[Ask IB] ① ING "Korea Faces Low Inflation, Not High Inflation... Due to Declining Potential Growth Rate"

Global Comprehensive Financial Group ING Economist Kang Minju

Kang Minju, Senior Economist at ING Bank, is being interviewed by Asia Economy on the 12th at the ING conference room in Seoul Finance Center, Jung-gu, Seoul. Photo by Kim Hyunmin kimhyun81@

"South Korea is more likely to experience low inflation rather than high inflation going forward. This is because it is difficult for prices to remain high when the country's potential growth rate itself is declining."

Kang Minju, Chief Economist at ING Bank, said in an interview with Asia Economy on the 12th that South Korea's inflation rate is expected to fall from 3.7% this year to 1.7% by the year after next. Considering the increasing burden of high interest rates due to recent high inflation, low inflation in the 1% range might actually be welcome, but since this is a result of weakened growth potential in South Korea, it is hard to interpret it positively.

ING also forecasted South Korea's economic growth rate to be 1% this year and 1.8% next year. This is significantly lower than the Bank of Korea's conservative forecast of 1.4% this year and 2.2% next year. Economist Kang said, "South Korea grew by 0.6% quarter-on-quarter in Q2 this year, but if you look closely, nothing actually increased; it was just that imports fell more than exports," adding, "Since the U.S. is also expected to experience a technical recession next year, South Korea's growth rate is likely to recover only in the second half of next year."

Although the economy is not doing well, he forecasted that Seoul housing prices will continue to rise. This is because demand for Seoul real estate remains solid despite reduced supply and high interest rates. He said, "There will be an ongoing tug-of-war between 'I can't buy a house because interest rates have risen' and 'I can't buy a house even though prices will double,'" adding, "The Bank of Korea, which must manage household debt, will likely continue to send signals to the market that even if people buy houses, the expected returns won't be high due to prolonged high interest rates."

However, Economist Kang explained that the export situation should not be viewed pessimistically because the situation in China, which greatly affects the Korean economy, is gradually improving, and domestic technological development is continuing. He emphasized, "South Korea has achieved rapid technological advancement and quickly discovers new export items," adding, "Since the domestic market is too small, it is an advantage that exports are considered first when making investments."

He also predicted that international oil prices, which weigh heavily on the Korean economy, will not rise indiscriminately. Economist Kang said, "If Iran or Saudi Arabia get involved in the Israel-Hamas war, it could be problematic," but explained, "From the perspective of Middle Eastern oil-producing countries, since oil demand is not strong, rising international oil prices alone could be a burden, so they will likely regulate it."

Below is a Q&A with Economist Kang Minju.

Kang Minju, Chief Economist at ING Bank, is being interviewed by Asia Economy on the 12th at the ING conference room in Seoul Finance Center, Jung-gu, Seoul. Photo by Kim Hyunmin kimhyun81@

-Recently, expectations for a U.S. Federal Reserve (Fed) rate cut have diminished, and more forecasts predict prolonged high interest rates. Will high interest rates become the 'new normal' again?

▲It is true that the U.S. 'business cycle' is good this year, but I believe the effects of rate hikes will eventually appear. There will be a slight 'technical recession' (two consecutive quarters of negative growth) next year, and then the Fed will start cutting rates. Since student loan repayments have resumed in the U.S., consumption may shrink initially, and inflation will clearly decline from Q4 this year. The Fed is expected to cut rates by 25 basis points (1bp = 0.01 percentage point) around March next year and reduce rates by about 50bp in the 2nd and 3rd quarters. Therefore, rates are expected to fall to 3% by 2025.

Of course, 3% is still higher than pre-COVID-19 levels. However, whether 3% is considered high interest depends on the benchmark. The reason I do not consider 3% a high level is that during COVID-19, the U.S. experienced many technological innovations, which increased the potential growth rate. Since interest rates rise with the potential growth rate, it is questionable whether this level can be considered high interest given the economic situation.

-Aging and deglobalization are factors that cause inflation. Some analyses suggest that the 'low inflation era' caused by globalization and cheap Chinese exports in the 2000s has ended, and a 'high inflation era' will return.

