KDI Lowers This Year's Growth Rate to 2.5%... "Domestic Demand Slumps Due to Prolonged High Interest Rates"

Slightly Lowered from May Forecast (2.6%)
Domestic Demand Slumps Despite Export Growth
"Private Consumption and Facility Investment Affected by High Interest Rates"

The Korea Development Institute (KDI), a government-funded research institute, has revised this year's economic growth rate slightly downward to 2.5% from the previous forecast of 2.6%. Unlike exports, which are showing growth led by semiconductors, domestic demand centered on private consumption and facility investment is falling short of earlier projections.

Due to the prolonged impact of high interest rates, domestic demand weakness is expected to continue, delaying economic recovery somewhat. KDI assessed that since inflation has stabilized, attempts to normalize interest rates are necessary.

Private Consumption Expected to Increase by 1.5%, Facility Investment by 0.4%

On the 8th, KDI forecasted an economic growth rate of 2.5% for this year in its 'Economic Outlook Revision.' After initially projecting 2.1% growth in February and revising it upward to 2.6% in May, the forecast was lowered again this time. Although expectations for economic easing grew in the first quarter due to export recovery, the prolonged domestic demand slump led to the revision.

KDI stated, "Compared to previous forecasts, export growth will expand, but domestic demand will remain weak, causing a slight delay in economic recovery." Exports are showing growth centered on semiconductors, but domestic demand, mainly private consumption and facility investment, is expected to fall short of earlier projections. In particular, KDI evaluated that "the prolonged high interest rate stance relative to domestic inflation and the economy will delay domestic demand recovery."

This year, private consumption is expected to grow by 1.5%, lower than the previous forecast of 1.8%. Facility investment is projected to increase by only 0.4%, significantly below the earlier forecast of 2.2%, as semiconductor growth has not translated into investment. Construction investment is expected to decline by only 0.4%, as the impact of real estate financing project (PF) defaults remains limited.

Jung Kyu-chul, head of KDI's Economic Outlook Office, explained, "Interest rate cuts are being delayed more than expected," adding, "The negative effects of high interest rates were strong in the second quarter, so we significantly lowered the private consumption forecast." He also added, "Facility investment is also affected by interest rates, so the prolonged high interest rate environment likely contributed to investment delays."

Consumer Price Inflation Revised Down to 2.4%

Due to weak domestic demand, both inflation and employment growth forecasts have been revised downward. KDI reflected the recent decline in international oil prices and lowered the consumer price inflation forecast to 2.4%, down from the previous 2.6%. Core inflation, excluding food and energy, is also expected to be 2.2%, slightly below the earlier forecast of 2.3%.

The employment increase forecast was revised down from 240,000 to 200,000. Corresponding to the downward revision in consumption forecasts, employment projections were also lowered. Kim Ji-yeon, head of KDI's Economic Outlook Division, explained, "Although we do not publish the economic activity participation rate, that indicator was also revised downward." However, the unemployment rate is expected to remain unchanged at 2.8%.

Total exports are expected to grow by 7.0%, higher than the previous forecast of 5.6%, due to the semiconductor effect. The World Semiconductor Trade Statistics (WSTS) recently revised upward the growth rate of the global memory semiconductor market transaction value, where domestic companies hold a majority share, from 44.8% to 76.8% for this year. Due to export improvements and domestic demand weakness, the current account balance is expected to continue a large surplus trend.

"Interest Rate Normalization to Resolve Unnecessary Domestic Demand Weakness"

KDI believes that if the high interest rate stance continues while inflation is slowing, domestic demand recovery will be further delayed. Given the large increase in private debt, a continued high interest rate environment could limit not only household consumption but also corporate investment capacity, exerting downward pressure on domestic demand.

Jung said, "If interest rates are normalized while inflation is stable, unnecessary domestic demand weakness will be resolved." He added, "Regarding household debt and real estate risks, macroprudential policies should be prioritized to pursue financial stability, and considering inflation and the economy, interest rates could be lowered to a low level. Adjusting the base interest rate at any time would not be inconsistent with the domestic economic situation."

Regarding recent volatility in Asian stock markets, including Korea, and growing concerns about a U.S. economic recession, KDI sees no clear indicators yet. Jung explained, "There are few indicators outside the stock market suggesting a sharp U.S. economic downturn, so we did not include it in the economic outlook. Nevertheless, we described the possibility of a sharp U.S. economic decline as a risk factor."

With the recent passage of the Livelihood Recovery Support Act, which provides 250,000 won to all citizens, some domestic demand stimulation effects are expected. Jung said, "If the act is implemented with a budget between 13 trillion and 18 trillion won, it could raise the gross domestic product (GDP) growth rate by 0.1%."

Geopolitical Risks in the Middle East Could Delay Economic Recovery

Looking at external conditions surrounding our economy, the global economy is expected to show moderate growth through this year and next. The International Monetary Fund (IMF) recently maintained its global economic growth forecast at 3.2% for this year. The won's value, assessed by the real effective exchange rate, is expected to remain stable at recent levels.

If geopolitical risks in the Middle East escalate or if the economies of China and the U.S. deteriorate, the recovery of our economy is likely to be further delayed. In particular, a sharp rise in international oil prices due to Middle East issues could exert upward pressure on inflation and downward pressure on the economy. After the U.S. presidential election at the end of the year, if protectionism strengthens, it could negatively affect domestic exports.

Reflecting recent oil price declines amid concerns about economic recessions in China and the U.S., this year's crude oil import price (based on Dubai crude) has been slightly revised down to $82 per barrel from the previous forecast of $85 per barrel. The forecast for next year's oil price remains unchanged at $82 per barrel.