Growing Trade Deficit Sends Alarming Signals

Korea's trade deficit swelled to US$22.8 billion in the first three months of this year, which is already half of the entire shortfall of $47.8 billion for last year. The dismal performance is largely due to lackluster semiconductor exports and slow shipments to China. Semiconductors account for 20 percent of Korea's total exports and earnings have plummeted more than 40 percent due to a sharp decline in prices. Also, slowed economic growth in China had resulted in a more than 30 percent drop in Korea's exports to the neighboring country since last year. The government expects the trade deficit to narrow in the second half of this year, but at this rate a record deficit appears inevitable.

What is even more worrisome is that the current account balance, which includes services and investments, is also showing signs of trouble. Korea suffered a record $4.5 billion current account deficit in January, mainly because outbound travel surged after COVID, which resulted in the travel deficit tripling on-year to $1.5 billion. At this rate, the annual travel deficit could reach around $24 billion or three times the size of last year. The government expects a current account surplus for the year, but that now seems highly unlikely. 

The U.S. Inflation Reduction Act has cast a dark cloud over Korea's exports since it scraps tax credits for electric cars manufactured outside of North America. Now trade protectionism is spreading around the world, with the EU creating a similar law in retaliation. Global economic growth is expected to fall from 3.2 percent in 2022 to 2.4 percent this year, which will depress demand. A current account surplus is essential for Korea, which depends heavily on exports. The Asian financial crisis of 1997 and global financial crisis of 2008 both occurred when Korea suffered current account deficits. Government officials say Korea's foreign currency reserves of $400 billion are ample ammunition to ward off another financial crisis. But Korea spent $40 billion last year alone to keep the won from falling precipitously against the dollar.

A continuing and growing current account deficit could cause the won to plummet and foreign capital to exit Korea. The government must come up with measures to stimulate exports, attract more foreign tourists and investment and reinvigorate the stock and bond markets to improve the situation.