China's Economic Woes Should Set Alarm Bells Ringing

The junior Kosdaq plunged over six percent at one point during trading on Wednesday due to fears over a Chinese economic slowdown and closed down 4.2 percent. The Shanghai Composite Index had fallen more than six percent on Tuesday, and on Wednesday it fell over five percent before rebounding to close up 1.2 percent due to expectations of an intervention from Beijing.

The Chinese government insists that the economy is sailing smoothly and will achieve its seven-percent growth target, but exports and domestic consumption are slowing.

Electricity consumption in July fell 1.3 percent compared to the same month of last year, while car sales dropped to the lowest since February 2014. Some department stores are closing down due to a lack of customers. These factors have led to fears that growth would stop at five to six percent this year.

The biggest problem in China is that government measures are not having any effect. Authorities have cut interest rates since last year and devalued the yuan recently, but the stock and real estate market slumps are worsening. This is the first time since China embraced a free-market economy 30 years ago that state measures have not worked. And now foreign investors are leaving. 

The shock from China's slowed growth is more dangerous to Korea than one might think. China accounts for a quarter of Korean exports and is its top export destination. That means Korea is among the Asian countries set to suffer the most from the devaluation of the yuan, according to Morgan Stanley.

The state-run Korea Development Institute said Korea's economy would contract 0.17 percentage point for every one percentage point fall in China's economy.

The impact is already visible. Last month, foreign investors sold almost W6 trillion worth of Korean stocks and bonds, the biggest monthly sell-off in four years (US$1=W1,184). The situation may not be too serious yet, but the Korean economy stands to take a big hit if the U.S. hikes interest rates and China further devalues the yuan.

The government and Bank of Korea must assess the situation and prepare for any contingency, and businesses must do the same. Investors should be wary of parking their money in China.

Read this article in Korean