▲Central banks' inflation targets of 2% have not changed yet. This means it is difficult to conclude that there has been a structural change significant enough to alter economic fundamentals. Of course, there are various recent changes that could exert upward pressure on prices, and China may no longer be a country exporting deflation, but on the other hand, technological developments such as artificial intelligence (AI) could lower prices further. Therefore, we basically expect inflation to remain in the 2% range.

Especially in South Korea, low inflation is more likely than high inflation going forward. (Since the elderly mostly do not engage in production activities and consume, they are inflationary.) Aging can stimulate prices and consumption, but since the country's potential growth rate itself is declining, it is difficult for prices to remain high. We expect this year's inflation rate to be 3.7% annually, 2.4% next year, and about 1.7% the year after next. In the past, there was a high-growth phase, but now, as we move toward an advanced country model, volatility will decrease, and we will enter a phase of stable growth and inflation.

-Despite concerns about high interest rates and recession, the labor markets in the U.S. and South Korea remain robust. What is the reason?

▲First, the U.S. had very strong investment during COVID-19. Increased investment means increased production capacity. Accordingly, hiring and job seeking must increase. Additionally, the pent-up consumption effect during the post-COVID-19 normalization has driven the current robust labor market. In contrast, South Korea's labor market is supported by social welfare and medical jobs that had high demand during COVID-19, government work programs, and short-term job policies. The private sector is not doing well. Unlike the U.S., South Korea's labor market is not flexible, so labor market volatility is not large.

The indicators I focus on are manufacturing, construction, and then services. Manufacturing employment is not very good, construction shows slight signs of rebound but is expected to remain weak due to poor leading indicators. In the service sector, consumption has been maintained somewhat, but it is questionable whether this can continue after the summer vacation season ends.

-What is your outlook on the real estate market?

▲Construction is an easy sector to predict because leading indicators are very clear. Permits must be issued, and construction must start before completion. The number of permits and construction starts has been declining this year and has been negative for the past six months. This means supply cannot increase much in the future. When supply and demand mismatch, prices move. Seoul leads South Korea's real estate market, where supply is insufficient, while provinces have surplus. Seoul housing prices will continue to rise, and provinces will polarize due to aging and demographic structure over the next 10 years. People are not avoiding buying houses in Seoul; they simply cannot afford them. Demand is solid. I do not expect Seoul housing prices to crash, though provinces may differ.

Looking at South Korea's real estate market over the past 2-3 years, it seems more sensitive to government policies than interest rates. In fact, when interest rates rise like now, countries like South Korea with many variable-rate loans inevitably face increased household debt burdens. However, people invest because they believe the expected returns from asset growth outweigh this. This sustains the real estate market.

-As expectations for Seoul housing prices revive, household debt is rising again. How will the Bank of Korea respond?

▲There is concern that when the Bank of Korea reaches the point to cut the base rate later, it may want to cut more but be unable to. Despite high interest rates now, household debt is increasing, so if rates are cut, household debt could increase further. However, raising rates further could abruptly plunge the economy, so additional hikes are difficult. Household debt and housing prices are hard to control solely with interest rates. It can be one method but not the main tool.

People adapt to high interest rates. Although current rates are considered high, there were times in the past when rates were in the double digits. Initially, there is resistance, but once adapted, it becomes 'normal.' The tug-of-war between 'I can't buy a house because rates rose' and 'I can't buy a house even though prices will double' will continue. The Bank of Korea will likely continue signaling to the market that even if people buy houses, expected returns won't be high due to prolonged high interest rates.

-South Korea's economy is heavily influenced by China. China's economy has been sluggish recently; do you expect long-term growth recovery?

▲I believe China's high-growth era has ended. It may or may not achieve its 5% annual growth target. The Chinese government seems to accept this. Rather than pursuing growth above 5%, it will likely aim for growth in the 4% range while resolving structural issues such as debt. It is qualitative growth rather than quantitative. Rumors of China's collapse have existed for 20 years, but China still controls the market through its political system and can still manage.

-The U.S. is rebuilding supply chains centered on allies and friendly countries while continuing export restrictions on advanced industries like semiconductors to China. Can China overcome this?

▲This only delays the time when China reaches advanced industrial technology development. China will invest more money and effort. When relations with Japan deteriorated 2-3 years ago and Japan excluded South Korea from its whitelist, South Korea responded by developing its own industries. China will also shift funds from construction and infrastructure to advanced industries to accelerate technological development. Artificial restrictions cannot change the flow.

