The Bank of Korea: "Domestic demand recovered more than expected, but sustainability remains to be seen" [Q&A]

Q1 Real Gross Domestic Product (GDP) Press Briefing
Domestic Demand Recovered Better Than Expected, but Sustainability Remains Uncertain
Uncertainty Persists in Private Consumption and Construction Investment

[Image source=Yonhap News]

The Bank of Korea evaluated that domestic demand in the first quarter of this year showed a much stronger recovery than expected, but it is uncertain whether this will be sustained.

On the 25th, Shin Seung-chul, Director of the Economic Statistics Bureau at the Bank of Korea, said at the briefing on the "Q1 Real Gross Domestic Product (Preliminary)" that "Looking only at the first quarter results, the growth contributions from private consumption and construction investment were quite high, so domestic demand can be assessed as having shown a recovery trend," but he also emphasized, "We need to observe the sustainability."

According to the data released that day, the real GDP growth rate (preliminary) for the first quarter of this year rose by 1.3% compared to the previous quarter. This is the highest level in nine quarters since recording 1.4% in Q4 2021.

The strong growth was driven by robust exports and domestic demand recovery. Exports increased by 0.9% quarter-on-quarter, centered on IT items such as semiconductors and mobile phones. Private consumption rose by 0.8% due to improved consumer sentiment, with increases in goods (such as clothing) and services (such as food and accommodation). Construction investment also increased by 2.7%, with both building and civil engineering construction rising.

Director Shin stated, "The high private consumption in Q1 reflects increased external activities, the effect of new mobile phone releases, and consumer sentiment exceeding that of Q4 last year," adding, "Since it increased by 1.6% compared to the same period last year, it is difficult to say that it has fully returned to recovery."

He also pointed out that it is difficult to be optimistic about the construction sector. Shin said, "Construction investment was high partly due to a low base effect from poor Q4 last year results, and some of the results reflect the completion of large-scale projects. There are still uncertainties related to real estate project financing (PF), and the negative impact of poor construction-related indicators may fully emerge, so the construction sector could return to a sluggish trend."

Below is a Q&A with Director Shin.

-Q1 growth was 1.3%. It rose above zero after a long time. Was this growth much higher than initially expected?

▲The Q1 results seem to exceed the growth path forecasted by the Economic Outlook Division in February. The upcoming revised economic outlook next month will reflect the favorable Q1 results. Recently, geopolitical risks in the Middle East, exchange rates, and oil prices have shown instability. Additionally, changes in domestic economic conditions will be reflected, so the growth path is expected to be adjusted compared to February.

-There were initial concerns about weak domestic demand, but it contributed to economic growth similarly to exports. Can domestic demand be considered to have improved?

▲Looking only at Q1 results, private consumption increased by 0.8% quarter-on-quarter, which is quite high. Construction investment also contributed positively, so the growth contribution from domestic demand was quite significant. Based on Q1 results alone, domestic demand can be assessed as showing a recovery trend.

However, sustainability needs to be examined considering various conditions. Private consumption was low last year but high in Q1 due to increased external activities, the effect of new mobile phone releases, and consumer sentiment exceeding that of Q4 last year. Compared to the same period last year, it increased by 1.6%, so it is difficult to say it has fully recovered.

Construction investment was high partly due to a low base effect from poor Q4 last year results. The completion of large-scale projects also contributed to the results. Therefore, whether the domestic demand recovery will continue remains to be seen. Uncertainties related to real estate PF remain, and the negative impact of poor construction-related indicators may fully emerge, so the construction sector could return to a sluggish trend. Although Q1 indicators show domestic demand recovering, sustainability must be observed.

-Is the mobile phone release effect referring to the new Galaxy model?

▲The basic data mainly used for private consumption is the retail sales index published by Statistics Korea. This index increased in January but decreased in February. Retail sales movements and private consumption of goods may differ, so this is one factor for the increase. The new product was released at the end of February and sold in February and March. This contributed to the increase in goods consumption.

-Domestic demand showed a strong recovery this quarter. Please explain the specific reasons.

▲Initial forecasts expected capital investment to be decent due to global IT market improvement, but private consumption and construction were expected to be sluggish due to poor domestic sentiment. Especially, private consumption was expected to decline continuously due to high inflation and high interest rates, and construction was expected to be weak due to real estate PF issues. The good Q1 figures reflect a rebound in private consumption after continuous weakness and the base effect, weather conditions, and results affecting construction.

Given the concerns about weak domestic demand, the high results raise questions about sustainability. Overall conditions remain challenging for sensitive private consumption and construction investment. We hope the Q1 recovery signs will continue, but it is necessary to watch the situation.

-Q1 GDP exceeded previous forecasts significantly. What about forecasts for Q2 to Q4?

▲Q1 growth rate is quite high, close to last year's annual growth rate of 1.4%. It also exceeds market expectations and the Economic Outlook Division's forecast. These results will certainly be reflected in the revised economic outlook in May. The February growth path forecast expected a similar level of improvement in the short term for both the first and second halves of the year. Since Q1 results are high, revisions to the growth path for Q2 to Q4 are inevitable. Technically, if Q1 is high compared to the previous quarter, Q2 might be lower. Therefore, forecasts for Q2 to Q4 will need adjustment. Uncertainties such as high exchange rates and high interest rates may ease toward the second half, and improvement is expected to continue. It is difficult to predict how the growth path will be revised.

-Construction investment increased by 2.7%, but facility investment decreased by 0.8%. What are the specific reasons?

