VZCZCXRO4723
OO RUEHGH
DE RUEHUL #0847/01 1481029
ZNR UUUUU ZZH
O 281029Z MAY 09
FM AMEMBASSY SEOUL
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4498
RHEHNSC/NSC WASHDC IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCPDOC/USDOC WASHDC PRIORITY 8639
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUEHBJ/AMEMBASSY BEIJING PRIORITY 5976
RUEHBY/AMEMBASSY CANBERRA PRIORITY 8921
RUEHJA/AMEMBASSY JAKARTA PRIORITY 2553
RUEHGP/AMEMBASSY SINGAPORE PRIORITY 6651
RUEHKO/AMEMBASSY TOKYO PRIORITY 6065
RUEHGZ/AMCONSUL GUANGZHOU PRIORITY 0032
RUEHHK/AMCONSUL HONG KONG PRIORITY 3890
RUEHGH/AMCONSUL SHANGHAI PRIORITY 0773
RUEHSH/AMCONSUL SHENYANG PRIORITY 4482
RUEHIN/AIT TAIPEI PRIORITY 3455

UNCLAS SECTION 01 OF 05 SEOUL 000847 
 
SENSITIVE 
 
SIPDIS 
 
STATE PLEASE PASS TO USTR FOR CUTLER AND TRICK 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ENRG ETRD KS
SUBJECT: KOREAN ECONOMY BEGINS TO SHOW FASTER-THAN-EXPECTED SIGNS OF 
IMPROVEMENT 
 
¶1. (SBU) This cable is sensitive but unclassified and not rpt not 
intended for internet distribution. 
 
¶2. (SBU) Summary: The Korean economy has proved more resilient than 
most think tanks expected during the steepest part of the global 
downturn in January and February. In the first quarter of 2009, the 
economy grew by 0.05 percent over the level of the fourth quarter of 
2008 (when the economy declined by 5.1 percent).  This apparently 
made Korea the only OECD economy to show positive growth - however 
negligible - in the first quarter.  While the weak won and sharp 
decline of the Korean stock market were symptoms of the global 
financial crisis, the weak currency also helped buffer the economy 
by making Korean exports more competitive and imports more 
expensive. Thus, exports reached their nadir in January and began a 
mild recovery, while imports have continued to decline.  The result 
has been increasingly large current account surpluses -- reaching 
USD 6.6 billion in March. Together with renewed inflows of foreign 
investment capital, these developments have helped the won recover 
over 20 percent of its value from its low approaching 1600 per U.S. 
dollar in early March. Korea's benchmark stock index has recovered 
even more strongly, rallying by more than 40 percent off of its 
early March low, one of the best global performances over that 
period.  Capturing a mood of increasing if cautious optimism, U.S. 
economist Nouriel Roubini drew considerable attention when he told 
Seoul audiences on May 27 that he expected Korea's 2010 growth rate 
could come in above the 1.5 percent projected by the IMF (in 
February). 
 
¶3. (SBU) While acknowledging that the Korean economy appears to be 
in a much better position than was predicted a few months ago, some 
economists remain concerned that the ROK economy is not as strong as 
recent developments may indicate. Some argue that the ROKG crisis 
measures -- the stimulation of the economy and stabilization of the 
financial system through the easing of monetary policy and the 
provision of liquidity to banks -- have created a situation of 
excessive liquidity. These economists believe that the ready 
availability of all this cash, particularly during a period when 
corporate facility investment has not recovered, makes the economy 
vulnerable to the development of new speculative bubbles. An 
alternate perspective holds that the impact of government measures 
will begin to dissipate during the third quarter of 2009 and that, 
given that external demand is likely to remain weak for Korean 
exports, the economy will experience a double-dip recession. 
 
¶4. (SBU) A closer look at Korea's shipbuilding industry reveals both 
the strengths and vulnerabilities of the economy. The top firms are 
holding orders stretching over the next three years worth over USD 
150 billion and experiencing very few cancellations. Newer SME 
shipbuilders have a much smaller order book, have experienced higher 
cancellations and are facing greater competitive pressures from 
China. More of these firms are likely to require restructuring or 
fall into bankruptcy as global demand for new ships remains anemic. 
The larger shipbuilders are well equipped to handle the downturn, 
but would be hurt if orders do not rebound within the next two 
years. End Summary. 
 
¶5. (SBU) Recent developments with North Korea are not, at this 
point, expected to meaningfully affect South Korea's medium-term 
financial and economic performance.  Following the North Korean 
nuclear test on Monday, May 25, the Korean stock market and won 
dipped initially but made back most of the losses.  Markets closed 
Thursday, May 28, with the benchmark KOSPI stock index off less than 
one percent (0.6 percent) from its May 25 opening, and with the won 
similarly off less than one percent (0.6 percent) of its May 25 
open. 
 
ROK Economy Surprises with Slight Growth in Q1 
--------------------------------------------- - 
 
¶6. (SBU) The Korean economy, hit hard by the global financial 
crisis, experienced a GDP decline of 5.1 percent in the fourth 
quarter (Q4) of 2008. This was accompanied by 40 percent declines in 
the value of the Korean currency, the won, as well as Korea's 
 
SEOUL 00000847  002 OF 005 
 
 
benchmark stock index, the KOSPI. Following some recovery in 
December, the currency and stock values began to decline again in 
January and February and some stories  even surfaced in the 
international press (particularly in British publications) about the 
potential for sovereign default in Korea. For a time in February and 
March, each successive economic forecast projected a deeper decline 
in GSP in 2009 (the lowest was for a GDP contraction of 7.2). Yet, 
despite this clamor, in Q1 2009 ROK GDP actually posted a slight 
increase of 0.05 percent over the weak performance of Q4 of 2008 
(but, of course, still 4.38 percent below the level of Q1 2008). 
This apparently made Korea the only OECD country to experience 
positive growth in the first quarter. 
 
¶7. (SBU) The ROKG has taken a number of steps to ease monetary 
policy and stimulate the economy, but perhaps the biggest single 
contributing factor to this outcome was the unanticipated weakness 
of the won (driven principally by foreign portfolio investors 
pulling out of the Korean equity markets after September).  Korean 
goods exports declined 34.8 percent in January, 19.4 percent in 
February, and 17.8 percent in March (all year-on-year), but the 
decline would have been considerably worse had the weak won not made 
Korean goods more attractive than those of competitors, especially 
Japan and China, in global markets. On the other side of the ledger, 
Korean goods imports declined by 31.9 percent in January, 30.6 
percent in February, and 35.8 percent in March (all year-on-year), 
in part reflecting lower commodity prices compared with a year 
earlier. Services imports and exports followed a similar pattern, 
with Koreans dramatically curtailing other overseas travel and 
educational activities as the weak won made them unaffordable. 
 
¶8. (SBU) Looking at components of growth, the steeper fall in 
imports than in exports (after January) generated a boost to net 
exports, which were 26.2 percent higher than in Q4 2008 and 67.2 
percent larger than in Q1 2008. Government spending also played a 
role, increasing by 3.6 percent over the previous quarter. Private 
consumption was neutral, posting a 0.45 percent gain over the 
depressed Q4 2008 result (but 4.38 percent below the level of Q1 
2008). Investment, on the other hand, continued to decline, dropping 
a further 12 percent after the already steep 16 percent decline in 
Q4 2008. 
 
Monetary and Financial Stabilization 
------------------------------------ 
 
¶9. (SBU) The gradual easing of the global credit crunch in Q1 2009 
provided room for improvement in the stability of the ROK financial 
system. This was not immediately apparent as the won renewed in 
January and February its fall against the dollar, reaching a low of 
nearly 1600 per dollar on March 3. As markets became concerned with 
the potential for sovereign defaults in Eastern Europe, speculation 
increased regarding the possibility that Korea was also vulnerable, 
with some (superficial) analyses focusing on Korea's relatively high 
short-term foreign currency debt.  However, much of that debt is 
currently held by international commercial and investment banks 
operating in Korea and is owed to their headquarters - an internal 
corporate transaction considered unlikely to lead to defaults 
(unlike in the 1997/98 financial crisis, when Korea's high foreign 
currency debt was held by over-extended chaebol conglomerates). 
 
¶10. (SBU) While a scenario involving ROK sovereign default may have 
seemed plausible in February under worst-case assumptions, the 
situation changed rapidly and the won began to strengthen 
substantially in March. The prevailing outflow of foreign funds out 
of Korea reversed course and became a rapid inflow into Korean 
stocks and bonds. The impact of the weak currency on trade also made 
itself felt as the current account, which posted a USD 1.64 billion 
deficit in January, surged into the black in February and March with 
surpluses of USD 3.56 billion and USD 6.65 billion, respectively. 
The April trade surplus of USD 5.8 billion exceeded that of March 
and initial indicators point to continuation of the trend in May. 
These factors have supported a 20 percent rise in the value of the 
won and a 40 percent increase in the value of the benchmark KOSPI 
stock index (from their 2009 lows of early March). Foreign reserves 
 
SEOUL 00000847  003 OF 005 
 
 
have also begun to climb, rebounding from USD 201 billion at the end 
of February to USD 212 billion at the end of April. 
 
¶11. (SBU) The ROKG has undertaken many policy actions since 
mod-October to increase the stability of the financial system. These 
measures, facilitated by the improving global financial environment, 
have had a positive impact. The Bank of Korea (BOK) has undertaken 
the most aggressive monetary easing measures in its entire history. 
The policy interest rate was slashed from 5.25 percent to 2 percent 
(although the BOK has signaled that further cuts are unlikely 
barring unexpected financial system deterioration). The BOK has also 
used various tools to inject liquidity into the banking system, to 
assist with bank recapitalization, and to support the bond market. 
These BOK measures were accompanied by a broader ROKG shift to 
massive fiscal stimulation of the economy with additional spending 
and tax cuts between Q4 2008 and into 2010 totaling 7.4 percent of 
GDP. 
 
¶12. (SBU) Additional measures taken include guarantees of SME debt 
and ROKG purchases of construction-related debt and assets. Planned 
actions include the creation of funds to support construction, 
shipbuilding and shipping sectors (including through the purchase of 
idle assets, such as ships). The positive impact of this set of 
measures can be seen in reduced spreads (differences) between Korean 
Treasury bonds and those of banks and larger firms, in reduced 
numbers of bankruptcies, and in a radical improvement in the ability 
of Korean banks to roll over debt and issue foreign 
currency-denominated bonds (Korean banks raised over USD 12 billion 
in new capital in overseas markets in the first five months of 
2009). 
 
¶13. (SBU) The BOK has indicated that the banking system's liquidity 
situation has improved markedly and that capital adequacy ratios 
remain in solid territory. The BOK has, however, acknowledged some 
deterioration in the soundness of the commercial banks because of a 
sharp contraction in profitability. This view was seconded by the 
one-notch downgrading by Moody's in mid-May of the creditworthiness 
of Korea's major commercial banks. Household debt has increased 
relative to income and financial assets, but this has been offset by 
lower interest rates. Real estate prices have continued to decline 
through Q1 2009, but the lower loan-to-value ratios required in 
Korean real estate financing have thus far ensured that home values 
continue to exceed loan values. 
 
Some Wonder:  Too Much of a Good Thing? 
--------------------------------------- 
 
¶14. (SBU) There is general acknowledgement among economists in Korea 
that the Korean economy appears to be in a much better position than 
was predicted a few months ago.  However, the very success of the 
government's stimulus measures, together with the strong rebound of 
the Korean stock market, have led some economists and investors to 
question whether the ROKG has injected too much liquidity into the 
financial system. One economist claimed that over 800 trillion won 
(or USD 623 billion) is floating freely in the Korean market, a 
ready supply of hot money that could flow rapidly between 
investments in a potentially destabilizing search for higher 
returns.  Similar analyses have highlighted concerns about the 
possibility of liquidity-induced speculative bubbles developing 
within the economy. 
 
¶15. (SBU) One senior investment banker argued a somewhat different 
unpleasant scenario for the near future of the economy. He suggested 
that the surging price of stocks (both in Korea and globally) is a 
symptom of a classic bear-market rally. In this view, the Korean 
market has been buoyed by the weakness of the currency, by the low 
interest rates, by the additional liquidity and by the fiscal 
stimulus measures. All of these effects were strong in Q1 and carry 
some momentum into Q2 but they will begin to dissipate during Q3. 
Global demand will remain sluggish throughout 2009 and thus the 
Korean economy will have nowhere to go but down, resulting in a 
double-dip or W-shaped recession. 
 
 
SEOUL 00000847  004 OF 005 
 
 
¶16. (SBU) Economists and market analysts have pointed to other areas 
of concern as well. Some argue that corporations are resisting 
bank-led restructuring efforts to avoid selling core assets. This 
argument does not really apply to the top ten conglomerates, which 
learned during during the 1997/98 financial crisis to hold onto cash 
(most have low debt rates below 100 percent).  The main concern in 
this regard is Korea's second-tier conglomerates (which are not 
generally as successful in export markets), as well as large firms 
that sought to expand through high-priced leveraged buyouts of other 
firms (Doosan Infracore, STX Shipbuilding, and Kumho Asiana group, 
all of which embarked upon transformative acquisitions in recent 
years, are the Korean companies most prominently mentioned in this 
regard). Banks too are said to be hesitant to write down assets in 
the present environment, hoping for further improvement in business 
conditions and market prices. Another concern is that the financial 
sector remains vulnerable to an external shock, possibly through the 
outstanding SME loans that have been rolled over or possibly even 
through foreign investor-led short-selling of Korean stocks. 
 
Shipbuilding - A Critical Sector 
-------------------------------- 
 
¶17. (SBU) The shipbuilding industry has become increasingly 
important within the ROK economy. The industry accounted for 10.2 
percent of Korean exports in 2008 and, accounting for approximately 
5 percent of GDP, was Korea's single biggest industry (and the 
largest shipbuilding industry in the world). Shipbuilding is one of 
a small group of industries with a considerable lag (three-or-so 
years) between the time an order is received and the product is 
finished and delivered. Payments are generally spread across this 
period in five equal increments. The shipbuilding firms book the 
payments as liabilities rather than income until the completion of 
the order. Since prices are set in dollars but most costs are in 
won, firms take futures currency contracts to hedge against the risk 
of exchange rate fluctuations. 
 
¶18. (SBU) Shrinking global trade during the economic slowdown has 
led to dramatic declines in demand for new ships, and many orders 
for lower-end vessels, especially bulk carriers, have been 
cancelled.  Korean shipbuilders currently have an order book 
(backlog of orders) worth approximately USD 200 billion. The top 
three Korean shipbuilders account for approximately 83 percent of 
these backlogged orders. The Korean industry is structured toward 
high-end vessels such as large container vessels, chemical carriers, 
and specialty vessels designed for various functions within the oil 
industry. Thus, while China has reportedly experienced the 
cancellation of about 200 vessels, Korea has suffered the 
cancellation of only around 20 vessels (worth approximately USD 1 
billion). 
 
¶19. (SBU) The Korean industry has had a significant number of new 
entrants in recent years, particularly SME enterprises involved in 
construction of lower-end vessels, an area where competition from 
China is particularly strong. SMEs account for approximately 
two-thirds of Korean shipbuilders but only 30 percent of the value 
of the contracts. With no new orders, smaller order backlogs, 
shorter lags between orders and completion, and the burden of 
cancellations falling disproportionately on these firms, it is not 
so surprising that analysts are concerned about the solvency of 
Korea's SME shipbuilders. Yet only a few of these firms have been 
pushed into the bank-led restructuring program. Additional 
restructuring or bankruptcies are likely among these smaller Korean 
shipbuilders in the near term as global demand for new ships is 
estimated to be depressed for at least several more quarters. 
However, the larger shipbuilders are well positioned to weather the 
storm provided that orders begin to pick up within the next two 
years. The longer term issue for the industry is how to maintain 
competitiveness against the Chinese shipbuilders. 
 
Comment 
------- 
 
¶20. (SBU) The ROKG has scored success through its efforts to 
 
SEOUL 00000847  005 OF 005 
 
 
stimulate the economy, stabilize the financial system, and insulate 
vulnerable sectors from the impact of the financial crisis and 
global downturn. The weakness of the currency, which came as a 
result of the vulnerability of the Korean financial system to global 
developments - most notably foreign investors repatriating capital 
to U.S., EU and other markets -- also ended up buffered the economy 
from further harm. The downside risks to the economy are many, and 
the ROKG seems to be well aware of these and is developing methods 
to identify, track, and respond to them. Finance Minister Yoon 
Jeung-hyun was quoted in early May in response to the excess 
liquidity argument, "We recognize the concerns, but now is not the 
time to absorb liquidity." Yoon has repeatedly made clear that the 
government is concerned that withdrawal of its ample support for the 
economy would be premature at this point. Instead the ROKG has 
indicated that it is prepared to fine tune economic policy to 
prevent the emergence of speculative bubbles within the economy, 
e.g., to make real estate speculation in the most desirable Seoul 
neighborhoods more expensive. While the Korean economy has proven to 
be more resilient than its critics believed possible, ROKG policy 
makers face many constraints and are unlikely to be able to maintain 
economic growth unless global demand begins to recover 
 
STEPHENS