Author: Troy Stangarone, Korea Economic Institute of America
In May 2022, South Korean President Yoon Suk-yeol was elected on a platform calling for a break from his predecessor’s income-led growth strategy to one focused on deregulation and corporate tax cuts. While the new administration has taken steps to implement Yoon’s free market approach, external events have loomed large over South Korea’s trade-dependent economy.
After two years of uncertainty and economic disruptions from the COVID-19 pandemic, coming into 2022 the worry was that the global recovery would lose steam from the spread of the Omicron variant, inflation and continued supply chain disruptions. These challenges were made more difficult due to Russia’s invasion of Ukraine, which accelerated fuel and food inflation.
Russia’s war has most directly impacted the South Korean economy through rising fuel costs. Early on, Seoul took steps to align its policies with the United States and Europe by agreeing to enforce US and European financial sanctions and export controls on strategic items that could aid Moscow’s war effort.
While South Korea did not adopt US or EU sanctions on Russian energy exports, it has worked to reduce energy imports from Russia. In 2022, South Korean imports of Russian crude petroleum dropped by 60.3 per cent, refined petroleum by 72.9 per cent and liquefied natural gas by 31.6 per cent — rising coal imports were the exception to this trend. But overall energy costs have grown. Imports of fossil fuels were up 58.9 per cent by value, but only 3 per cent by volume.
Rising fuel costs from imports have also filtered into the domestic economy. Kepco, South Korea’s state-owned energy monopoly, instituted three domestic electricity price increases in 2022 and an additional record 9.5 per cent increase on 1 January 2023 to deal with the rising costs of energy imports. Energy price increases have also been a factor in inflation, which peaked at 6.3 per cent in July 2022.
More broadly, inflation has also been driven by increases in consumer demand from the relaxation of COVID-19 restrictions, government stimuli and a significant decline in the South Korean won. The won has been under pressure from the deteriorating South Korea trade balance and the US Federal Reserve’s interest rate increases.
Outside of Russia’s war and inflation, China’s COVID-19 policies and decreasing global demand have weighed heavily on South Korean trade. Overall, exports to China declined during the last seven months of 2022 (year-on-year) and fell 4.4 per cent for the year. Weakening demand for semiconductors — which accounted for 20 per cent of South Korean exports in 2021 — also declined for the final five months of 2022. These factors, along with surging energy prices, led South Korea to record its second trade deficit this century.
Beyond the lingering effects of the COVID-19 pandemic and Russia’s invasion, two major pieces of US legislation — the CHIPS and Science Act and the Inflation Reduction Act — are expected to have a significant impact on South Korea.
The CHIPS Act is designed to spur investment in US semiconductor production, providing up to US$3 billion for each investment in the United States. But the caveat is that Samsung and other South Korean chip producers now face restrictions on expanding their production of advanced chips in China.
The United States has also continued to tighten export restrictions on the sale of advanced semiconductors and semiconductor equipment to China. While Samsung and SK Hynix have received a one-year exemption, the new export restrictions place deeper constraints on the ability of South Korea’s most important industry to do business in China.
The Inflation Reduction Act has perhaps caused the most concern. Currently, only electric vehicles (EVs) assembled in the United States, Canada or Mexico are eligible for a US$7500 tax credit for consumers. Starting in 2023, additional restrictions on the mineral and component content of EV batteries must also be met to be eligible for this tax break. As Hyundai and Kia will not have an assembly plant ready to produce EVs in the United States until 2025, they are ineligible for the tax credit and are at a disadvantage to US and foreign producers who can meet the requirements.
But in the longer term, South Korean EV battery producers are expected to be the main winners from the legislation. By 2025, the United States is expected to account for 44 per cent of the global EV battery market and thanks to significant Korean investment in US production facilities, South Korea’s market share in the United States is expected to grow from 26.5 per cent to 69 per cent.
With GDP growth expected to slow to less than 2 per cent in 2023, factors such as a quick return to growth in China and continued stability in global energy markets are largely beyond the Yoon administration’s control. But steps can be taken over the medium term to address policy-related issues. Seoul’s Indo-Pacific Strategy hints at one approach involving deeper regional cooperation on energy security and the clean energy transition. Addressing concerns about the Inflation Reduction Act or US semiconductor policy will require a more direct approach, but deeper regional economic engagement can help minimise some of South Korea’s economic risks.
Troy Stangarone is Senior Director and Fellow at the Korea Economic Institute of America. The views expressed here are solely those of the author alone and do not reflect the views of the Korea Economic Institute of America.
This article is part of an EAF special feature series on 2022 in review and the year ahead.