▲Facility investment is divided into machinery and transportation equipment. Machinery increased in Q1, largely influenced by semiconductor manufacturing equipment. However, transportation equipment decreased significantly. Recently, aircraft deliveries have caused large fluctuations depending on volume. Domestic airlines plan to introduce many aircraft this year. Supply disruptions in Q1 greatly affected this. We need to monitor how this develops. Facility investment itself is expected to recover as the IT and manufacturing sectors improve. However, uncertainties related to aircraft deliveries remain.

-You mentioned exports have been good mainly due to semiconductors. The export growth rate in Q1 was lower than in Q3 and Q4 last year. What caused this?

▲Exports are still growing, but evaluations differ depending on whether nominal GDP, real GDP, year-on-year, or quarter-on-quarter comparisons are used. It is true that the growth rate slowed compared to the previous quarter. One reason for recent export slowdown is the weakening demand for electric vehicles, which has slowed growth in the automobile sector. Semiconductor volumes were very low in Q4 last year, but the semiconductor market has recovered in the second half, increasing volumes. The growth rate appears to have slowed compared to the previous quarter, but it is not accurate to say the automobile or semiconductor markets have worsened.

-At the December monetary policy direction meeting, Governor Lee Chang-yong mentioned the possibility of upward revision of growth forecasts. Is there a chance the annual forecast will be raised?

▲It is cautious to mention the direction of revisions in the upcoming revised economic outlook. Governor Lee mentioned the possibility of upward revision because exports have been better than expected, although clear indicators have not yet emerged. The Q1 results show a clear economic recovery, so this will likely be reflected in next month's revised outlook.

-Government consumption increased from 0.5% in Q4 last year to 0.7% in Q1. Was this influenced by the general election? Do you expect government consumption to continue increasing?

▲Election-related spending contributed significantly. The government is maintaining a rapid fiscal execution policy in the first half, so good results are expected next quarter as well.

-Despite high inflation and high interest rates, why has private consumption sentiment changed?

▲The Bank of Korea publishes the Consumer Sentiment Index through the Consumer Survey. It was below 100 last year but has exceeded 100 for four consecutive months in Q1 this year. This reflects expectations for economic improvement, hopes for monetary policy pivots in major countries like the U.S., and expectations for future interest rate cuts. Private sentiment has improved compared to last year through April. Sustainability depends on factors such as recent instability in real estate prices and oil prices. The good Q1 results in the U.S., China, and Korea suggest improved fundamentals, which will gradually be reflected in private consumption.

-Government growth contribution is 0%. How do you evaluate this?

▲There was a base effect from heavy fiscal spending in Q4 last year. Government consumption contributed positively, but government facility investment decreased, resulting in an overall 0% contribution. The government is maintaining a rapid fiscal execution policy without major issues. One consideration is that government spending must flow through education offices and local governments to be recorded in statistics, which may cause a time lag. The drop from 0.4% to 0.0% in government contribution is not a cause for concern. Fiscal execution is currently proceeding without major problems.

-On the 12th, Governor Lee said growth would be better than previous forecasts. Is it better than the April Monetary Policy Committee forecast?

▲Governor Lee mentioned the possibility of exceeding initial forecasts, mainly based on export conditions. However, data on how much domestic demand will recover is insufficient, so caution is needed. Internally, the Bank of Korea sees domestic demand as much higher than expected. The high exchange rate, high inflation, and high interest rates remain burdens on the economy. Whether conditions will improve in the second half will be reflected in the next forecast after further analysis. Recently, oil prices and exchange rates have weakened due to geopolitical risks, causing short-term increases. Personally, I expect easing. The Economic Outlook Division will analyze the second half economy in depth.

-Domestic demand is not very strong on an annual basis but better than expected. Is there pressure on inflation?

▲So far, core inflation is driven more by supply-side factors than demand-side factors, which is why the Consumer Price Index (CPI) has not fallen. Demand-side pressure is still limited. Inflation pressure depends on whether the domestic demand recovery strengthens and continues.

-Is it difficult to know whether the domestic demand recovery will be sustained?

▲Since only Q1 indicators are high, we need to observe whether this continues into Q2.

-In February, the forecast for construction investment growth in the first half was -2.4%, and -2.6% annually. The actual path greatly exceeded this. Is there a chance construction investment will turn positive in the first half or annually?

▲The initial forecast expected construction investment to remain weak from this year’s first half through next year. How much the high Q1 construction figures will affect the forecast remains to be seen. The high Q1 construction investment was influenced by weather conditions and the completion of large-scale projects. Related indicators are still poor and will continue to have an impact. The forecast will likely be revised, but the overall trend is expected to remain weak due to persistent PF uncertainties and sluggish construction orders. However, if PF uncertainties ease recently, the impact on the real economy will be limited.

-What are the upside and downside risks related to construction investment?

▲Upside risks include strong economic performance in the U.S. and China, with the U.S., a major trading partner, showing considerable strength. The recovery speed of the IT sector is also influencing exports, and export growth is higher than expected in February, suggesting a faster recovery than initially thought. The IT recovery speed is an upside risk.

Downside risks include domestic PF issues, geopolitical risks such as instability in the Middle East, and the Russia-Ukraine war. Especially since April, oil price volatility has increased, posing a risk.

-There are predictions that the U.S. interest rate cut will be delayed. What impact will this have on Q2 growth?

▲The timing, frequency, and occurrence of the U.S. pivot affect domestic and international financial market indicators. U.S. Treasury yields and stock prices move accordingly, as do domestic financial market indicators. However, these do not seem to directly affect the real economy at each moment. They may increase volatility in market price variables but are unlikely to directly impact real economic growth. The U.S. economy is clearly strong, and Korea showed a rapid recovery in Q1, but since it is still early in Q2, the recovery momentum needs to be monitored.