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Seoul Grapples With Uneven Growth

Market Volatility Further Complicates the Task Facing Policymakers

On the face of things, the South Korean economy is rapidly overheating. After a 10 percent recovery in gross domestic product in 1999, estimates for 2000 are constantly being revised upward, with forecasts now in the 7.5 percent to 9 percent range compared with just 6 percent at the start of the year. The last quarter of 1999 saw a 13 percent growth rate, and the first quarter this year is much the same. Manufacturing output was up 25 percent in February. Altogether, this looks more like overdrive than continuing recovery.

South Korea has become the first of the crisis-hit Asian economies in which the recovery is no longer export-led. Domestic demand is now rising faster than exports, and capital spending has taken a sudden leap forward. Imports grew 58 percent in March from a year earlier. The trade surplus, which was $2 billion a month in 1999, was only $746 million in the first quarter this year, and oil was only partly to blame.

Employment has improved, with the jobless rate falling sharply in March to 4.7 percent, from 5.3 percent in February. That is down from levels of more than 8 percent in January 1999 but still far above historical levels of around 2 percent.

Demand is growing as wages rise at an annual rate of 11 percent, with roughly half of the growth representing longer hours and the other half higher rates. Profits are strong as interest rates stay low, sales are rising, and prices in key sectors such as semiconductors and steel are strong. Meanwhile, the Internet craze and its attendant boom - and partial bust - on the Kosdaq market has spawned a surge of telecommunications-related investment and dot-com start-ups.

The money supply is scampering ahead, and bank lending, which only turned positive last May, is now up 28 percent from a year ago. But the strength of the real economy means liquidity is tighter than last year, when the massive payments surplus translated into a $40 billion rise in foreign-exchange

reserves and a boom in the money supply. The less abundant liquidity partly explains the stock market's 25 percent decline from its 12-month high.

Given all this, it is not surprising to hear calls for higher interest rates or for fiscal measures to slow the expansion and prevent inflation from rising past the 2 percent to 3 percent range deemed acceptable. So far, the consumer price index is up only 1.6 percent from a year ago, but producer prices are rising faster. Other voices call for allowing the won to rise to offset imported inflation and force companies to stay focused on productivity improvements.

But the picture is complicated, with the gains unevenly distributed. The small-business expansion has tended to leave the less educated behind. Some sectors are investing heavily again, but others, such as autos, still have huge excess capacity. The economy as a whole is not at full strength.

Meanwhile, many companies whose debts were restructured are still struggling. Higher interest rates or a slowdown in demand would put them under greater pressure and would increase the amount of government funds needed to clean up the financial sector. An interest-rate increase would also put more upward pressure on the currency. Though short-term rates are low, the key three-year corporate bond yield is now stuck at around 10 percent, having fallen to 7.6 percent last year.

Some economists argue that there is scope to allow the won to appreciate. The currency has been roughly stable at around 1,120 to the dollar this year but is 9 percent above its year-ago level. In theory, it needs to track the strong yen as well as the dollar. But there is plenty of pressure from industry to keep the currency competitively priced. To these concerns have recently been added the question of the sustainability of the U.S. boom, and hence of the South Korean export surge. Recovery in Asia has recently been a more important stimulus than U.S. demand. But the danger that U.S. growth will be killed off by interest rates, a stock-market meltdown or a sharp fall in the dollar is now clearly in the minds of policymakers.

A setback in the United States need not lead to stagnation in South Korea, but it would take the shine off exports, and off prices of electronic products in particular. So, some ask, why make exporting more difficult and probably give an unneeded boost to domestic demand by letting the currency appreciate?

The dilemmas facing policymakers make minimal action the easiest course, and perhaps even the wisest.