MEDIUM-TERM FOREIGN TRADE OUTLOOK FOR SOUTH KOREA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000100410001-4
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 24
• Document Creation Date: December 22, 2016
• Document Release Date: February 22, 2011
• Sequence Number: 1
• Publication Date: February 13, 1986
• Content Type: MEMO

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CONFIDENTIAL
Central Intelligence Agency
DATE
DOC NO _C 19 20 o Sa
ocR 3
P&PD
13 FEB 1986
Acting Chief, Economics Division, OGI
SUBJECT Medium-Term Foreign Trade Outlook for
South Korea
Attached is a typescript recently produced by the Economics
Division at the request of George Payne, Desk Officer, East Asia
and the Pacific Division, Department of Commerce. If you have
any questions or comments, please contact
International Trade Branch E__~
Northeast Asia Division, Office of East Asian Analysis
Attachement:
GI M 86-20050, February 1986
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SUBJECT: Medium-Term Foreign Trade Outlook for South Korea
OGI/ECD/IT) I(14Feb)
Distribution:
4 - Byron Jackson, Department of Commerce
1 - Peter Allgeier, USTR
1 - Alexander H. Platt, NSC
1 - William Barreda, Department of the Treasury
1 - Marshall Casse, Department of State
1 - Ann Hollick, Department of State
1 - John St. John, Department of State
1 - Allen P. Larson, Department of State
1 - Ch/OEA/NA/K
1 - SA/DDCI
1 - Executive Director
1 - DDI
1 - DDI/PES
1 - NIO/ECON
1 - CPAS/ISS
1 - D/OGI, DD/OGI
3 - OGI/EXS/PG
6 - CPAS/IMC/CB
1 - Ch/OGI/ECD
1 - Ch/OGI/ECD/IT
5 - OGI/ECD/IT
CONFIDENTIAL
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Central Inte igenc AAgency
DIRECTORATE OF INTELLIGENCE
13 February 1986
South Korea: Medium-Term Outlook for Exports and Import Capacity
Surnnary
South Korea strongly depends on foreign trade to fuel its
domestic economy; a substantial part of GNP growth can be
attributed to higher exports, and many crucial industrial
inputs are imported. After a poor performance last year, we
forecast higher growth of real exports, real imports, and real
GNP over the 1986-90 period. However, growth rates will still
be well below the average for 1970-84. Lower economic growth
and continued high unemployment could unite student and labor
dissidents and make it more difficult for Seoul to carry
through plans for trade liberalization with the United
States. Despite this, we do not believe that economic issues
will provoke a dramatic confrontation between the Korean
government and opposition groups. However, should export
growth remain low, due to a recession in developed countries,
the domestic situation likely would become more troublesome.
This memorandum was prepared byl (International
Trade Branch , Office of Global Issues with a contribution from
Northeast Asia Division, Office of East Asian
Analysis. This analysis is based on information received as of
5 February 1986. Comments and queries may be addressed to the
Chief, International Trade Branch, OGI or Chief of
Korean Branch, 0
GI M 86-20050
February 1986
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SOUTH KOREA: MEDIUM-TERM OUTLOOK FOR EXPORTS AND IMPORT CAPACITY
Background
South Korea strongly depends on foreign trade to fuel its
domestic economy; over one-third of overall GNP growth during the past
fifteen years can be attributed to higher exports. During 1970-79
export earnings increased an average 37 percent annually, with real
exports up 25 percent per annum. This powerful export performance
fueled strong import and real GNP growth, with the latter rising
nearly 10 percent per year during that period. However, between 1980
and 1984 export increases slowed considerably, with gains only half as
large as during 1970-79 (figure 1). This forced a slowdown in the
pace of import growth, in turn contributing to a sharp reduction in
the average real GNP growth rate.
Slower export growth was accompanied by an explosive increase in
external debt (particularly short-term), as Seoul tried to avoid the
adverse domestic impacts of high oil prices and large fiscal deficits
in the late 1970s and early 1980s. As a result, total debt has risen
to an estimated $46 billion in 1985--a three-fold increase since
1978--and is now the fourth largest among developing countries. While
the pace of debt accumulation slowed in recent years, it accelerated
to over 7 percent in 1985 as concern over the slowing economy led to
GI M 86-20050
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FIGURE 1
SOUTH KOREA: EXPORTS AND IMPORTS, 1975-85
RIWON US $
1975 76 77 78 79 80 81 82 83 84 8e
IMPORTS
EXPORTS
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increased government pump-priming and extension of trade credits.