Kang Minju, Senior Economist at ING Bank, is being interviewed by Asia Economy on the 12th at the ING conference room in Seoul Finance Center, Jung-gu, Seoul. Photo by Kim Hyunmin kimhyun81@

-What is the outlook for South Korean exports, including the recent sluggish exports to China?

▲There is no need to have a pessimistic view of South Korean exports. South Korea has achieved rapid technological advancement and quickly discovers new export items. Since the domestic market is too small, exports are considered first when making investments. This applies to nuclear power plants, renewable energy, and bio sectors alike. South Korea often conducts pilot tests and links them to exports, which is a strength. I compare the economic situations of South Korea and Japan; South Korea remains a very dynamic country. It rises and falls quickly and adapts well to new situations.

-The Bank of Korea forecasts 1.4% growth this year and 2.2% next year. Do you expect low growth to continue?

▲ING forecasts South Korea's economic growth at 1% this year and 1.8% next year. Initially, the forecast for this year was 0.6%, but it was raised to 1% because U.S. growth was stronger than expected. The biggest reason for strong U.S. exports was automobiles. In fact, this year's exports were largely driven by automobiles (including batteries). Another shield was Middle Eastern exports. The Middle East moves according to oil cycles rather than global economic cycles, and after increasing oil industry investment post-COVID-19, South Korea benefited.

-Why is there a difference between ING's and the Bank of Korea's growth forecasts?

▲Net exports. South Korea grew by 0.6% in Q2 this year, but nothing actually increased; imports fell more than exports. Industrial trend indices show construction, investment, and manufacturing are all weak. Growth comes from net exports. The difference in positions on net exports between ING and the Bank of Korea leads to different growth forecasts. The current account deficit bottomed in Q4 last year, rose in Q1 and Q2 this year, peaked in Q2, and is expected to slow in Q3 and Q4. Since the U.S. technical recession is expected to deepen in Q2 next year, South Korea's growth rate is likely to recover significantly only in the second half of next year.

-There is analysis that U.S. policy rate hikes are causing economic damage to emerging countries. What is the impact of U.S. tightening monetary policy on the global economy?

▲Emerging countries with good fundamentals were less affected, while countries like Argentina in South America suffered significant shocks. From the U.S. perspective, it cannot support other countries now. The global capital market became risky, and unless this damages the U.S. economy, tightening was inevitable. Emerging countries had to bear more pain than developed countries. The Korean won is very volatile, and the interest rate differential between Korea and the U.S. causes market stress, but this does not trigger a crisis.

-If the U.S. raises the policy rate by another 25bp this year, do you think the Bank of Korea should follow?

▲No. Even if the U.S. raises rates, the Bank of Korea is unlikely to follow. Last year, the Bank of Korea followed the Fed because it was uncertain whether the Fed would raise rates by 100bp or 50bp. Now, the market believes that if the Fed raises rates once more, it will be the last time. The Fed also has limited policy room. Moreover, the Bank of Korea's loan system reform in July (to reduce liquidity burdens on financial institutions) seems intended to maintain market stability through means other than interest rate policy if the interest rate gap widens and crisis signs appear.

-The Israel-Hamas war situation is unfavorable. How do you assess the risk to international oil prices?

▲If Iran or Saudi Arabia get involved, it could be problematic. However, this is not a period of rising oil demand. From the perspective of Middle Eastern oil-producing countries, since demand is not recovering, rising international oil prices alone are not favorable. When the Russia-Ukraine war broke out, oil prices rose with demand, but now the U.S. and Europe are at the end of their economic cycles, and China's recovery is not strong. The current oil price increase reflects a risk premium, but whether this premium will grow further is unknown.

Kang Minju, Senior Economist at ING Bank, is being interviewed by Asia Economy on the 12th at the ING conference room in Seoul Finance Center, Jung-gu, Seoul. Photo by Kim Hyunmin kimhyun81@

Kang Minju, Chief Economist at ING

Kang Minju is the Chief Economist at ING, a global comprehensive financial group headquartered in the Netherlands, responsible for the Korean and Japanese economies based in Seoul. Before joining ING, she worked as Head of Investment Research at the National Pension Service and also worked at JP Morgan and the World Bank. She holds degrees from Yonsei University, Ohio State University, and the University of Chicago.