[Issue Interview] "We Must Escape China's Trap by Establishing a Multilateral System for Economic Security and Value Trade"

Park Yang-su, Head of KERI
China's Reopening Positive for Korea
Inflation Poses Risks
Need to Diversify Raw Material Import Sources While Maintaining Exports to Chinese Market
Not the Time to Discuss Interest Rate Cuts

Park Yang-su, President of the Economic Research Institute at the Bank of Korea, is being interviewed on the 6th at the Bank of Korea Sogong Annex in Jung-gu, Seoul. Photo by Kang Jin-hyung aymsdream@

[Asia Economy Reporter Seo So-jeong] "In the context of strengthening global fragmentation, strategic choices are crucial for the sustained growth of the Korean economy. To overcome the current crisis, it is necessary to approach multilayeredly the establishment of a multilateral system based on economic security and value-based trade."

Park Yang-su, Director of the Economic Research Institute at the Bank of Korea, stated that economic security in the energy, raw materials, and technology sectors has become increasingly important as global economic fragmentation accelerates due to the COVID-19 pandemic, US-China trade conflicts, and the Russia-Ukraine war.

Recently, the Korean economy has fallen into the "China trap." While the Korean economy benefited from China's rapid growth, exports to China have been severely shaken due to the impact of COVID-19, triggering alarm bells on the export front. Amid intensifying US-China conflicts, exports, which are the backbone of our economy, continue to show unstable trends, and inflation triggered by the Russia-Ukraine war still shows no sign of easing. Asia Economy met with Director Park to diagnose the current economic crisis and explore solutions for the sustained growth of the Korean economy.

-There are many calls to reduce dependence on China as exports to China have significantly decreased. What kind of breakthrough is needed?

▲Recent global supply chain restructuring is proceeding on two tracks. The first is to emphasize economic or technological security and strengthen cooperation systems centered on items such as semiconductors, electric vehicles, and batteries. The second is a trend to strengthen value-based trade by scrutinizing production processes such as ESG (environment, social, governance). Trade with China should also be examined from this perspective. Although the Korean economy benefited from export growth due to China's high growth, the dependence on imports and exports has also become very high. As of 2021, the dependence on intermediate goods imports from China was 23%, second only to Taiwan. There was also a side effect of delaying the transition to a manufacturing-centered economic structure. To overcome the crisis going forward, strategic choices are even more important. In trade with China, efforts are needed to maintain the Chinese market as an export market as much as possible while diversifying raw material import sources to ASEAN, Australia, South America, and others. At the same time, efforts to pioneer countries with expanding markets such as India as new export markets should be doubled.

-This year, the Korean economy is expected to be greatly influenced by the speed of China's economic recovery.

▲China is expected to gradually normalize economic activities from the second quarter of this year due to the reopening effect following the easing of quarantine measures, and international organizations and investment banks are successively revising upward China's growth rate for this year. For Korea, which has a very large trade volume with China, China's technical rebound will positively affect the improvement of intermediate goods exports and the increase in consumer goods exports. Also, in the semiconductor sector, signs of easing global oversupply are emerging, and the easing of production disruptions in China and improvement in IT device consumption will help our export recovery. Furthermore, the surge in Chinese overseas travel is expected to improve Korea's service exports. However, China's economic normalization may act as a global inflationary pressure through the recovery of raw material demand and may exacerbate Europe's energy problems. Ultimately, China's economic normalization will be positive for Korea's growth but a risk factor for inflation.

-Bank of Korea Governor Lee Chang-yong mentioned at last month's Monetary Policy Board meeting that this year's economic growth rate would be revised downward from the forecast of 1.7%. Has there been any change recently with China's growth rate being revised upward?

▲In November last year, the Bank of Korea's Research Department announced an economic growth forecast of 1.7% for this year. The base shift effect, caused by worse-than-expected fourth-quarter results last year due to worsening COVID-19 conditions in China, semiconductor market contraction, and sluggish consumption, raised the possibility of falling below this forecast. However, since then, many conditions have changed, including upward revisions of economic outlooks for the US, Europe, and China. Considering these comprehensively, the Bank of Korea's Research Department plans to announce new economic growth figures on the 23rd of this month.

-The US Consumer Price Index (CPI) for January rose 6.4% year-on-year, exceeding market expectations. Concerns about prolonged inflation are resurfacing.