Low Export Growth in 1985
South Korean export growth slowed dramatically in 1985. Based on
data from the first three quarters of the year, we estimate that
export earnings increased less than 1 percent, a sharp reduction from
the 20 percent increase recorded in 1984 and the smallest export gain
since 1958. Three factors have contributed to the export slowdown:
--Slowing growth of OECD real GNP has reduced the growth of
import demand. Lower economic growth is most evident in the
United States--South Korea's largest export market-- where real
GNP growth was about 2 1/2 percent in 1985, compared with
nearly 7 percent the previous year. Real GNP growth also
slowed in Japan, which is South Korea's second-largest export
market.
--Lower export prices, due to weakening demand, greater
competition, and Seoul's aggressive devaluation of the won,
sliced South Korean export earnings last year. We estimate that
export prices declined 7 percent, compared with a 4-percent drop
in 1984.
--Increased trade protectionism reduced South Korean export
revenue. As of February 1985, twenty industrialized countries
2
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were applying restrictions against South Korean exports, ranging
from anti-dumping measures to import quotas to voluntary export
restraints. Restrictions were intensified last year in the
traditionally protected sectors and introduced for new areas.
Anti-dumping duties were imposed by Canada on certain steel
products, voluntary export restraint was maintained on steel
exports to the United States, and quotas were imposed by France
on quartz watches. While the impact of these measures on Korean
exports is difficult to quantify, the South Korean authorities
estimate the cost to be $1 billion in lost export earnings in
1985.
Sales to the United States and West Germany fell, while exports to
Canada, Japan, and the United Kingdom increased (table 1). Exports of
manufactures declined slightly, while exports-of foodstuffs (mostly
fish, fruits, and vegetables) and raw materials fell sharply. Foreign
sales of fuels (mostly petroleum products) showed a strong increase.
1
Stronger Export Growth in the Medium Term
Over the medium term the pace of export growth should increase.
Under our baseline scenario, we forecast an average annual 13 percent
increase in export earnings during 1986-90, with real
(inflation-adjusted) export gains averaging just over 9 percent per
1
Our assessment of South Korea's medium-term export prospects is based
on an econometric model of South Korean exports. See the appendix for
a description of the model and the export scenarios.
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Table 1
South Korea Exports: First Three Quarters 1984-1985
Exports by Country
Million US $
1984
1985
Change (percent)
20,990
20,760
-1
Of
which:
United States 7,940
7,627
-4
Canada 655
893
36
Japan 3,236
3,254
1
United Kingdom 644
658
2
West Germany 675
618
-8
Exports by Commodity Groupa
1984
1985
Change (percent)
Foodstuffs 816
709
-13
Raw Materials 142
128
-10
Fuels 347
441
27
Manufactures 11,251
11,149
-1
Other 149
98
-34
aDue to data limitations, based on partner country data from the
United States, Canada, France, Japan, the United Kingdom, and
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year. However, real export growth will remain well below the pace
recorded during 1970-84.
Three factors will have a positive influence on exports:
--Real exchange rate depreciation. South Korean exchange rate
policy is geared toward balance of payments objectives, and we
believe the authorities will allow the real (price-adjusted and
trade-weighted) exchange rate to depreciate at a moderate pace
(about 3.5 percent per year) to improve export competitiveness in
the face of increasing competition from other Asian countries.
--Higher export prices. South Korean export prices have fallen
every year since 1981, cutting the growth of export earnings, and
we forecast an additional 1 percent drop in 1986. However,
export prices should begin to rise after this year as steady
economic growth in the major industrialized countries, combined
with the expected real exchange rate depreciation, boosts demand
for manufactured goods. However, competitive pressures will keep
price increases modest, on average about 4.5 percent per year
during 1987-90.
--Export promotion programs. In addition to exchange rate
devaluation, Seoul has implemented other measures to enhance the
competitiveness of South Korean goods. These include simplified
export procedures, favorable export financing, increased loans to
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small- and medium-sized firms for export facilities, and
providing funds to the textile industry for modernization. These
steps should improve exporters' efficiency and increase export
revenue over the medium-term.
Continued moderate real GNP growth in developed countries will
underpin higher South Korean export growth. Under our baseline
scenario, we assume real OECD income growth of 3 percent annually
during 1986-90, about the same pace as last year. Higher real GNP
implies continued growth of import demand in industrialized countries,
which should in turn boost South Korean exports.
