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CHANG Jaechul

Global Recession and Korean Exports

CHANG Jaechul

May 22, 2009

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Despite the recent indications of world economic recoveries such as booming stock markets, many countries, advanced and developed, are still far removed from re-establishing sustainable exports. The world recession has yet to bottom out, meaning world trade will continue to contract. Not surprisingly, the IMF's latest outlook for 2009 has an 11% decline year-on-year in global trade volume.

Korea's exports' own tailspin began in the fourth quarter last year, when they fell 9.9% year-on-year, a dramatic reversal from the previous quarter, which saw a 27% year-on increase. The decline accelerated in the first quarter this year to 24.9% as the world downturn steepened. No turnaround should be expected in the short-term.

The slump is the third crisis that has engulfed Korean exporters in the last 10 years, following the 1997-98 Asia financial crisis and the 2001 tech bubble burst. The previous crises were painful as well. In 1997, Korean exports suffered annual growth rate of -2.8%, the first negative since 1960. In 2001, the growth rate fell to -12.7%, a steep drop from 19.9% increase in 2000.

Three factors are pressuring Korean exports --- and may worsen. First, lost wealth and income are weighing on households and companies. Despite the recent snapback in equities, household assets are severely retarded because of collapsed housing prices. Meanwhile, companies are grappling with low demand and attendant cash flow setbacks. Layoffs are inescapable. Although national governments have adopted a flurry of stimulus measures to reignite their flagging economies, mounting unemployment and restored household proclivity to save will retard private consumption. Americans, for example, cannot be counted on to scoop up Korean electronic goods and other exports at the pre-crisis pace any time soon.

Another factor is prices. Low demand for finished goods and commodities has diluted pricing power. For example, the price of petrochemical products and steel, which accounted for 14.7% of total Korean export in 2008, has skidded for months. Of course, the sharp depreciation of the won against the U.S. dollar since last year has made Korean exports attractive to overseas markets and cushioned the impact of forced price cuts. But the won is now reversing course. Recent appreciation of the won will exert an opposite effect on Korean shipments. A stronger won will also decrease the level of profits converted to Korean won, constraining corporate ability to invest and ramp up production. The negative effect will likely become bigger and bigger. SERI expects the USD/KRW exchange rate to average 1,124 won in the second half this year, 13.5% lower than in January.

The last factor is the precarious state of the global financial system. Exporters face high borrowing costs and foreign exchange risk, which hampers regular operations. They also are confronted with reduced export credit lines because of the high uncertainty in the financial and real economies. In March, the World Trade Organization estimated that the lack of export credits would amount to US$100 billion, which is four times more than that of November 2008. The WTO also warned that the shortfall could have serious repercussions on the export sectors of developing nations.

A SERI analysis found that the financial constraints such as high borrowing costs, high foreign exchange risk and less export credit exert negative effects to the export levels. If one of those constrains deteriorates in the financial markets as in the same level of the previous financial crises, it would lower the Korean export by 7.6% point. If all of the constraints are binding at the same as in the 1997 crisis, Korean export will decrease by 11.7% point. In applying the trade obstacles on a company level, we found that small and medium-size enterprises (SMEs) are more sensitive, especially in terms of credit lines. Those engaged in external trade simply do not have the financial cushion to ride out a prolonged slump in overseas markets and unfavorable terms in financial operations.

This last finding suggests that during a financial crisis, it is imperative to reduce the financial stress on exporting companies. In our review of policy response to the financial crises, we found that the central bank and the government need to coordinate their actions to ease any credit squeeze that exporters encounter. Loans must be available at low rates from banks in order to maintain production and to meet normal operating costs. Of course, a low-interest rate environment will help non-exporting companies and individual consumers and that, in turn, will help maintain production activity that will eventually assist exporting companies.

The Bank of Korea keeping its base rate at 2%and there are signs that the rate of the downturn is slowing both here and abroad. But that does not mean the risks to Korean exports are about to evaporate.

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