South Korea: A Rising Tide May Bring Rising Prices

South Korea seems to be one of the first economies to shake off the global downturn. But the nation might also be one of the first industrialized economies to confront price pressures.

Korea's real gross domestic product grew by 1.6% in the fourth quarter, and it was up 3.7% from its year-ago levels, with the increase led by domestic demand (chart). Consumer spending accelerated in 2001, and government stimulus plans also pumped up growth, especially in construction. Even with the extra spending, however, Seoul managed to post a 2001 budget surplus of about 1% of GDP.

But exports, which account for about half of Korea's GDP, are suffering, in part because the weak yen has made Japanese goods more competitive with Korean products. Fourth-quarter exports were down 1.1% from a year ago. The drop-off was acute in computers and vehicles.

For 2002, the government forecasts real GDP to rise by 4%, and private economists think growth could top 5%. The early monthly numbers suggest that the economy is off to a good start. Industrial production and consumer confidence are on the rise, and unemployment is falling. Growth will also get a big boost from the World Cup. Korea expects upwards of 400,000 soccer fans to visit when the games begin on May 31.

Better growth prospects have raised worries about an overheating economy and price pressures. In February, yearly consumer inflation was just 2.6%, but Chon Chol Hwan, the central bank governor, is concerned that the rise in domestic demand, coupled with World Cup spending, could push up consumer prices. In addition, the won has fallen just over 5% against the U.S. dollar since November. If the weakness persists, import prices could rise later on.

As a result, investors are betting that the central bank will lift short-term interest rates this year to cool growth and fight inflation expectations. Some are gambling on a hike as soon as May, but most expect rates to begin rising early in the second half.

By James C. Cooper & Kathleen Madigan

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