Finally, while the South Korean export sector continues to be
dominated by manufactured goods, substantial progress has been made to
reduce dependence on light manufactures and instead increase exports
of chemicals, electronics, iron and steel products, ships, machinery,
2
and other transport equipment (figure 2). For example, South Korea
now provides a significant portion of the United States' consumer
electronics market under brand names such as Gold Star and Savin;
Hyundai Motors will begin marketing its Pony subcompact car in the
United States later this year. South Korea's rapid climb up the
technology ladder should continue, a trend that should boost the
importance of technology-intensive products in the export mix. This
greater diversification could lead to higher export earnings over the
next five years.
2
In some light manufacturing industries, such as textiles, efforts are
underway to improve efficiency and maintain competitiveness.
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FIGURE 2
SOUTH KOREAN EXPORTS BY COMMODITY
NON-MANUFACTURES
4.0%
OTHER MANUFACTURES
4.0%
IRON AND STEEL ELECTRONICS
3.0% 13.0%
1978 EXPORTS
LIGHT MANUFACTURES
53.0% -i
11.0% 1 \ SHIPS
LIGHT MANUFACTURES
40.09
1983 EXPORTS
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There are two powerful factors that could limit future export
gains, however; industrial country protectionism and competition from
other Asian nations. South Korea is vulnerable to protectionist
measures, particularly from the United States. Over 35 percent of
total exports go to the United States, and Korea runs a $4 billion
trade surplus with the United States. In some industries, such as
textiles, steel, and footware, South Korea has made substantial
inroads into the US market, and further trade friction has arisen in
the areas of intellectual property rights, computer software
protection, and US access to the South Korean insurance markets.
The United States has already initiated actions against Seoul
under Section 301 of the Trade Act of 1974, and South Korea has made
some concessions in response. However, nettlesome problems--such as
import liberalization--remain, and further sanctions are possible if
negotiations stall or exports to the United States continue to rise
sharply. Additional US trade action, such as legislation to restrict
imports, would have a strong adverse impact on South Korean trade
performance over the medium-term.
Foreign competition is also likely to intensify as South Korea
continues to diversify its export base. Seoul is reducing its
dependence on light manufacturing as it loses competitiveness with
countries such as India and Bangladesh, and is expanding production of
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knowledge- and technology-intensive industries such as electronics and
transport equipment. However, even though South Korea has a labor
cost advantage, competition in these areas with countries such as
Japan and Taiwan is likely to be fierce, which could dampen South
Korean export growth in the medium term.
Debt Service Needs and New Credit Availability
South Korea's debt situation has shown substantial improvement in
recent years with the rate of debt increase declining from a high of
37 percent in 1979 to around 5 percent in 1984 (figure 3). In
addition, the use of short-term debt has been sharply curtailed.
While debt rose an estimated 7 percent last year--$1.2 billion above
its planned limit-- this reflected problems with the commercial
banking system and economic pump-priming measures, as Seoul relaxed
its heretofore austere monetary and fiscal policies in response to
last year's poor economic performance. Overall, the South Korean debt
service ratio (including short-term payments) stands at 70 percent.
Under the current five-year plan, Seoul is committed to reducing the
growth of debt and lowering the debt service burden.
Our analysis indicates that under the baseline scenario, debt
service payments should remain manageable over the 1986-90 period.
Restraint in the growth of debt and use of short-term credit implies
slower growth of debt service than in past years. Moreover, under
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FIGURE 3
SOUTH KOREAN FOREIGN DEBT; 1978-85
sod BIWON us $
1978 1979 1980 1981 1982 1983 1984 1985
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baseline assumptions export growth should rise from last year's
depressed rate, and outstrip increases in debt service payments. As a
result, the debt service ratio (including short-term payments) should
decline over the medium-term to 44 percent by 1990.
Seoul is likely to have little difficulty obtaining external
financing. Korea has easy access to external credit--unlike most
other LDC debtors--and foreign creditors regard South Korea as one of
the best risks among LDC borrowers. Under baseline assumptions, we
see little likelihood that this attitude would change signficantly.
However, bankers' confidence in Korea rests largely on a rate of
export growth that outpaces the growth of debt. Should export growth
falter and debt continue to rise, bankers may become skittish about
adding to their exposure and could offer poorer terms of repayment.
