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Weaker won compounds South Korea's growing economic woes

Cheaper currency no longer lifts exports as it did in the past

SEOUL -- The South Korean won has fallen to its lowest levels in nearly two and a half years, and that has investors worried. The escalating trade spat between the U.S. and China is fueling anxiety about the nation's economy, which is heavily dependent on exports to its giant neighbor.

The won traded at 1,190.9 to the dollar on May 31, down about 6% this year. It is at its lowest levels since January 2017.

The won had stayed within the 1,120-1,130 range since last summer, but started sinking in late April. The slide was triggered by unexpectedly weak gross domestic product data for the first quarter of this year, which showed the economy shrank 0.3%, the first dip into negative territory in five quarters.

A weaker won was once seen as a boon to the country's export-driven economy, as it boosts the price competitiveness of South Korean exports. But the expansion of overseas production and other changes in the country's industrial structure have reduced the benefits of a cheaper currency and increased its drawbacks.

"The weak won reflects the cooling of the global economy," said Stephen Lee, an economist at MERITZ Securities. "Looking at export volumes, it will work to bring them down."

In May, the escalation of the U.S.-China trade war made investors even more pessimistic about the country's export-oriented economy. China is South Korea's largest trade partner, accounting for 27% of its exports.

China is even more critical for South Korea's electronics producers. The International Monetary Fund estimates that China buys 80% of South Korean exports of smartphone parts, which totaled $24.4 billion in 2016. Investors fear that knock-on effects of the trade war between the world's two largest economies will hit a broad range of South Korean parts suppliers, including SK Hynix.

And a weaker currency will not help the country's major chipmakers much. "For semiconductors, for example, price and volume move more based on market conditions instead of currency," said MERITZ's Lee. "Samsung's strategy isn't prioritizing currency." 

Foreign funds are fleeing the country, accelerating the won's downward march. Foreign exchange is pouring out of the economy as investors, anticipating a further drop in the currency, scramble to sell South Korean shares and change their won into dollars. This trend is creating a vicious cycle for the currency.

Net sales of South Korean stocks by foreign investors surpassed 3 trillion won ($2.5 billion) in May.

South Korea depends heavily on external demand for economic growth. Overseas shipments make up more than 40% of the country's nominal GDP. A cheaper won, which lowers the dollar prices of South Korean exports, has long been welcomed as a tailwind for economic growth.

But one in three companies said their operating profits would not be affected by a won 10% cheaper than their projections, according to a survey of the country's biggest 1,000 companies in terms of sales conducted by the Korea Economic Research Institute.

Such a fall will push up operating profit margins by an average 0.5 point, and expand the export ratio by 1 point, according to the survey.

The institute pointed to major changes in the country's industrial structure due to globalization, like more complex corporate supply chains and diversification of currencies used in settlements.

Because of these changes, a lower won against the dollar no longer directly leads to expansion of exports, the institute said.

Other factors behind the vanishing benefits of a cheaper won are the fact that many manufacturers have shifted production overseas in response to rising labor costs at home, and the rising values of South Korean products.

Samsung Electronics' flagship smartphone model was priced $871 on average in 2018, according to U.S. research company International Data Corporation, more expensive than Apple's iPhone.

That means prices are no longer a decisive factor for South Korean exports.

Price competitiveness used to be important, according to Bank of Korea Governor Lee Ju-yeol, when South Korean exports were mostly low-priced products. Now that high-end products account for a big chunk of exports, the exchange-rate effects on export growth are not as large as they used to be, he said.

To be sure, some companies will benefit from a cheaper won, according to Trinh Nguyen, an economist at Natixis in Hong Kong, particularly businesses like Samsung that make most of their earnings abroad. "The more competitive aspects of the Korean economy benefit, while the small and medium-sized enterprises don't."

Still, a growing number of economists and analysts are warning about the downsides of a falling won.

The main effect of a cheaper won will be higher material costs, according to 40% of respondents, the largest group, in the Korea Economic Research Institute's survey. Only 11% of respondents cited higher price competitiveness of exports.

A senior executive at a steel bar maker is concerned that a declining won will raise the prices of billets, half-finished products used to manufacture steel bars, and thereby hurt earnings.

The average price of gasoline in South Korea hit 1,532 won per liter in the fourth week of May, up 13% from January.

The government is on alert, and not willing to allow the won to slide much further. As the won approached the 1,200 level, Hong Nam-ki, minister of economy and finance and deputy prime minister, made a "verbal intervention" on May 20, pledging to take "appropriate measures to maintain stability in the market" in case the won starts fluctuating wildly due to "excessive moves in financial markets."

Many market players believe the government wants to prevent the won from falling below the 1,200 mark.

Natixis' Nguyen expects the won to stay relatively weak until the third quarter of 2019. The dollar will likely weaken in the fourth quarter, she said, offering the won some respite.

Nikkei staff writer Kim Jaewon in Seoul contributed to this article.

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