The Zhitong Finance App learned that in the last quarter, the South Korean economy reversed again after exceeding expectations at the beginning of the year, which increased the challenges faced by policymakers in their efforts to stimulate investment and consumption.

The Bank of Korea said on Thursday that in the three months ending June, South Korea's gross domestic product (GDP) shrank by 0.2% compared to the previous quarter. This figure is lower than the 0.1% increase generally expected by economists.

This unexpected contraction may increase calls for the Bank of Korea to cut interest rates, but it is unlikely that immediate action will be taken. Prior to that, in the January-March quarter, rapid economic growth exacerbated this weakness. Currently, the Bank of Korea is focusing on ensuring that it does not signal short-term policy easing, thereby inadvertently stimulating a further increase in household debt.

The South Korean government and central bank have raised their growth forecasts for 2024, which shows that they see the second-quarter results more as a speed bump on the path to continued expansion than a warning sign that the trend is changing.

Despite this, the report highlights weak domestic demand. Compared to the previous quarter, private consumption fell by 0.2%, while government spending increased by 0.7%. Real exports increased by 0.9%, while investment in facilities fell by 2.1%.

Kwon Young-Sun, chief economist at the Woori Finance Research Institute, said, “What is really worrying is the contraction of investment, which indicates a deterioration in long-term growth potential.” He pointed out that if companies wait until after the US election in November, their investment plans may be further delayed.

The Bank of Korea said in a statement that machinery and equipment, including chip manufacturing equipment, has led to a decline in investment. Construction investment contracted 1.1% after an unexpected 3.3% increase in the previous quarter.

The continued slump in consumer spending suggests that strong external demand is not driving the overall strengthening of the economy.

The boom in global artificial intelligence development has boosted the development of South Korea, which has two of the world's largest semiconductor manufacturers, Samsung Electronics (SSNLF.US) and SK Hynix. In particular, memory chips led the growth of South Korea's exports, driving South Korea's economy to grow by 1.3% in the first quarter, which is more than double the economists' forecast.

Trade data shows that the technology-led rebound in exports continued from April to June and is likely to continue into the current quarter. Semiconductor shipments increased by more than 50% year-on-year in the first 20 days of July, supporting the central bank's expectation that the chip rebound may continue until the first half of next year.

According to a Bloomberg Economics model, South Korea now needs to grow by about 0.8% in the second half of the year compared to the previous six months to achieve the mid-term target of around 2.5% in 2024.

Consumption is the key to the economy in the second half of this year, as private spending remains sluggish in the face of rising interest rates and continuing consumer inflation.

Most economists disagree on whether the Bank of Korea may cut interest rates in August or October. The authorities have kept the policy interest rate at a restrictive level of 3.5% for a year and a half. The weakening of the won against the US dollar is a factor in the central bank's caution about cutting interest rates prematurely, as further currency weakness will increase the cost of food and energy imports.

The economic momentum at the beginning of this year was stronger than expected, which gave the Bank of Korea another reason to be cautious in adjusting policies. As the authorities gained confidence from the semiconductor boom, South Korea increasingly relied on semiconductors to overcome economic challenges, including the COVID-19 pandemic.

Pantheon Economics researcher Kelvin Lam said in a report before GDP was released: “At the same time, strong export growth driven by artificial intelligence should support economic growth and give central banks more room to adopt a more cautious approach to policy changes.”

As South Korea's fertility rate continues to set the world's lowest, the country also finds itself at risk for another long-term economic viability. With an estimated average of 0.72 children per woman, South Korea faces the prospect of its workforce shrinking at the fastest rate in the world, so the country is moving more actively to automation and artificial intelligence to cushion the effects of an aging population.

Bank of America economists, including Benson Wu, said in a report: “We believe artificial intelligence can continue to drive South Korea's long-term growth without harming the existing labor market. The overall productivity growth brought about by the development of artificial intelligence may be a potential driver of South Korea's economic growth in the next few years.”

In the short term, South Korea needs to address continuing concerns about credit risk, as credit risk casts a shadow over the construction industry. The construction industry is a key component of South Korea's GDP. In addition to rising raw material costs, high interest rates make it difficult for developers to repay their debts.

After a warm winter helped encourage investment, the industry saw an unexpected increase in output in the first quarter. Chong Hoon Park, an economist at Standard Chartered Bank Korea Ltd., said that this may not be the case in the next few quarters, and he predicts a month-on-month contraction in the second quarter.

Hyosung Kwon, economist at Bloomberg Economics, said, “GDP data clearly shows that there are hidden growth risks at home and abroad. In the struggling real estate market, there is great uncertainty about how restructuring will work. At the same time, the cooling of the US economy is likely to slow demand for computer chips, which we have seen as Korea's main growth driver this year.”