Economy faces growing downside risks

By Kang Seung-woo

Staff reporter

Policymakers and regulators should not lower their guards in the second half of this year as the economy is likely to experience unexpected hiccups on its path to full recovery, according to analysts.

In its economic outlook report Sunday, the Hyundai Research Institute (HRI) said that despite strong signs of an economic rebound, Asia's fourth-largest economy is facing a myriad of downside risks in and out of Korea in the coming months.

It cited the stalled recovery of the global economy, market volatility caused by the European debt crisis and escalating geopolitical risks as the main threats to Korea's fiscal health.

The South Korean economy is on the rebound thanks to robust exports and improving domestic demand. It grew 1.8 percent in the first quarter, up from a 0.2 percent expansion in the fourth quarter of 2009.

The institute said that the on-going southern European sovereign debt crisis has shaken the rebounding global economy, going beyond the continent.

Despite the rescue package of 110 billion euros ($136 billion) from the European Union (EU) and the International Monetary Fund (IMF) earlier this month, the Greek fiasco has shown no signs of abating, threatening to spread across the world as well as Portugal, Ireland, Italy and Spain, the so-called PIIGS, that includes Greece.

In addition, growing pressure for China to revalue its currency is expected to hamper a global recovery, it added. The United States has pushed China to appreciate the yuan in order to boost its trade with the communist nation.

China has pegged the yuan to about 6.83 per dollar for 22 months, after letting it rise 21 percent versus the greenback since July 2005. "Its appreciation is expected to pressure other Asian countries' currencies to rise, which will result in affecting their exports," it said in the report.

Implementing an exit plan is another hot issue for many economies, which have seen steady growth amid rising inflation concerns.

The Bank of Korea (BOK) has frozen its key interest rate at a record low 2 percent for the 15th straight month amid growing calls, as moves to alter the rate have been conducted in the United States, China, India and Australia.

It pointed out that enforcing an exit plan can lead to slowing economic growth in the euro zone, increasing a risk of a double dip recession and unrest in the global financial market.

The think tank said that a slowdown in Europe can also hit Asia's economic recovery due to a poor showing of exports.

Rising concerns in the euro zone and growing tensions on the Korean Peninsula hit the market hard, as foreign investors scrambled to stash their cash in greenbacks.

Volatile liquidity can cast a murky outlook over the nation's economy and let capital in the market flow out in the short run.

Hyundai Securities reported that in the worst case scenario, the country is expected to face a foreign capital outflow of up to $300 million from the local financial market.

In addition, volatility in foreign currency can increase concerns among local investors and cause a downfall in the stock market, the institute said.

After the Lee Myung-bak administration concluded last week that the sinking of naval warship Cheonan in March is linked to North Korea and slashed its trade with its Northern neighbor, the Korean currency fluctuated to hit an eight-month high and the benchmark KOSPI tumbled.

"If the standoff lasts longer, it, along with the euro zone trouble, will drop Korea back to a slump, failing to attract foreign capital and undermining spending and investment," it said.

The economic rebound is showing signs of losing momentum, with manufacturers' business confidence falling for the first time in six months.

The central bank reported Friday that the business sentiment index dropped to 104 from 107 to a three-month low for June. The index measures manufacturers' outlook on business conditions for the coming month.

"Rising inter-Korean tensions, coupled with the euro zone debt fears, affected business sentiment," said an official at the BOK.