Impact on Imports and Economic Growth
Under our baseline export scenario, we believe South Korea will
be able to increase real imports at a rate that should allow
domestically-acceptable rates of real income growth. To reach this
assessment, we used a methodology (table 2) that linked: our
expectations for export growth, our figures for debt service payments,
our estimate of the services balance (excluding interest payments), an
assumption that the level of new credit extended to South Korea
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Table 2
South Korea: Projected Growth of Import Capacity Under Alternative Scenarios, 1985-90
Billion US $
1985
1986
1987
1988
1989
1990
Baseline Export Growth
Exports
26.5
28.9
32.5
37.0
42.5
48.6
Plus: Gross borrowing
17.8
17.2
17.5
18.4
18.8
19.4
Plus: Other services balance
1.0
1.5
1.5
1.5
1.5
1.5
Less: Debt servicea
18.6
18.9
18.9
20.0
20.5
21.3
Less: Change in foreign
0.3
0
0
0
0
0
exchange reserves
Balance (import capacity)
26.4
28.7
32.6
36.9
42.3
48.2
Change in import capacity
--
8.7
13.6
13.5
14.6
13.9
(percent over previous year)
Exports
26.5
28.8
30.2
34.0
38.5
44.0
Plus: Gross borrowing
17.8
17.2
17.5
18.4
18.8
19.4
Plus: Other services
1.0
1.5
1.5
1.5
1.5
1.5
Less: Debt servicea
18.6
18.9
18.9
20.0
20.5
21.3
Less: Change in foreign
0.3
0
0
0
0
0
exchange reserves
Balance (import capacity)
26.4
28.6
30.3
33.9
38.3
43.6
Change in import capacity
--
8.3
5.9
12.3
13.0
13.8
(percent over previous year)
aFigures include short-term payments.
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remains constant at the 1985 level, and an assumption that foreign
exchange reserves remain unchanged at this year's level. We then used
these estimates of import capacity to assess the potential strength of
future economic growth.
Based on this analysis, we forecast nominal import capacity to
rise nearly 13 percent per year on average, with real import gains
averaging around 7.7 percent per year, compared with growth rates of
20.5 percent and 12.5 percent per year respectively during 1970-84.
Lower export growth will be the main factor contributing to the import
slowdown. With foreign exchange reserves at about $8 billion (about
four months import coverage), South Korea would need to substantially
increase foreign borrowing in order to boost import growth, which we
do not believe would occur given Seoul's concern over the size of
3
South Korean debt.
To predict the pace of future real income gains, we made use of
the relationship between real imports and real income. Most
developing countries--South Korea included--strongly depend on imports
to fuel consumption and investment. The ratio of real imports to real
GNP has risen over the past decade, reflecting South Korea's growing
import dependence. We believe that over the medium term the South
Korean authorities will institute measures--such as import
substitution in the machinery and cattle feed areas--to curb the
dependence on imports and bring the import/GNP ratio down. However,
3
A drop in the price of oil to $20/bbl would reduce South Korean oil
imports by $1.4 billion per year according to our estimates, providing
a substantial boost to Korea's ability to import other crucial
industrial inputs.
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FIGURE 4
SOUTH KOREA: PROJECTED REAL IMPORT CAPACITY, 1975-90"
220,
40
1975 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90
BASELINE
RECESSION
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it is unlikely that these steps will be sufficient to completely
offset the impact of lower real import growth on real GNP.
Given these assumptions we forecast a modest rate of real GNP
growth over the next five years. Real GNP gains could average about 6
percent per year over the 1986-90 period under our baseline scenario,
lower than the average annual growth rate of 8.3 percent between 1970
and 1984, but an improvement over last year's estimated 4 to 4.5
percent real growth rate.
Political and Social Impacts
The slowdown in economic growth this year has not significantly
weakened Chun's grip on power. Chun has deflected much of the
criticism aimed at his economic policies by pointing to cyclical
factors, an upsurge in protectionism, and slack world demand for
Korea's exports. The opposition has failed to capitalize politically
on the weak economy--largely because it has no economic agenda of its
own--confining its policy prescriptions to the argument that long-term
economic development and stability depend on progress toward
democratization.
With real GNP growth forecast to pick up over the rest of the
decade, we feel that the economy will become a less contentious issue,
although problems will remain. Economic growth is likely to no more
than match the 6 to 7 percent rate needed to absorb new entrants into
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South Korea strongly depends on the developed countries for
export earnings, shipping 70 percent of its exports to the OECD.
Thus, a drop in OECD real income growth, such as occurred in 1982,
would reduce export gains, leaving South Korea with less foreign
exchange to meet debt service payments and boost import growth. To
quantify the impact of a recession in developed countries on South
Korean exports, we modified the baseline scenario so that OECD real
GNP growth falls to 1.5 percent this year and minus 1 percent in 1987,
recovering to 1.5 percent in 1988 and 3 percent per year thereafter.
