Harvest up 23% on 2010. The grain harvest is good this year, with the Ministry of Agriculture expecting a 42 million tonne grain harvest, compared to 39.3 million in 2010. As of August 1, 30 million tonnes of grain was collected, 23% higher than in 2010.
Agricultural exports spiked in June, up 4.5 times year on year. June will be an outlier month, as on June 1 grain export quotas were removed, and on July 1 export tariffs come into force. So, grain exporters tried to export as much as possible of their accumulated stocks in the quota-free, tariff-free June window.
Wheat exports the main driver. Wheat exports spiked 3 times in volume terms with prices on the world market being 73%Y higher. This year we expect the value of wheat exports to increase by 40% compared to last year, adding US$363 million (0.03% of GDP) to exports on our estimates. Extrapolating to total agricultural exports, we expect them to increase from US$4.0 billion in 2010 to US$6.0 billion in 2011, adding about 1.2% of GDP to the current account balance, on the back of a good harvest and high world prices for grain.
Muted impact on domestic food prices. The ability to export without quotas could in theory lift prices on the domestic market, particularly if the global market is tight. However, exports and upside pressure on inflation will be limited by the 9-14% tariff in force from July 1.
Chemical and metals exports also made a strong contribution. First, chemical exports accelerated to 76%Y in June from 60%YTD in May as demand and prices on external markets increased. According to the NBU, many plants were using cheaper Central Asian gas from 2Q11 in place of Russian gas, which helped to maintain their competitiveness. According to the Institute of Energy Research, the price of Central Asian gas was about US$230-250/1,000m³ (20% lower than the US$297 Gazprom gas price in 2Q). Second, rising world metal prices (up 20%Y) pushed base metals exports up 31.7%Y, which was the biggest positive contribution to the headline export number.
Despite high oil prices, import growth slowed down 1.7%M, seasonally adjusted. The main cause of the slowdown was a reduction in non-energy imports. In fact, the slowdown was in consumer-driven non-energy imports (cars), while the producer-driven non-energy imports (equipment) continued to grow, which supports our view of a pick-up in investment in 2H prior to Euro 2012. Energy imports were still strong, partly reflecting, we think, pre-purchases of gas in advance of Gazprom price rises later this year.
In contrast to previous months, the financial account turned to deficit. This was driven by private sector debt repayments and continuing high purchases of dollars, partially offset by foreign purchases of government bonds. FDI slowed down to US$427 million in June. FX cash outflows were as high as US$1 billion, we think because confidence in the hyrvnia was shaken by events in US and eurozone. The overall deficit drove a small fall in international reserves to US$37.6 billion on July 1, which amounted to a still comfortable 4.6 months of imports. In July, however, the reserves went up US$229 million, which points towards continued improvement in the current account.
Despite this improvement, we still expect the current account to widen further from 4.0%YTD in June to 4.2% of GDP, reflecting Ukraine's worsening terms of trade as the price of imports (energy) outpaces the price of exports (metals, food). However, we see the current account deficit being successfully funded by financial account inflows, provided, as we expect, the government completes the reforms - signing the pension reform into law and increasing gas tariffs - which secure the next tranche of IMF funding. We think this would also unlock access to the private markets, as suggested by the recent Fitch decision to improve Ukraine's credit outlook to ‘positive', following parliamentary approval of the pension law.
During the 2008-09 global financial crisis, the Korean economy showed its resilience. Korea did not even suffer from a recession as it posted only one quarter of negative sequential growth. Is Korea as defensive this time? We think that Korea's exports will fall less than other countries (like last time) but domestic consumption could see more adjustment this time. Meanwhile, next year will be an election year in Korea, with the parliamentary election in April and the presidential election in December. Even without the external uncertainties, we would view positively a step up in infrastructure spending by the Korean government to support the economy by creating jobs and narrowing the income gap in the provincial areas. If global demand were to contract at a much faster-than-expected rate, we think it would help to speed up fiscal stimulus. The Korean government has a good track record of initialising and executing economic stimulus measures.
