong, Jung-gu, Seoul, an in-depth discussion was held under the theme ‘Will a Crisis Arise from Project Financing (PF)? - An In-depth Diagnosis of Korean Finance’ with Kwak Young-kwon, Executive Director of Meritz Securities, Kim Dong-won, former invited professor at Korea University, Park Jae-ha, former Deputy Director of Korea Institute of Finance, Lim Jin, Director of the Korea Chamber of Commerce and Industry’s Sustainable Growth Initiative (SGI), and Cho Won-dong, former Chief Presidential Secretary for Economic Affairs (in alphabetical order). The participants predicted that “the current economic recession situation will not reach the level of the past International Monetary Fund (IMF) foreign exchange crisis.” However, opinions differed on the extent of the government’s role in overcoming the crisis. There was a sharp debate between those who argued for proactive and aggressive policy responses and those who countered that government intervention might rather hinder the market’s natural restructuring. Many also pointed out that preparing for the deepening polarization and super-aged society after 2023 is more urgent than immediate market instability. Asia Economy Chatham House follows the ‘Chatham House Rule,’ disclosing the list of participants but anonymizing each speaker’s remarks. The full discussion will be published in several parts.

On the 1st, participants are sharing their opinions at the 1st Asia Economy Chatham House event titled 'Is a PF Crisis Coming?

◆ Moderator = Lee Jung-jae, Director and Editorial Advisor of Asia Economy Economic Media School

(Reference)

PF-triggered Financial Crisis, Is It Really Coming?

"Korea Electric Power Corporation (KEPCO) is a bottomless jar and a black hole, electricity rates must be raised" continued

"Long-term recession shaped more like an L than a V... The shock of aging starts now"
"Foreign investors are withdrawing money from Korea... The large interest rate gap with the U.S. is risky"

Thank you all for your insightful comments. I agree with many points. Generally, I concur with the forecast that the second quarter of next year will be the most difficult period for both our economy and the global economy. At that time, another shock may hit our real estate market, which I believe deserves close attention. In that regard, I absolutely agree with Speaker B’s opinion that more proactive real estate measures are necessary. Also, I think the current situation is a mix of cyclical and structural issues, causing the steps to be completely tangled. The difficulties we face now are structural problems coinciding with a cyclical contraction phase. This means the government’s options are significantly limited.

The focus of Speaker D’s remarks is on how long the recession phase will last. I believe it is more likely to be a prolonged L-shaped recession rather than a V-shaped one. From 2012 to 2016, the global economy crawled along the bottom for five years, and during that period, the Park Geun-hye administration was hit hard. Looking at the current global economic situation, it seems worse than the 2012-16 recession period rather than better. The next decade could be more challenging than the last ten years. Therefore, a long recession is more likely than a short recovery.

Speaker E mentioned that the industry situation is very serious and urgent government support is needed, but this is no easy matter. In fact, the government has devised very sophisticated measures. The Bank of Korea and supervisory agencies are injecting liquidity into banks and purchasing bonds. For example, the Bank of Korea is backing banks, banks are backing large securities firms, large securities firms are mobilizing 5 trillion won to back small securities firms, and small securities firms are backing PF projects. This is like putting an oxygen mask on the market. Since last Friday, 5 trillion won has been used to support small securities firms’ PF, which has slightly lowered interest rates, but whether this is sufficient remains to be seen. The entire PF market is about 200 trillion won, and the problematic portion held by credit finance companies is about 26.7 trillion won. Savings banks hold about 10.7 trillion won, and securities firms hold 3.3 trillion won. I think securities firms are not a big problem. The top 10 securities firms can cover small securities firms’ PF. The problem lies with the rest. How to handle PF from credit finance companies and savings banks? In my view, this is a complete bomb. In December last year, unsold apartments numbered 17,700 units. Now, a year later, it has increased to about 50,000 units. Will this decrease by December next year? I think it will be difficult. Therefore, the government must either continue to expand this PF backup system until next year or at least sustain it, but is that feasible? Realistically, it is not easy.

