Korean Economy Korea Economic Research Institute Korea Economic Research Institute

2 Outline  Korea Now  Outlook for 2008 and Beyond  Korea and Taiwan, Partners to Prosperity

3 The Big Picture  For the past 10 years, the Korean economy’s potential growth rate has declined  Until the early 1990s, real GDP growth of 8%  In 2000s, average real GDP growth of 5.2%  Pickup in domestic demand unlikely due to adverse external conditions  Private consumption and investment showed some signs of revival in the early  Uncertainties in the international financial markets and high oil prices deal a big blow to the Korean economy  Export performance remains strong, but with gloomier outlook  The global demand contracts due to prolonged financial instability and higher oil price  Internal political conflicts make much needed reforms difficult  Import of the U.S. beef  Resistance to structural reforms

4 Economic Growth Slows Down  Economic slowdown now apparent due to rising oil prices  GDP growth of 0.8% in the 1 st quarter (lowest since the 2 nd quarter of 2006)  Manufacturing output growth slows down from 10.7% (1Q) to 9.8% (2Q)  Service output growth down from 6.4% (1Q) to 5% (2Q) y-o-y

5 Weakening Domestic demand  Private Consumption shows no sign of recovery  1.3% (’07 3Q) → 0.8% (’07 4Q) → 0.4% (’08 1Q)  Investment is on the decline  Facility investment growth down from 2.1% (’07 4Q) to -0.4% (’08 1Q)  Construction investment growth down from 1.2% (’07 4Q) to -1.4% (’08 1Q) q-o-q

6 Increasing Inflationary Pressure  Despite weaker domestic demand, prices are rising fast  CPI Inflation rate: 3.4% (’07 4Q) → 3.8% (’08 1Q) → 4.8% (2Q)  International commodity price shock is beginning to pass through  Specter of stagflation is making policy choice difficult  BOK has frozen the policy interest rate for the past 11 months  BOK expected to raise the interest rate next month to stave off inflationary expectations y-o-y

7 Robust Export Sector with Rising Oil Imports  The export sector remains competitive  Export Growth (y-o-y): 17.3% (1Q) → 23.3% (2Q)  Average Daily Export Amount: $14.9b (1Q) → $17b (2Q)  Strong Performance of Key Industries due to enhanced non-price competitiveness  But imports are also rising rapidly  40% of imports are oil billion US$

8 Outlook for the 2 nd half of 2008  External Environment  Global economy expected to slow down due to uncertain international financial market conditions and instability in the commodities markets,  IMF projection for the global economy in 2008: 3.7% (4.9% in 2007)  Oil price is likely to stabilize, albeit at a higher level than in the past, in the second half of this year (Annual average of $100/barrel; Dubai oil)  Internal Environment  The government's policy priority shifts from growth to stability Target growth rate from 6% to 4%  Domestic demand stimulus packages Moving up the investment schedules of public enterprises (5 trillion won in SOC projects) Implementation of oil tax refunds (3 trillion won)  Structural reform efforts halted due to controversy regarding U.S. beef import

9 Outlook for year1Q2Q3Q4Q1st H2nd Hyear GDP (SA, q_o_q,%) Private consumption Construction Investment Facility Investment Consumer Prices Current Account (in billion US$) Goods Exports growth(%) Imports growth(%) Service & Others Ex. rate(Ave, KRW/USD) y-o-y, %, billion US$ Note: Actual data in the shaded area

10 Long-term Challenges  Export-dependent economic growth  Contraction in domestic demand base due to the 1997~98 financial crisis  Growth rates for real GDP (6%), private consumption (5%), investment (6%),exports (13%) in the post-’99 period  Demographic changes  The ratio of the 65 years old to the population: 9.9% in 2007, expected to go up to 44.91% by 2050  Bipolarization  Export vs. Domestic demand, Manufacturing vs. Service sectors, Large vs. SM firms etc  Market flexibility  How to reduce labor market rigidity  How to privatize public enterprises

11 Korea and Taiwan, Partners to Prosperity  Korea’s trade with Taiwan on the increase  Since 2000, Korea’s exports to Taiwan has grown 11% (yearly average)  At the same time, Korea’s imports from Taiwan has grown 17.6% (yearly average)  With Increase in trade, two countries are growing more interdependent  One of top 5 largest trading partners to each other  Small but focused mutual investment with big potential  The absolute size of mutual investment is relatively small now due to high costs  But, Taiwan is the 4 th largest investment destination in Asia for Korea  Focused investment in partner firms in machinery parts and IT  Normalization of the Taiwan-China relations could offer a new dimension for Korea-Taiwan-Mainland China linkage