Construction Sector: Recovery Short-Lived
BMI View: The lack of construction growth in Q2 2012 has dampened our outlook for South Korea's construction sector. Although we continue to expect construction activity in the country to return to positive territory in 2012, the lack of infrastructure activity to date, and the sudden reversal in non-residential building activity suggests that this recovery could be weaker than expected. As such, we have revised down our construction and infrastructure forecasts for South Korea to real growth of 2.2% and 1.4% in 2012 (previously 3.5% and 4.0% respectively).
It appears that the recovery in South Korea's construction activity was short-lived. The latest data from the Bank of South Korea showed that the construction industry contracted by 1.9% year-on-year (y-o-y) in Q2 2012, compared to a growth of 2.7% in Q1 2012.
This reversal was primarily due to contractions in the residential and non-residential building construction sector. Residential and non-residential building activity both shrank by 1.4% y-o-y in Q2 2012, compared to a growth of 3.5% y-o-y and 8.9% y-o-y in Q1 2012 respectively. The civil engineering (or infrastructure) sector continues to perform poorly. The sector contracted by 0.2% y-o-y in Q2 2012, a slight improvement from the contraction of 3.2% y-o-y in Q112.
|Q2 2011||Q2 2012||% chg y-o-y||H1 2011||H2 2012||% chg y-o-y|
|*Building Maintenance Is Incorporated Into BMI's Residential & Non-Residential Building Industry Component. Data is seasonally adjusted and based 2005 prices. Source: Bank of Korea, BMI|
|Construction Of Residential Structures||2233||2192||-1.4||4456||4505||1.1|
|Construction of Non-Residential Structures||5315||5506||-1.4||10901||11296||3.6|
|Civil Engineering (Infrastructure)||5475||5298||-2.0||10883||10596||-2.6|
Infrastructure Fails To Perform
This poor Q212 performance has prompted us to revise our forecast for the South Korean construction sector. Although we continue to expect construction activity in the country to return to positive territory in 2012, the lack of infrastructure activity to date suggests that this recovery could be weaker than expected. We have revised down our construction and infrastructure forecasts for South Korea to real growth of 2.2% and 1.4% in 2012 (previously 3.5% and 4.0% respectively).
The lack of infrastructure activity indicates that infrastructure investment from the South Korean government has not been as forthcoming as previously announced. The South Korean transport ministry had announced a US$170bn plan to upgrade the entire country's transport infrastructure by 2020, which includes building or expanding roads, railways (high- and normal- speeds), airports and seaports. It had also announced plans to invest US$43.9bn in the country's power generation capacity by 2024, with a particular emphasis on developing alternative energy sources (nuclear, renewables) to reduce the country's reliance on oil imports.
We believe there could be several reasons for this lack of infrastructure activity; chief among them being the adverse sentiment towards nuclear generation. In March 2012, officials at the Kori nuclear power plant in South Korea had covered up a power failure in one of the reactors for more than a month and this had stoked opposition towards nuclear generation. It also prompted the South Korean bureaucracy to carry out a fresh round of safety checks for nuclear plants currently in operation or in the pipeline. Both factors have led to construction delays for several new nuclear reactors, such as two reactors in Uljin.
|Infrastructure Fails To Outperform|
|South Korea Construction, Infrastructure, Residential and Non-Residential Industry Value Real Growth Forecasts, % y-o-y|
Non-Residential Tailwind Falters
The downward revision of construction is also due to the lack of activity in the residential and non-residential building sector. In our July analysis of South Korea's construction sector, we highlighted a disconnect between exports and non-residential construction in Q1 2012 data. A decline in exports has typically led to a decline in non-residential building activity ( see chart), but non-residential building activity accelerated in Q1 2012 despite a decline in exports growth.
This disconnect has since ended in Q2 2012, with the fall in export activity negatively affecting non-residential activity. This downward trend for exports and non-residential building activity is expected to continue over the near-term as we have yet to see a material improvement in the global economy. The demand for South Korea's manufacturing exports continues to be weak - South Korea exports marginally contracted by 0.16% y-o-y in July - and this would curb investment in industrial facilities.
|Declining Exports Affects Non-Residential|
|South Korea Total Exports Growth And Non-Residential Building Construction Real Growth (At 2005 Prices, Seasonally Adjusted), % y-o-y|
Residential Potentially Boosted By Stimulus
Activity in the residential building sector failed to stablise at around KRW2.3trn and continued its downward trend in Q212. The rate of increase in housing prices also continued to decline sharply throughout South Korea's major cities, from a peak of 7.1% in January 2012 to 1.9% in August 2012. Although the South Korean government recently launched a stimulus plan to reignite the demand for housing - the stimulus includes a temporary easing of taxes on property transactions, where taxes on home purchases would be halved to less than 2% until the end of 2012 - it remains to be seen if the stimulus will be effective in reinvigorating growth in residential building activity
Household debt in South Korea remains at a very high level, and acts as a cap on the population's ability to finance new housing. South Korea's deteriorating economy could therefore place considerable weight on consumers' debt repayment ability, as incomes come under pressure while the unemployment rate ticks up. Credit extended to households stood at KRW911.4trn (US$774.5bn) at the end of March 2012. Measured against the size of the domestic economy, South Korea's debt-to-GDP ratio came in at 69% at the end of March 2012, more than double the levels seen in the late 1990s when the financial sector went through a period of liberalisation.
|Stimulus An Aid To Housing|
|South Korea - Quarterly Residential Construction Real Industry Value (At 2005 Prices, Seasonally Adjusted), KRWbn; And Housing Prices, % chg y-o-y|
Infrastructure Outperformance The Long-Term Trend
Beyond 2012, we believe that infrastructure activity should pick up and outperform the residential and non-residential construction sector. Real growth for the South Korean infrastructure and residential/non-residential building sectors is forecast to average 3.2% and 0.7% per annum between 2013 and 2017 respectively. This is because the government remains committed towards improving the country's infrastructure over the long-term. The South Korean government is scheduled to release its 6th Electricity Supply & Demand Plan by the end of 2012. The plan would outlook the government's plans for electricity generation and this could boost the project pipeline in the country.
Non-residential building activity should also pick up as we approach the 2018 Winter Olympics. The event is expected to trigger an estimated US$8.4bn construction boom in South Korea over the coming years, with most of the activity originating in the commercial construction sector. Not only are there several stadiums to be built and refurbished, but hotels, retail and leisure developments are also expected to be developed to cater for the increase in arrivals from tourists and Olympic participants. Tourist arrivals in South Korea also continue to grow robustly and this will drive demand for tourism-related infrastructure. Tourist arrivals have reached record highs since the start of 2012, with year-to-date tourist arrivals growing by 20.4% y-o-y to reach 7.5mn at the end of August 2012.
|Still Achieving New Highs|
|South Korea - Tourism Arrivals, By Month|
However, we maintain our view that real growth for the residential/non-residential building sector will be dragged down by the residential sector over the long-term. This is because the macro fundamentals in South Korea (ie, declining population growth, stagnant wage growth and static unemployment rate) do not support a robust demand for housing over the coming years.