November 24, 2015

Economics Group
Special Commentary
Tim Quinlan, Economist
tim.quinlan@wellsfargo.com (704) 410-3283

Erik Nelson, Economic Analyst

erik.f.nelson@wellsfargo.com (704) 410-3267

Korean Economic Outlook for 2016

More to the Export Story than Just Slower Growth in China

Trade is very important to Korea. In 2014, the last full year for which we have data, exports of
goods and services were equivalent to more than 50 percent of GDP. However, in 2015, it appears
likely that share will fall below 50 percent for the first time since 2009 and 2010 when world
trade dried up in the wake of the global recession. So far in the first 10 months of 2015, exports
have been negative every month on a year-over-year basis.
The slowdown in trade is largely attributable to slower growth in China, Koreas top trading
partner. That factor will remain a key headwind for Korea in the coming year. However, as we
discuss in this report, falling prices for some key Korean exports bear much of the blame; export
volumes have been steadier. Also, the broad deterioration in Korean exports masks a growing
share of exports headed to Koreas second largest export market, the United States. Continued
U.S. economic expansion and expected weakening of the Korean won versus the dollar may prove
to be a welcome offset to concerns about the negative effect of Fed tightening on emerging
markets.
Figure 1

The slowdown in
trade is largely
attributable to
slower growth
in China,
Koreas top
trading partner.

Figure 2
South Korea Export Volumes

South Korean Real GDP

Index, 2010 = 100

Bars = Compound Annual Rate

150

150

Line = Yr/Yr % Change

15%

15%

10%

10%

Total Exports: Sep @ 139.5

12-Month Moving Average: Sep @ 134.7
120

120

90

90

60

60

30

30

5%

5%

0%

0%

-5%

-5%

-10%

-15%

-10%

-15%

Compound Annual Growth: Q3 @ 5.0%

Year-over-Year Percent Change: Q3 @ 2.7%

0
00

02

04

06

08

10

12

14

-20%
2001

-20%
2003

2005

2007

2009

2011

2013

2015

Source: IHS Global Insight and Wells Fargo Securities, LLC

The Bank of Koreas (BoK) rate-setting Monetary Policy Committee (MPC) cut its target lending
rate twice this year, taking the base rate to 1.50 percent at present from 2.00 percent at the start
of the year. We are of the view that there is little pressure on the BoK to reduce rates more in the
near future, especially in light of the somewhat better-than-expected outturn for Q3 GDP and
expected firming in prices next year.
The outbreak of Middle Eastern Respiratory Syndrome (MERS) held back GDP growth in the
second quarter, but owing to a swift response from the government, a payback surge lifted third
quarter GDP growth to an annualized rate of 5.0 percent. After some moderation in the final
quarter of the year we expect full-year GDP growth of 2.5 percent in 2015 before growth firms

This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

There is little
pressure on the
BoK to reduce
rates more in
the near future.

Korean Economic Outlook for 2016

November 24, 2015

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

somewhat to a 3.0 percent rate for 2016, a view that is informed partly by a less negative view on
exports.

Ties That Bind: No Country Imports More from Korea than China

The trajectory of Korean export growth has been stuck in neutral for at least the past three years.
Figure 1 on the first page of this report shows how, aside from the disruption from the global
recession in 2009, the value of Korean exports maintained a clear upward trend from 2000 until
about 2012 when outgoing trade clearly began to decelerate. What pattern can we see that is
negatively impacting trade and what can we expect to see in the year ahead?
China is Koreas
largest export
market.

The year-over-year rate of GDP growth in China, which had been running at double-digit percent
rates in 2010 and 2011, slowed to single-digit territory in 2012 and has been trending down in the
years since. China is Koreas largest export market. That is true for a lot of countries; China is the
largest export partner for many economies around the world, particularly in Asia. What makes
the relationship with Korea unique is that China imports more from Korea than any other country
in the world.
After years of having its cart hitched to the right horse, Koreas trade ties to China have not been a
big positive in recent years. Our own forecast for Chinese GDP growth anticipates continued
moderation in the growth rate. On that basis and in the context of prospects for continued slow
growth in global trade more broadly, there is little reason to anticipate a swift turnaround in
prospects for Korean exports.

Taken together,
the three largest
categories of
goods exports
comprise more
than a quarter
of all exports
and all have
been under
significant price
pressure.

