Economic Report

(Extracted from 2002 Economic Outlook)

REAL GROSS DOMESTIC PRODUCT : In the first half of 2002, Korea’s real GDP increased by 6.1 percent. Growth was mainly due to an increase in exports and investment, while consumption grew steadily. The major industries such as electronics, semi-conductors, and automobiles showed a robust rebound.

In July 2002, industrial output continued its upward trend rebounding from 5.4 percent in June to 8.9 percent in July. This was due, in large measure, to an increase in automobile and semi-conductor production. Domestic consumption improved as wholesale and retail trade increased 6.6 percent year-on-year in July. As for investment, capital investment in July was less than in June, while imports of equipment and domestic order for equipment increased. Construction investment in July recorded more than 10 percent growth since June, bolstered by the increase in private sector construction.

INFLATION : The Consumer Price Index (CPI) remained stable until August 2002, increasing 2.9 percent compared to the end of last year, and 2.5 percent compared to the same period last year. In August, mainly due to the increase in food prices as a result of flood damage, the CPI increased by 2.4 percent as opposed to 2.1 percent in June. In view of the fact that economic effects from flood damage usually vanish in a short time, the prices are expected to normalize. Despite uncertainties over domestic and foreign economic recoveries as well as international oil prices, consumer price increases in Korea are expected to remain stable at around 3.0 percent aided by the strengthening won and little change in public utility charges.

EMPLOYMENT : Due to the contraction of the economy and nationwide structural reform after the financial crisis, the unemployment rate reached a peak rate of 6.8 percent in 1998, but has continued to decrease for the last four consecutive years. Strong growth in private consumption, concentrated in cars and other durable goods, helped to improve labor market conditions. Furthermore, an increase in service sector hiring has caused the unemployment rate to fall to 2.7 percent since June 2002, the lowest rate since the onset of the Asian financial crisis.

BALANCE OF PAYMENTS : In 2002, the current account surplus in July narrowed to US$30 million from US$0.8 billion in June. The narrowing is mainly due to the increased service account deficit. The current account included the goods account surplus of US$0.9 billion which is down US$0.9 billion from the previous month and the service account deficit of US$ 0.8 billion which is down US$0.3 billion from June due to an increase in outbound tourist spending.

The current account surplus by July was US$3.5 billion, much smaller than US$7.0 billion during the same period of last year. On the other hand, the capital account surplus expanded to US$2.9 billion in July from a surplus of US$0.8 billion a year ago.

Export growth, continuing the positive trend since the second quarter, has increased by almost 20 percent since July, partly because of the technical rebound from the lows in the second half of last year. For the remaining period of the year, export growth is expected to be more than 10 percent.

GROSS EXTERNAL DEBT : After the early completion of repayments to the International Monetary Fund (IMF) in August 2001, foreign reserves are now at a level that provides substantial insulation against shocks. Moreover, due to Korea’s outstanding restructuring efforts and macro-economic performance, its sovereign credit rating was returned to pre-crisis 'A'-levels by the three major credit rating agencies during the first half of 2002. Moody’s first changed the rating to ‘A3’ in March, then Fitch Ratings upgraded Korea’s long term foreign currency rating from ‘BBB+’ to ‘A’ in June, followed by Standard & Poor’s raise from ‘BBB+’ to ‘A-’ in July.

Korea’s total external liabilities stood at US$125.8 billion at the end of June 2002. The ratio of total external liabilities to GDP was 29.0 percent, while Korea has maintained its position as a less-indebted country according to World Bank standards.

Total external assets, meanwhile, increased US$1.7 billion to US$171.4 billion mainly due to the increase in foreign exchange reserves and external assets in the banking sector. As a result, the value of net external assets climbed to US$45.5 billion, down US$0.6 billion from the previous month, maintaining the net creditor position Korea established in September 1999.

EXCHANGE RATE : The weakness of the yen and falling demand for Korean exports downgraded the won to the 1,362 per US dollar level at the end of 2001. The won-dollar exchange rate has continued to decline since mid-April due to the weakening of the dollar and the continuing Korean export upturn. On 22 July, the dollar rate closed at 1165.6, the lowest since 2001. However, since August, the dollar rate has stabilized around 1200.

FISCAL POLICY : For the first half of 2002, the government initially intended to carry out fiscal policy with a focus on early economic recovery by stimulating domestic demand. The government approved a 112 trillion won budget for 2002, a 5.5 percent increase from the previous year. Over the first six months of 2002, the government allocated 65.4 percent of the budget, focusing on expanding social infrastructure investment. However, the actual expenditure was only 48.4 percent of the budget during the same period. For the second half of 2002, in consideration of the strong economic recovery during the first half year, the fiscal policy was switched back to a neutral regime.

MONETARY POLICY : In the first half of 2002, exports and facilities investment showed recovery while both consumption and construction investment continued buoyant. Consumer inflation eased to 2.4 percent on a year-on-year basis in August from the 2.1 percent of the previous month, as prices of farm products increased because of flood damage.

Looking ahead, the strength of the Korean won against the US dollar and the expected stability of international oil prices will mitigate inflationary pressures. Demand-side inflationary pressures, however, are expected to accumulate and wages seem likely to increase in line with the continued economic recovery.

In the financial markets, stock prices, long-term interest rates and the exchange rate have been falling back simultaneously due largely to the turbulence in the US and other major financial markets. It is necessary therefore, to watch carefully how the impact of the financial market feeds through to the real economy. Laying stress on price stability, the Bank of Korea will operate its monetary policy in a flexible manner with a focus on the stability of financial markets and the prevention of a sharp slowdown in the economy.

MEDIUM-TERM OUTLOOK : The economic growth rate in 2002 is forecast to rise up to 6 percent as domestic demand maintains its steady growth trend while export growth accelerates with the world economy’s recovery. Private consumption is expected to increase to the 7 percent range this year. Equipment investment and construction investment growth is forecast to slow down slightly in the second half of 2002, as a rebound from last year’s stagnation; the growth rates being expected to rise to a range of 10 percent and between 9 and 10 percent respectively.

Exports in the second half of this year, due to the recovery of the world economy, are expected to increase by around 10 percent. However, imports are also expected to increase by 14 to 15 percent due to the continuing economic growth trends and depreciation of the won/dollar exchange rate. Therefore the current account will remain at 4~5 billion surplus. Consumer prices due to an increase in domestic demand and increase in wages, have been under sustained inflationary pressure. Still, consumer price increases are forecast to remain at a low 3 percent level due to the won appreciation.

It is feared, however, that instability in international financial markets, in the US stock market in particular, may spread to the domestic financial market. Foreign exchange volatility could also weaken the competitiveness of Korean exports. Moreover, regional political agendas and the presidential election might also have a dampening effect on the economic recovery.

With this in mind, the government will maintain its current macro-economic policy framework while monitoring economic demands in order to promote stable economic growth. Efforts will also be made to ensure that market-driven principles take root in the corporate and financial sectors and that improvements in public-sector efficiency and labor-management relations continue. Furthermore, government will develop logistical, business, and financial infrastructures, which will increase industrial competitiveness and transform Korea into a Northeast Asian Hub.

Annex I

KOREA : OVERALL ECONOMIC PERFORMANCE

Note: 1 Korean economy recorded 3.0 percent growth in 2001, but nominal GDP in US$ was 422.2 billion dollar, which was smaller than that for 2000, due to changes in exchange rates.

Annex II

KOREA: FORECAST SUMMARY (percent change from previous year)