Another point to note is the situation of foreign institutional investors’ purchases of our government bonds. This is a key part of our foreign exchange supply. Since September, when government bond repayments began, they have started withdrawing money without rolling over issuance. This deserves close attention. Previously, they naturally rolled over and bought more Korean government bonds, but now they do not. The reason is interest rates. Earlier, Speaker C mentioned the 1% interest rate gap by the Bank of Korea Governor, but I think it was a serious mistake that the Bank of Korea raised rates by only 0.25 percentage points this time. It was a very complacent decision. Widening the interest rate gap with the U.S. this much is very risky, in my opinion.

As seen in the October industrial production trends, manufacturing and services, production and consumption have all been in recession for four or two consecutive months. This means the Korean economy has entered a complex multi-dimensional imbalance. As both external and internal conditions worsen, the range of policy choices narrows due to conflicts between real and financial sectors domestically and externally. I believe the focus should be on correcting external imbalances rather than internal ones. Policy priority should be on financial stability rather than real economy. Next year’s economic policy should aim to prevent the worst-case scenario. That is the best approach. The current crisis is a result of accumulated policy problems from the previous administration combined with external issues, causing the steps to be tangled and harder to resolve. We should not be greedy to solve everything at once but prioritize policies accordingly. The most important is to avoid external imbalance shocks. Since the trigger is financial, financial stability is crucial... Still, we should not be overly pessimistic. As long as the Korean economy remains competitive and the government maintains trust by managing the economy properly, there should be no major problems.

Speaker C also mentioned ‘Japanification.’ Regarding aging, we face more difficulties than Japan. Japan’s deficits have increased due to aging countermeasures, but we are just beginning. I think our situation will be much more severe than Japan’s.

On the 1st, participants are sharing their opinions at the 1st Asia Economy Chatham House event titled 'Is a PF Crisis Coming?

"Cheap electricity rates are subsidies from taxpayers to foreign companies like those in Japan"

Japan experienced this as well, but I believe short-term economic responses should not lead to structural problems. For example, as Speaker E mentioned, the problem of non-performing bonds is serious. The government needs to respond to stabilize the market. However, what is capitalism? In the economic cycle, entering a recession is painful but involves restructuring. It is very important to save only the companies that must be saved and decisively restructure those that should be liquidated to keep the economy healthy and prevent structural problems from accumulating.

Globally, there is general agreement that the second quarter of next year will be very bad. The Bank of Korea also lowered its growth forecast to 1.7% for next year, so the outlook is indeed bleak. However, capitalism’s success or failure depends greatly on how the recession period is utilized. We need economic measures that carefully distinguish the wheat from the chaff, manage the market to prevent collapse, and prevent structural problems from accumulating.

Also, regarding the KEPCO issue mentioned earlier by Speaker B, I consider it a structural problem. About ten years ago, the Nihon Keizai Shimbun reported a rush of many Japanese companies to Korea, mainly because of electricity rates. Korea’s electricity rates are incomparably cheaper than Japan’s. Our electricity rates are internationally competitive enough to attract foreign companies. But is that really good? No. It is because electricity produced at high cost is sold cheaply, which is essentially the government subsidizing foreign companies with taxpayers’ money. This is not right and unsustainable. As Speaker B said, electricity rates should be normalized as soon as possible. The delay in raising electricity rates has accumulated deficits and KEPCO bonds, turning into structural problems. We should manage economic policies to prevent such situations from recurring. There is some debate about whether the economy will enter a long-term recession phase after next year. Even if the global economy follows an L-shaped path, I hope our economy can achieve a V-shaped recovery through good economic management.

Looking back, during the 2008 financial crisis, it was said to be more severe and longer than the Great Depression, but that did not happen, although various aftereffects remained. So, things always look worse during bad times, but it is precisely at such times that the government needs to respond quickly and effectively with policies. (To be continued in the next part, see also: Should the ‘Yeongkkeul’ group be rescued? Government intervention "Yes vs No")