Boston, MA -- (SBWIRE) -- 08/01/2013 -- Despite the upside surprise in South Korea's Q113 real GDP growth, we are maintaining our view that economic momentum is likely to wane in the quarters ahead. Incipient signs of weakness in global trade activity are starting to surface, and the domestic economy faces its own set of problems, namely a faltering property market and a high household debt burden. We highlight, however, that Seoul's endeavour to introduce wholesale changes to the country's investment framework could prove to be a structural positive.

The Bank of Korea's decision to cut the benchmark interest rate by 25 basis points on May 9 vindicated the out-of-consensus dovish view we held. We are happy to maintain a neutral view towards domestic monetary policy. However, with the economic recovery struggling to gain traction and with inflationary pressure remaining well-contained, we highlight that the balance of risks are heavily weighted to the downside.

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We believe the government's recently announced debt relief programmes are unlikely to significantly affect the country's fiscal health in the near term. However, we highlight that Seoul's policies may give rise to the issue of moral hazard by encouraging risky borrowing. Additionally, the 'hidden' debt (debt undertaken by state-owned enterprises) problem we highlighted in early 2012 appears to be growing and continues to present a salient threat to the government's debt profile.

Newly elected president Park Geun-hye's policies exude sensibility and pragmatism. The chaebol reforms that were widely promulgated during her presidential campaign are likely to be immaterial given the adverse economic ramifications they may entail. Despite the bellicose attitude that North Korea has been exhibiting, we expect Park to adopt a largely conciliatory posture towards Pyongyang, which may eventually lead to an acceleration in economic ties between the two Koreas.

Key Risks To Outlook

Downside Risks To Economic Growth Forecast: Should we see a sharper-than-expected downturn in the global economy or even an implosion in South Korea's household debt market, we would certainly expect to see a substantial weakening in its exports sector, which in turn may push the economy into a pronounced recession.

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