Some Non-China Factors Influencing Exports

Having acknowledged the widely accepted role of Chinas slowdown in Koreas export woes, we
think there are a few other aspects to Korean trade that sometimes go overlooked. Korea is
internationally recognized for its high-tech and semiconductor sector as well as its auto industry,
which has grown rapidly over the past two decades. Korea is also a major oil refiner. It imports
crude oil and exports products derived from oil. Refined petroleum exports actually comprise a
slightly larger share of exports than automobiles for Korea.
Taken together, the three largest categories of goods exports (integrated circuits, refined
petroleum and automobiles) comprise more than a quarter of all exports. What do the three of
these products have in common? All have been under significant price pressure. Oil prices have
been more than halved since June 2014. According to the Korean producer price index,
electronical and electronic equipment prices are down 3.3 percent over the past year and prices
for manufacturing industry products are off 7.6 percent.
Figure 3

Figure 4
Korean Exports by Destination Country

Korea Volume and Value of Exports

Share of Total Exports

Year-over-Year Percent Change of 3-Month Moving Average

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0%

-10%

50%

50%
Japan

40%

7.2%

China

U.S.

7.1%

6.2%

5.6%

5.0%

26.1%

25.4%

25.3%

30%

20%

40%

30%

24.2%

24.5%

10.2%

10.7%

11.1%

12.3%

13.4%

2011

2012

2013

2014

2015 YTD

20%

-10%

-20%

-20%
Volume of Exports: Sep @ 4.1%

-30%

10%

-30%

Value of Exports: Sep @ -9.7%

-40%

-40%
05

06

07

08

09

10

11

12

13

14

10%

0%

15

0%

Source: IHS Global Insight and Wells Fargo Securities, LLC

The point is that prices are playing a role in export weakness. In Figure 3, we plot the growth
trajectory for Korean exports in volume terms and in value terms. While exports look
exceptionally weak in value terms, the tepid growth rate for the volume growth in exports does

Korean Economic Outlook for 2016

November 24, 2015

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

not look meaningfully different from any other time in the past three years or so. After such steep
price declines in the past year (particularly for oil) even a modest retracing of some of the recent
price declines could help offset some of Koreas export challenges.
Another interesting development that has gone largely unreported is that Korea is increasing the
amount of exports it is sending to its number two trading partner, the United States. Figure 4
looks at the composition of trade among Koreas three largest trading partners. Chinas share of
Korean exports has been flat to slightly down in recent years, but on a year-to-date basis in 2015
still commands just over a 25 percent share. Japans portion has dropped from 7.2 percent in 2011
to just 5.0 percent so far this year.
Between 2010 and 2014 (the last full year for which we have data), Korean exports to the United
States increased more than 40 percent. That lifted the U.S. share of Korean exports to
12.3 percent in 2014. Year to date, the U.S. is on track to take a 13.4 percent share of Korean
exports in 2015, which is a little more than half the share of exports that are destined for China for
the same period. This development is likely reflective, at least in part, of a bilateral free trade
agreement between the two nations that went into effect in 2012. Going forward, this agreement
may play a vital role in further increases in the share of Koreas exports that are destined for the
United States.

Between 2010
and 2014,
Korean exports
to the United
States increased
more than
40 percent.

There has been a great deal of hand-wringing over negative implications for emerging markets of
eventual rate increases from the Federal Reserve. The growth of Korean exports to the United
States shows the other side of the coin, specifically how steady U.S. economic growth amid U.S.
dollar appreciation versus the won are a positive offset.

Inflation and the Bank of Korea

Like many central banks around the world, the BoK conducts monetary policy with a mind toward
achieving stable inflation, and like many central banks the drop in oil prices has been a major
setback toward achieving that goal. In Korea, the inflation target is presently set to a range
between 2.5 and 3.5 percent, although a new target will be set later this year.
Some members of the BoKs MPC have advocated lowering the inflation target. Headline CPI
inflation in Korea came in at just 0.9 percent on a year-over-year basis through October. Core
CPI, which excludes volatile oil prices, is somewhat firmer at 2.3 percent, but still below the low
end of the current target range.
Figure 6

Figure 5

South Korean Official Bank Rate

South Korean Consumer Prices

Some members
of the BoKs
MPC have
advocated
lowering the
inflation target.