The results indicate that South Korean export earnings would be
reduced $14 billion over the 1986-90 period (table 2), which would
adversely affect imports and real GNP growth. The average annual real
import growth rate over the period would drop by over 25 percent, with
the sharpest impact on imports in 1987 (figure 4). Our forecast of
real income growth would be reduced by 1 to 1.5 percentage points per
year.
Under ese circumstances the domestic situation would become
more troublesome. The government economic management team would need
to maneuver between policies to reignite the economy without
increasing inflation or imposing drastic measures. Higher
unemployment and pressures to protect South Korean markets would
become focal points for discontent and could figure prominently in
unifying opposition forces. An alternative would be a large increase
in external borrowing to boost imports and avert an economic slowdown.
However, given slower export growth lenders could become reluctant to
extend large amounts of new credit in a one of the few LDC markets
considered safe. Higher borrowing would also be contrary to Seoul's
efforts to reduce the rate of debt accumulation and ease the debt
service burden.
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the labor market. Unemployment--particularly among college
graduates--will remain an exploitable issue for the political
opposition. However, it is unlikely that economic issues will become
so serious as to provoke a dramatic confrontation between the Korean
government and the opposition.
Implications for the United States
The interaction between economic performance and political
developments in South Korea, in our view, will be an increasingly
important factor shaping US-South Korean relations. Trade issues are
likely to remain the most contentious issue between the two countries.
Chun's reorganization of the cabinet in January apparently signals his
continued backing for the proponents of liberalization, and is
significant in light of the economic slowdown and rising domestic
tensions over US-Korean trade. If opponents of liberalization can be
held off until the economy revives, additional progress on
liberalization will proceed step-by-step.
Nevertheless, a proliberalization policy carries risks that could
weaken the influence of advocates of market opening. Chun's fears of
a union of student and labor dissidents will only deepen and push
Seoul to dig in on trade policy if pressure from Washington to
liberalize coincides with another downturn in growth. In fact many in
Seoul are already arguing that they need not open markets as wide as
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Washington wants because of the "special" relationship--an argument
that will become increasingly alluring if economic and political
conditions deteriorate.
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Appendix
Methodology
Determination of Export Trends
We obtained estimates for exports through econometric analysis,
based on export data from 1969-85. Real (inflation-adjusted) exports
were assumed to depend on OECD real GNP and the real exchange rate. A
jump in OECD real GNP increases the demand for imports, boosting South
Korean exports. A decrease in the real exchange rate implies an
improvement in the competitive position of South Korea against its
major trading partners, thereby increasing exports. We also allowed
for a lag in the response of export demand to changes in OECD real GNP
or exchange rates.
We calculated the real--price adjusted and trade
weighted--exchange rate by taking ratio of South Korea's wholesale
price index to the trade-weighted average of the corresponding price
indexes of Seoul's 16 major OECD trading partners, and multiplying
this figure by the ratio of the index of the trade-weighted average of
the trading partner's dollar-exchange rates to the index of South
Korea's bilateral dollar exchange rate. The base year for our
calculations was 1980. The calculated real exchange rates provide a
measure of recent changes in competitiveness. With OECD real GNP and
the real exchange rate determined, real exports were derived.
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The export price index (in terms of US dollars) was taken to be
equal to South Korea's wholesale price index divided by the bilateral
dollar exchange rate index. The base year for these indexes was 1980.
The wholesale price index was used because it includes a wide variety
of tradeable or potentially tradeable goods. The export price index
was then multiplied by the estimate of real exports to obtain South
Korean export earnings in terms of US dollars.
Exports Under Alternative Scenarios, 1986-90
To determine the influence on key debtor exports of changes in
OECD real GNP and key debtor real exchange rates, we calculated export
growth for the period under several alternative scenarios for real GNP
and exchange rates. The results indicate that movements in OECD real
income exert considerably stronger influence than movements in real
exchange rates. Therefore, we decided to concentrate on the effects
of changes in OECD real GNP on key debtor exports, using two
scenarios:
--The baseline case, assuming OECD real GNP growth of 3 percent
per year annually and changes in real exchange rates consistent
with private forecasts.
--The recession scenario, assuming real GNP growth of 1.5 percent
in 1986, minus 1 percent in 1987, 1.5 percent in 1988, and
3 percent per year in 1988-90.
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