▲Recently, there has been a significant gap between the market and the Fed, but with January CPI exceeding expectations, concerns are growing that inflation may become more entrenched than anticipated. The market had hoped that the rise in price indicators would subside and that the previously high-intensity tightening might push the economy into recession, leading to expectations that the Fed might cut rates within this year. However, this announcement has led to speculation that the Fed may raise rates more than initially expected and maintain high rates for a longer period. The Fed believes that while commodity prices are undergoing disinflation (a slowdown in the rate of increase), high inflation in housing and non-housing services sectors persists. Especially, despite the slowdown in economic growth, the US labor market remains strong. From the Fed's perspective, there is concern about repeating the early 1980s scenario of under-tightening (doing too little), which led to a resurgence of inflation. Although the gap between the Fed and the market could cause instability in global financial markets, the likelihood is considered low. Fed Chair Powell's remarks at the February Federal Open Market Committee (FOMC) press conference, acknowledging the difference in views with the market on the pace of inflation decline, stating no intention to overtighten, and having appropriate measures ready if inflation falls rapidly, support this view.

-There is a growing view that the timing of US rate cuts will be brought forward. Could Korea start cutting rates before the US?

▲Chairman Powell stated at the last FOMC that if the economy proceeds as expected, there will be no rate cuts within this year. He also said that decisions would be data-dependent if data trends change. Although the interest rate differential between Korea and the US has inverted and the gap has widened to 1.25 percentage points, the exchange rate is generally showing a downward stabilization trend. This means that while interest rate differentials influence exchange rate determination, they are not the most important factor, and central banks can independently set policy rates according to their economic conditions. However, Korea's consumer price inflation remains high at around 5%, and due to accumulated cost increases, the decline is expected to be gradual, so Korea is not yet at a stage to discuss rate cuts.

-There is an argument that the era of price stability and long-term interest rate decline, which lasted for 40 years since the pandemic, has ended.

▲Many changes have occurred through the COVID-19 pandemic. First, due to global fragmentation, investments to secure supply chain resilience are expected to increase. In the process of green transformation toward an eco-friendly economy, investments in new technologies must increase. Also, income redistribution policies need to be more actively implemented. Government debts in many countries have increased significantly, exerting upward pressure on real interest rates. Global fragmentation and the production cost increases from green energy production are factors that raise inflation. Many argue that these changes will alleviate concerns about structural long-term stagnation similar to the pre-pandemic period. Korea's situation differs slightly from the global context, but as a small open economy, it cannot be free from global phenomena.

-Although last year's employment increased by 820,000, the largest increase in 22 years, a cold wave is expected this year. The Bank of Korea forecasts employment growth of about 90,000 this year, raising concerns about an employment cliff.

▲Before COVID-19, from 2015 to 2019, employment increased by about 250,000 annually on average but dropped significantly due to the pandemic and then surged by 820,000 last year due to the reopening effect. This is an extraordinary phenomenon, and from this year, employment is expected to approach the long-term trend. The long-term trend is determined by demographic structure, and recently, the population growth rate of those aged 15 and over is declining, and the retired population is increasing. Although the economic participation rates of those over 60 and women are rising, it is difficult to offset the effects of aging and declining birth rates. Considering this, the employment increase or decrease along the long-term trend will be significantly lower. Therefore, the rapid reduction in employment growth should not be interpreted as an employment cliff or lack of job creation but rather as a need to focus on mitigating the impact of population decline on potential growth rates through measures such as increasing female labor participation and utilizing foreign labor.

-Domestically, concerns are rising about wage-price interactions as inflation expectations increase due to inflation.

▲Recently, inflation expectations peaked at 4.7% in July last year and have gradually stabilized downward to 3.9% in January. Also, the degree to which inflation expectations strengthen wage-price interactions appears to be lower than in the US. In the US, labor supply is shrinking due to population aging and reduced immigration, and a tight labor market with high job vacancy rates maintains high wage growth, while non-housing services inflation remains high. In contrast, in Korea, the food service prices, which have a large labor cost component, have shown a slowdown in the upward trend since October last year. However, wage-price interactions tend to strengthen during periods of high inflation, especially if inflation expectations are not stabilized, so policy efforts should continue for a considerable period to stabilize inflation expectations downward.