The South Korean government’s decision to launch a $5.2bn fiscal stimulus package in September 2012 in an attempt to boost domestic demand has brought the country’s economy into sharp focus. The move to temporarily ease taxes on consumption and property transactions, which the Financial Times estimated would cost the government $40.7bn this year, was part of its bid to offset the country’s decelerating export performance by generating growth from within.

Long touted as one of Asia’s so-called 'tiger economies', South Korea’s export-driven economy has been losing momentum in recent years. Exports account for nearly 50% of South Korea’s GDP, so the protracted global economic slowdown has impacted it significantly. The country’s economic growth is set to slow from 3.6% in 2011 to 2.8% in 2012, according to the Economist Intelligence Unit (EIU).                                                                                                           

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“After the 2008 crisis, [South Korea] had a very strong rebound, and it was the strongest among all the Organisation for Economic Co-operation and Development [OECD] countries,” says Randall Jones, a senior economist at the OECD.

“Yet in the second half of this year, we saw a fairly strong financial slowdown, partly because of external factors. China accounts for about a quarter of South Korea’s exports and the problems in the euro area have compounded this as well. Korea has a very sluggish housing market and households have a very high debt, which has also constrained consumption. The economy is slowing down and performing below its potential, and the government’s fiscal package is quite small – it still represents about 1% of GDP.”

Although South Korea’s authorities are frank in admitting that the country's slowing export performance poses real risks, its finance minister, Bahk Jae-Wan, remains positive, saying that the government’s proactive approach to improving its business environment means South Korea still remains an attractive investment destination.

“The global economic crisis has… greatly affected the Korean economy,” says Mr Jae-Wan. “[Yet] Moody’s has upgraded Korea's sovereign credit rating from A1 to Aa3 and I think this is an evaluation of the Korean economy's fiscal soundness, its strong ability to recover from crisis, and the government's crisis management efforts. Korea has a firm foundation to respond to complicated risks thanks to favourable economic fundamentals and improving external soundness. The Korean government plans to... establish a Won3000bn [$2.7bn] facility investment fund to promote investment by foreigners.”

A satisfied customer

The government’s move to set aside more than $250m to attract FDI not only sent strong signals to the international business community of its continued support for attracting foreign investment, it was also significant in reassuring existing foreign investors of the government’s commitment to improving South Korea's investment environment. According to Dr Albert Heuser, president of market and business development for Asia-Pacific at BASF, a Germany-based chemicals company, the government’s proactive approach was key in encouraging his company to expand in the country. 

“[Although] the global financial and euro crises are having an even bigger impact [on South Korea] than other Asian countries, we remain very confident in its growth potential,” says Mr Heuser. “The investment plans we have announced in South Korea will not be affected by short-term slowdowns."

The company has imminent plans to expand its plastics plant in Ansan on South Korea's west coast, increasing production to 30,000,000 kilograms per year. It is also building a new plant for its high-performance specialty plastic, Ultrason, in the southern city of Yeosu. This will be the only plant dedicated to Ultrason outside of Germany and is set to create about 50 new jobs when it begins operations in 2014.

"The Korean industry is currently facing some challenges and this is having an impact on our customers," says Mr Heuser. "On the positive side, Korean inflation has been slowing down and the consumer price index rose by 1.2% in August, which is the slowest rate since May 2000. Overall, our sales are relatively stable, year on year. We think long term because our plants and sites are also there [for the] long term.”

Between 2003 and 2012, BASF has made considerable investments into South Korea amounting to about $1.3bn. Its most recent plans are proof that some foreign investors are not deterred by the country's current economic slow down and are viewing the country’s longer-term prospects positively.

Investment trends

Data from greenfield investment monitor fDi Markets shows that although capital investment into greenfield FDI projects in South Korea has declined, from $7.1bn in 2011 to $4.6bn in 2012, the number of greenfield projects has grown from 118 projects in 2010 to 132 in 2011. In the first eight months of 2012 78 projects have been recorded.

A closer examination of FDI trends shows that the software and IT services and chemicals sectors attracted the highest number of FDI projects between 2003 and 2012. According to fDi Markets, FDI into software and IT services, which attracted 128 projects between 2003 and 2012, grew by 7% between 2010 and 2011. The sector accounts for 12% of all greenfield FDI into South Korea between 2003 and 2012, making it the leading sector in the country.

The chemicals sector ranks second, having attracted 76 projects between 2003 and 2012, and in this field BASF is not the only company with expansion plans. In April 2012, Graphenea, a Spanish producer of graphene for industrial applications, announced plans to expand its South Korean operations.

Long and short of it

South Korea’s disappointing export performance is leading many investors to scale down their capital expenditure, and foreign companies are increasingly making strategic investments in smaller-scale projects, with a long-term view of maintaining a presence in the country’s markets. This shifting trend means that companies are adopting a longer-term perspective, viewing their projects as assets that will enable them to capture a share of South Korea’s industries once the country’s economy rebounds.

A long-term view is more difficult for South Korea's government and population to take, however. The country’s economic prospects for this year means the government will continue to face challenges when attempting to reignite growth. Moreover, professional services firm Deloitte has reported that the country’s high rate of inflation significantly reduced South Korean consumers’ real wages and their purchasing power. Given that private consumption grew by just 1.2% in the second quarter of this year, according to the Financial Times, the effectiveness of the government’s stimulus package in boosting domestic demand is being brought into question.

Another problem is that the country's outward FDI continues to outperform inward FDI. According to fDi Markets, between 2003 and 2012, inward capital investments into greenfield projects in South Korea have shown a decline. Capital investments declined from a high of $20.7bn in 2003, to a low of $3.6bn in 2010. They have since recovered but only marginally, with $7bn of investment in 2011.

In contrast, outward FDI grew from $14bn in 2003 to $37bn in 2010. Data from the first eight months of 2012 shows that outward FDI from South Korea is worth $27.9bn, while inward FDI is worth just $4.7bn.

“Our official OECD figures reveal that the stock of inward FDI is about 12% in South Korea, and this is in direct contrast to the OECD average of about 30%,” says Mr Jones. “Therefore it is one of the lowest among OECD countries. Although [the government] created special economic zones [SEZs] in various parts of the country, such as in Incheon as well as in the south-western part of South Korea, SEZs do not seem to be that effective. FDI seems to be attracted more to Seoul, the country’s capital, so these SEZs do not seem to be having a critical role in increasing [inward] investments.”

Test of time

The South Korean government has proactively engaged in a number of initiatives to attract FDI, but it is questionable whether its efforts will succeed in helping the country's economy regain momentum. “For this year, we are not very optimistic about prospects for FDI in South Korea,” says Rebecca Jackson-Young, a South Korea analyst from the EIU.

“The free-trade agreements with the US and the EU have helped to boost FDI into the country, and the Japanese earthquake [in March 2011] is likely to result in a refocusing on South Korea as a destination for investment, in order to ensure supply chains. Yet for South Korea to be effective in attracting more FDI, it should focus on its strengths. The country has a skilled population and good technological infrastructure, so it should focus on growth areas that will utilise these strengths. [There are] two elections [scheduled for] this year. For whoever wins the presidential election, the real test will be the implementation of balanced and sustained policies to support some reorientation of the economy.”