Korean spending spree sets right tone

January 4, 2012

By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

South Korea’s spending spree looks wise. The government plans to spend 70 percent of its budget in the first half of 2012, and will likely throw in an additional Keynesian deficit-spending package. With presidential elections in December, that might seem a sop to voters. But Korea can afford it. And it has so far resisted the less sensible course of weakening the won to boost exports. The rest of Asia should follow its lead.

Korea is vulnerable on a few fronts: gross exports still account for half of GDP, and borrowing from European banks, whose troubles are deepening, is equivalent to a fifth. Uncertainty over the situation in North Korea further hurts sentiment. Business investment fell 3.7 percent in November compared with a year ago.

Front-loading the budget alone won’t have much oomph: Seoul has done something similar every year since 2009. More important is the 18 percent annual boost, equivalent to around $10 billion, in spending for the first quarter. A separate, similar-sized spending package could follow in the second quarter, pushing the government into a small deficit.

Seoul’s response might seem politically motivated. Presidential elections are due in December and an upset in Seoul’s mayoral elections last October proved young voters are fed up with rising prices and unemployment. Like most of Asia, Korea’s debt is less than 50 percent of GDP. And financing a deficit should be easy when 10-year bond yields are still below 4 percent.

Spending is also smarter than lowering rates to weaken the won. Cutting rates would worsen recent capital outflows and do little to revive exports when global demand is weak.

Whether it works depends on the detail. The government says it will channel its accelerated spending into promoting domestic-oriented jobs. But if the slowdown persists, it will have fired too early. And pouring the equivalent of 17 percent of GDP into the economy in six months could fuel inflation. If the plan works, though, what Seoul is proposing should reduce its reliance on exports in favour of the domestic economy. That would allow it to emerge from the slowdown in better shape than it goes in.

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