Percent

Year-over-Year Percent Change

6%

6%

5%

5%

4%

4%

3%

3%

2%

2%

1%

1%

6%

6%

5%

5%

4%

4%

3%

3%

2%

2%

CPI: Oct @ 0.9%

Core CPI: Oct @ 2.3%
0%
2000

Official Bank Rate: Nov @ 1.50%

0%

2002

2004

2006

2008

2010

2012

2014

1%
2000

1%
2002

2004

2006

2008

2010

2012

2014

Source: IHS Global Insight, Bloomberg LP and Wells Fargo Securities, LLC

The MPC cut its target lending rate twice this year, taking the base rate to 1.50 percent at present
from 2.00 percent at the start of the year. We are of the view that there is little pressure on the
BoK to reduce rates more in the near future especially in light of the somewhat better-thanexpected outturn for Q3 GDP.

Korean Economic Outlook for 2016

November 24, 2015

The composition
of the new board
and the new
inflation
mandate present
a larger-thanusual degree of
uncertainty.

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

As we frame our thinking for the monetary policy outlook for 2016, there are a number of key
points that will influence our thinking. The most conventional concern is the outlook for CPI
inflation. Here, we expect to see full-year CPI inflation of just 1.6 percent. As oils price decline
fades farther into the rearview mirror, its negative influence on CPI inflation will fade. Provided
inflation expectations remain anchored, we see no immediate need for further monetary policy
accommodation due to prices alone. The new inflation target later this year will provide
additional context.
The other big factor is that on April 13, 2016, Korea will go to the polls for a general election and
the following week, terms expire for four of the seven members of the MPC. The composition of
the new board and the new inflation mandate present a larger-than-usual degree of uncertainty.
Barring a major move in CPI inflation or a significant disruption in domestic growth, we expect
the most likely course of action is that the BoK will remain on hold.

The Domestic Demand Offset

With all the discussion around the role of net exports, Koreas domestic economy has fared rather
well in 2015. As discussed previously, the MERS outbreak led to consumers staying home during
much of the third quarter, resulting in a drag from consumer spending. However, that was offset
during the period by modest growth in business spending as well as pickup in government
expenditures.
For five straight
quarters
domestic
demand has
boosted GDP
growth even as
net exports
exerted a drag.

Net exports have been a drag on headline GDP growth for five straight quarters and the
3.2 percentage point drag in Q3 was the largest of those periods. Interestingly, it is also true that
total domestic demand has been a positive offset during each of those periods and the
7.2 percentage point boost in Q3 was also the largest of those periods. The momentum was
building as the quarter went on. Retail sales finished the third quarter on a high note, posting the
second fastest year-over-year increase since 2012 (Figure 7).
Figure 7

Figure 8
South Korean Retail Sales

South Korean Unemployment Rate

Year-over-Year Percent Change

Percent

17.5%

17.5%

5.0%

5.0%

4.5%

4.5%

4.0%

4.0%

3.5%

3.5%

Retail Sales: Sep @ 5.2%

15.0%

6-Month Moving Average: Sep @ 2.7%

15.0%

12.5%

12.5%

10.0%

10.0%

7.5%

7.5%

5.0%

5.0%

2.5%

2.5%

0.0%

0.0%

-2.5%

-2.5%

-5.0%

-5.0%

3.0%

3.0%
Unemployment Rate: Oct @ 3.4%

12-Month Moving Average: Oct @ 3.6%

-7.5%
2001

-7.5%
2003

2005

2007

2009

2011

2013

2015

2.5%
2001

2.5%
2003

2005

2007

2009

2011

2013

2015

Source: IHS Global Insight and Wells Fargo Securities, LLC

We anticipate a
slower pace of
government
spending in
2016.

Recent gains in the labor market may be underpinning the resilience of the Korean consumer.
Although the unemployment rate has trended higher over the past couple of years, the number of
jobs added in October was the largest since May. Higher rates of youth unemployment are
worrying for the sustainability of consumer spending longer term, but the incremental rate of
hiring should underpin consumer activity in the near term. Further out, Koreas aging
demographics present the biggest risk to the sustainability of long-term domestic demand growth.
Since the start of 2013, the quarterly annualized growth rate of government spending in Korea has
averaged 3.7 percent. A 22 trillion won stimulus package rolled out by the Korean government in
response to the MERS outbreak helped underpin government outlays in 2015. We will get a better
sense of what fiscal spending will look like when next years fiscal budget is revealed in December.
For now, we anticipate a slower pace of government spending in 2016.