Why we think that Korea will remain defensive this time:
1. Korea's exports remain competitive. Compared to the beginning of 2008, KRW has depreciated 24% against USD, 12% against EUR and 55% against JPY. If market concerns about Korea's external debt exposure to Europe prompt an outflow of foreigners' portfolio investments, KRW could face renewed depreciation pressure, which, in our view, would be positive for Korea's export competiveness. Currency is not the only reason that Korea's export growth could outperform, but also because of its brand value and market strategies. Korea has successfully shifted its export focus away from developed countries, and it now sells 60% of its exports to emerging markets compared to only 45% 10 years ago. Thus, the slowdown that is concentrated in the developed markets should have less impact on Korea now. Meanwhile, Korea is actively signing free trade agreements with major economies. The FTA with EU has already become effective. Lower tariffs help to make Korea's products even more price-competitive, which is crucial in a world of declining purchasing power.
Some may simply look at Korea's high export/GDP ratio and conclude that Korea is more vulnerable than other countries. However, we see this higher ratio as evidence of Korea's export market share gains since 2008. Korea's export/GDP ratio averaged only 33.7% during the five years from 2003-07, but rose to 44.7% during 2008-10. This is because Korea's export posted record high performance but corporates have been disciplined about investment and restocking and thus capex/GDP did not rise, causing exports/GDP to have gone up faster.
2. Korea's financial system is also much less vulnerable now than in 2008 as it has rebuilt its foreign reserves and lowered its external debt level. Korea's foreign reserves rose to a record high of US$311.0 billion in July this year, on the back of solid trade surplus and inflow of foreigners' portfolio investment, much higher than the low of US$200 billion in 2008. Short-term external debt stood at US$146.7 billion in March this year, down from the peak of US$190 billion in 2008. Currently, Korea's foreign reserves could cover 200% of its total short-term external debt compared to the trough in 2008 when it was only enough to cover 110%. Even if there were capital flight caused by the intensified external uncertainties, we think that Korea has enough reserves to weather it this time. Therefore, although there are still concerns about Korea's exposure to Europe's financial system through external debt, we believe that any subsequent capital outflow and KRW depreciation will be much more orderly this time.
3. There is enough room for fiscal stimulus. Most countries cannot rely on monetary easing as much this time due to the higher starting point of inflation and, also, there is less room for further cuts since the interest rate is still low. Fiscal measures will be even more important this time and Korea is in a sound fiscal position. Korea was the only country in AXJ that ran straight years of fiscal surplus from 2000-08. It had to use deficits of 1.7% of GDP in 2009 and 0.2% of GDP in 2010 to support the economy during the global recession. Yet, it is quickly returning to a surplus again this year (expected at 0.4% of GDP) due to strong tax revenue. Meanwhile, Korea's government debt level is low at 32% of GDP compared to OECD average of 74%. In fact, the Korean government demonstrated its ability to execute a swift and sizeable stimulus package when it was needed in 2009, which partly helped the economy to avoid a recession. Meanwhile, expanding fiscal spending would particularly be welcoming ahead of the election year in 2012, in the areas of building infrastructure and welfare spending on the mid-to-low income households.
4. Inflation has been Korea's biggest challenge this year but potentially lower commodity prices could help Korea to ease its inflationary pressure. Due to growth concerns about the economic recovery in developed markets, international oil prices could see some downward pressure on demand worries. Korea is heavily dependent on imported raw materials, and we think that lower international commodity prices could help Korea to contain inflation and reduce the need for further rate hikes.
What could be different this time compared to 2008-09? We think that domestic consumption could suffer more. In our view, Koreans have been overspending since 2H10 despite negative real income growth (see Caution on Overspending, June 27, 2011). As a result, consumption is likely to see a sharper correction this time if the fall in global demand eats into income growth further and wealth evaporates from any financial market correction. Also, more Koreans have been relying on credit to consume now compared to 2008. So, if banks have to tighten lending, consumption growth will suffer more this time. Even if the government were to carry out fiscal stimulus to help the economy, we do not think that it is likely to focus on consumption because household leverage is already high and the government will not want to encourage further overspending.
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