[Trapped Chinese Economy]⑪ China on the Test Bench, South Korean Economy in Typhoon's Path

As China’s real estate, investment, and consumption sectors experience a triple slump, dark clouds are gathering over the South Korean economy, which had strongly anticipated a reopening (resumption of economic activities) effect. South Korea has a high dependence on exports to China and relies heavily on China for intermediate goods used in exports, making it vulnerable to a direct hit if the Chinese economy does not recover. The government forecasts a "low in the first half, high in the second half" scenario, expecting global economic recovery and export improvements in the latter half of the year. However, ongoing US-China geopolitical tensions and continued sluggish exports to China are shaking South Korea’s economy, which has a high mutual dependence on supply chains with China.

According to the Bank of Korea, one reason for lowering this year’s growth forecast to 1.4% in May was the judgment that the expected reopening effect from China, which was supposed to drive growth, was not clear. The Bank of Korea is scheduled to revise its economic outlook on August 24, and the market is paying close attention to how the recent sluggishness in the Chinese economy might affect the growth rate. In its May revised economic outlook, the Bank of Korea’s scenario analysis suggested that if China’s economic recovery is worse than expected, the growth rate could drop to 1.1% this year, 0.3 percentage points lower than the previous forecast. Last month, after the Monetary Policy Committee meeting, Bank of Korea Governor Lee Chang-yong expressed concerns about the economic outlook for the second half of the year, stating, "While the US is increasingly likely to achieve a soft landing, which would help our growth, uncertainties around the Chinese economy have grown," adding, "It seems that China’s growth rate is not rising as quickly as we had anticipated."

According to the Ministry of Trade, Industry and Energy, exports to China in July amounted to $9.9 billion, down 25.1%. Exports to China exceeded $10 billion for two consecutive months in May ($10.6 billion) and June ($10.5 billion), but fell below $10 billion last month due to declines in semiconductor and petrochemical prices and delayed recovery in industrial production within China. The trade deficit with China in July was $1.27 billion. The trade deficit with China has persisted for ten consecutive months from October last year through last month.

Particularly, due to the structural vulnerability of South Korea’s high external dependence, there are concerns that the spread of geopolitical risks could cause real economic damage and trigger foreign exchange and financial instability based on international financial market judgments. Senior Research Fellow Ji Man-soo of the Korea Institute of Finance explained, "South Korea, like Germany, is a manufacturing export-based economy with a high dependence on overseas markets for its exports," adding, "For example, to produce $10 billion worth of goods, $3.2 billion worth of imports are required, and only by importing can exports be made." Ji noted, "Because the international financial market understands this structure, if free trade is shaken, capital tends to be withdrawn starting from South Korea." Lee Chi-hoon, Head of Emerging Economies at the International Finance Center, diagnosed, "South Korea is connected to China through various channels such as demand, investment, and foreign exchange, making it sensitive to unexpected changes in China’s economic policies and environment," and added, "Not only is there exchange rate synchronization between the won and the yuan, but Chinese banks account for 50-60% of transactions in South Korea’s foreign currency funding market, indicating significant influence of China on the domestic foreign exchange market."

In fact, for key export items such as automobile battery core materials and semiconductor equipment materials, parts, and equipment (so-called 'Sobejang'), dependence on China and Japan is very high. As of the first half of last year, there were 636 imported items with over 75% dependence on a specific country, of which more than half, 351 items (55.2%), were dependent on China. Additionally, there were 339 items with over 90% import dependence on a specific country, with 178 items (52.5%) dependent on China, the highest number.

Experts predict that sluggish exports to China will continue long-term and agree that strengthening the Sobejang sector could become a driving force to revive the South Korean economy. They emphasize the urgency of the government’s active support to strengthen Sobejang, one of the most vulnerable sectors in the economy, as a fundamental solution. Ji explained, "Due to the geographical advantage of being close to China, we enjoyed a China-specific boom but failed to undergo the intense industrial upgrading that should have taken place domestically," adding, "By taking the Chinese market, which offers low costs, as an easy alternative, we did not pursue painful industrial upgrading, and in this process, especially small and medium-sized enterprises weakened structurally." Lee also emphasized, "To minimize risks arising from changes in China’s economy and policies, it is necessary to establish supply chain stability systems such as China Plus One to diversify procurement of parts and minerals," and added, "Despite the slowdown in China’s long-term growth rate, the expansion of China’s economy and its shift toward consumption suggest the need to expand entry into promising sectors such as online, cultural, silver (senior) services, and government procurement markets."

Furthermore, they urged close monitoring of China’s structural changes and preparation of countermeasures. With forecasts that China will no longer achieve the high growth rates of the past, there are calls for diversified solutions for South Korean exports. Kang Jun-young, Professor of Chinese Studies at Hankuk University of Foreign Studies’ Graduate School of International and Area Studies, said, "China has been importing intermediate goods from South Korea to manufacture finished products for export abroad, but with China’s rising technological competitiveness, its self-sufficiency in intermediate goods has increased, which is expected to further impact our exports to China," adding, "We need to break away from the Korea-China trade structure dependent on intermediate goods and discover new products or industries that can open China’s wallet."

The recent sluggishness in China’s economy has also brought attention to the 'Peak China' discourse. With an aging population, accumulated debt, and strong US containment measures slowing China’s growth, some voices suggest that beyond 'Peak China,' China may face an economic crisis. One of the main reasons for the 'Peak China' discourse is the worsening employment and job shortage problems.

Currently, youth unemployment in China has emerged as a significant social issue. During the economic growth process, the number of university graduates increased rapidly, but job opportunities for them have not expanded, causing a severe job mismatch. According to China’s National Bureau of Statistics, the number of university graduates was 8.34 million in 2019 and surged to 11.58 million this year. With no policy measures to expand employment for graduates, graduate school enrollment has noticeably increased. Between 2021 and 2022, China’s graduate school enrollment rate jumped from 34.2% to 40.8%.

Lee Il-hyung, former senior representative for China at the International Monetary Fund (IMF) and former Monetary Policy Committee member, pointed out, "Youth unemployment in China has become a social problem," adding, "As baby boomers retire in earnest, if China tries to stimulate the economy without industrial upgrading, it could cause labor shortages and wage increases for workers below the university graduate level." Uncertain future prospects and worsening employment conditions are also leading to reduced household consumption. Professor Park Seung-chan of Yongin University’s Department of Chinese Studies said, "Youth unemployment is an issue challenging President Xi Jinping’s leadership," adding, "China’s unemployment rate is a barometer of the Communist Party’s leadership, so the Chinese authorities cannot ignore it."

Global major investment banks (IBs) forecast that despite downward revisions to this year’s outlook, China’s economy will grow at a moderate pace averaging 5.2%. Growth rates are expected to slow by about 0.4 percentage points annually, reaching around 3.8% by 2027. They also expect that China’s economy is unlikely to face a crisis while maintaining growth of around 4% over the next two to three years, but downward pressure on the economy will persist due to conflicts between reform and growth and weakening policy momentum amid private sector contraction.

Professor Park said, "Going forward, China’s growth will gradually shift to a domestic demand-centered model as exports shrink," and urged, "South Korea should prepare a de-risking strategy against China while actively utilizing China’s shift toward consumption." Han Jae-hyun, Senior Resident Representative of the Bank of Korea in Shanghai, stated, "China achieved a 5.5% economic growth rate in the first half of the year and is expected to achieve around 5% growth for the whole year," adding, "Despite intense technological hegemony competition amid US-China tensions, China’s concentration in future industries such as batteries, solar power, and fuel cells is increasing, so we need to maintain close cooperative relations with China."