Korean Economic Outlook for 2016

November 24, 2015

WELLS FARGO SECURITIES, LLC

ECONOMICS GROUP

Bottom Line
Koreas export-driven economy depends to a large degree on prospects for global growth. With
Chinas economy no longer the vortex of activity it was a few years ago, much of the developing
world is negatively impacted. That cuts Korea in two ways: directly, in terms of falling exports to
China (Koreas top export market), and indirectly, in terms of falling exports to other economies
where activity is no longer underpinned by intense Chinese demand.
An offset to falling exports to China is that exports to the United States are on the rise. Korean
exports to the United States are now a little more than half the size of exports to China, a
development which has likely been driven by a relatively recent bilateral free trade agreement
between the two nations. Our forecast for continued U.S. growth and gradual firming in the dollar
versus the won is supportive of further improvement in this budding trade relationship.
Domestic demand in Korea has been resilient in recent years and that has been enough to offset
the export weakness. Korea also has some fairly substantial longer-term demographic problems.
In the near term, however, consumer activity remains robust and incremental jobs gains are
supportive of spending next year. Business spending should also be mildly supportive, although a
less supportive fiscal policy environment may mean less of a boost from government spending.

Koreas exportdriven economy

faces headwinds
from China but
steady domestic
demand and
growing exports
to the U.S. will
be positive
offsets.

CPI inflation figures will not likely face the big decline in oil prices that weighed on broader prices
over the past year or so. Barring an unexpected election shake-up that could change the
complexion of the MPC, we expect a gradually firming price environment combined with less of a
drag from trade should keep monetary policy neutral in 2016.

Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg

Global Head of Research,

Economics & Strategy

(704) 410-1801
(212) 214-5070

diane.schumaker@wellsfargo.com

John E. Silvia, Ph.D.

Chief Economist

(704) 410-3275

john.silvia@wellsfargo.com

Mark Vitner

Senior Economist

(704) 410-3277

mark.vitner@wellsfargo.com

Jay H. Bryson, Ph.D.

Global Economist

(704) 410-3274

jay.bryson@wellsfargo.com

Sam Bullard

Senior Economist

(704) 410-3280

sam.bullard@wellsfargo.com

Nick Bennenbroek

Currency Strategist

(212) 214-5636

nicholas.bennenbroek@wellsfargo.com

Eugenio J. Alemn, Ph.D.

Senior Economist

(704) 410-3273

eugenio.j.aleman@wellsfargo.com

Anika R. Khan

Senior Economist

(704) 410-3271

anika.khan@wellsfargo.com

Azhar Iqbal

Econometrician

(704) 410-3270

azhar.iqbal@wellsfargo.com

Tim Quinlan

Economist

(704) 410-3283

tim.quinlan@wellsfargo.com

Eric Viloria, CFA

Currency Strategist

(212) 214-5637

eric.viloria@wellsfargo.com

Sarah House

Economist

(704) 410-3282

sarah.house@wellsfargo.com

Michael A. Brown

Economist

(704) 410-3278

michael.a.brown@wellsfargo.com

Erik Nelson

Economic Analyst

(704) 410-3267

erik.f.nelson@wellsfargo.com

Alex Moehring

Economic Analyst

(704) 410-3247

alex.v.moehring@wellsfargo.com

Misa Batcheller

Economic Analyst

(704) 410-3060

misa.n.batcheller@wellsfargo.com

Michael Pugliese

Economic Analyst

(704) 410-3156

michael.d.pugliese@wellsfargo.com

Donna LaFleur

Executive Assistant

(704) 410-3279

donna.lafleur@wellsfargo.com

Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and
Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these
publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC,
Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC.
is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures
Association. Wells Fargo Bank, N.A. is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the
National Futures Association. Wells Fargo Securities, LLC. and Wells Fargo Bank, N.A. are generally engaged in the trading of futures and derivative products,
any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment
banking transactions. Wells Fargo Securities, LLCs research analysts receive compensation that is based upon and impacted by the overall profitability and
revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use
only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that
may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for
general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment
advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company
2015 Wells Fargo Securities, LLC.
Important Information for Non-U.S. Recipients
For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm
authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For
purposes of the U.K. Financial Conduct Authoritys rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as
defined in the Markets in Financial Instruments Directive 2007. The FCA rules made under the Financial Services and Markets Act 2000 for the protection of
retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be
relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general
informational purposes only.

SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE