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South Korea Eyes Bigger Fiscal Response to Europe Threat

South Korea's Finance Minister Bahk Jae Wan
Bahk Jae Wan, South Korea's finance minister. Photographer: SeongJoon Cho/Bloomberg

South Korea indicated that it’s preserving fiscal firepower for worsening economic conditions after Europe’s debt crisis triggered a cut to the nation’s growth forecast.

The government’s 8.5 trillion won ($7.4 billion) of economic support measures announced yesterday, including assistance for small businesses and low-income earners, leaves room for a bigger response if conditions deteriorate, said Choi Sang Mok, a director-general at the finance ministry.

Europe’s austerity drive is capping demand for Asian exports, with surging borrowing costs for Spain showing the euro region has yet to contain its crisis. South Korea’s gross domestic product may expand 3.3 percent this year, less than a December estimate of 3.7 percent, the Finance Ministry said yesterday in Gwacheon, south of Seoul.

“The European debt crisis is such a big challenge that South Korea will have to struggle to meet even the lowered growth target,” said Kim Nam Hyun, a Seoul-based fixed income analyst at Eugene Investment & Futures. “The worst may not be over yet.”

The government also yesterday announced incentives to attract foreign-currency deposits to banks, a buffer against volatility in capital flows. The cut to the growth forecast followed the central bank paring its estimate to 3.5 percent from 3.7 percent. The finance ministry predicts a 4.3 percent expansion next year.

Industrial output rose a more-than-expected 1.1 percent in May from the previous month, according to a report from Statistics Korea today.

‘Long-Term Threat’

“We now perceive the euro zone crisis as a long-term threat to the South Korean economy,” Finance Minister Bahk Jae Wan said yesterday. “We need to store up enough fiscal measures to endure this long journey and build strong economic fundamentals.”

He said the latest financial measures used money from the existing budget.

South Korea’s Kospi Index of stocks fell 0.2 percent at 11:27 a.m. in Seoul, and is down 0.5 percent this year. That compares with a gain of about 5 percent for Japan’s Nikkei 225 Stock Average and 4 percent for Hong Kong’s Hang Seng Index.

“South Korea’s growth momentum is weak, but it is faring well given deteriorating external conditions,” Choi said. Europe’s crisis “will continue for a long time,” he added.

Reduced Levies

Depositors outside South Korea will be exempt from interest income tax on foreign-currency savings at the nation’s banks, the ministry said. Banks will pay reduced levies on their foreign-currency borrowings if they attract more foreign-currency deposits, it said.

“The spread of the euro-zone fiscal crisis and belt-tightening in major advanced economies may slow global economic growth,” the finance ministry said. “Recession in the euro-zone may deepen amid fiscal tightening and political turmoil while financial markets show continued jitters.”

South Korea’s inflation this year may be 2.8 percent rather than a past 3.2 percent prediction, the finance ministry said.

In a bright spot, the government sees stronger employment growth this year -- 400,000 jobs, up from a previous estimate of 280,000. Services industries such as health care are hiring more workers than expected to meet increasing demand, the finance ministry said.

Exports have fallen for three straight months from a year earlier. South Korean officials also face weakness in the housing market and the inflationary impact of a drought that’s brought the driest spell in more than a century to the capital of Seoul and increased the prices of some foods.

“Consumers are sensitive to price increases in everyday items, especially food,” Lee Sung Kwon, an economist at Shinhan Investment Corp. in Seoul, said this week. “Although food prices account for about 10 percent or less in the consumer price index, they’re volatile and tend to have a bigger impact.”

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