November 11, 2009 / 8:08 PM / 8 years ago

South Korea presses home China advantage versus Japan

6 Min Read

BEIJING (Reuters) - Through a mixture of good fortune and well-executed strategy, South Korea has been better placed than Japan to catch a lift from China's heady growth and leave the global financial crisis in its rear-view mirror.

But the advantage of greater Chinese exposure will become more dubious in coming years as the Asian giant cranks up its own value-added production in electronics, shipbuilding and automobiles, turning from South Korea's customer to competitor.

Another trend will work in South Korea's favor, however. China's steady creep toward a more consumption-driven growth model will benefit those companies and countries that can produce attractive and reliable but relatively inexpensive goods.

"The Koreans are very, very competitive in that," said Ajay Kapur, head of global strategy at Mirae Asset Securities in Hong Kong. "Japan is at a much higher part of the value chain. It's just much more expensive in terms of price point."

Consumer goods account for just 4 percent of China's total imports at present, leaving vast room for growth.

No one is saying that Japan will miss out on the longed-for explosion of Chinese consumption. But in the race for customers, Korean firms already have a little more spring in their step.

Samsung Electronics (005930.KS) carved out the biggest share of revenue in China's television market at 10.9 percent in the year through October 2008, beating all domestic and foreign producers, according to data from Chinese TV maker Skyworth (0751.HK). Sony Corp's (6758.T) share was 10.2 percent.

In China's automobile market, Hyundai Motor's (005380.KS) local venture has taken fifth place so far this year with sales of 460,590 units. Among its Japanese rivals, Nissan Motor (7201.T) is closest in seventh place with 422,460 sales.

Emblematic of the occasional struggles of Japanese firms to adjust to China, Toyota's (7203.T) sales growth has lagged the red-hot car market because of a dearth of smaller models that qualify for tax breaks offered by Beijing this year.

Toyota said last week it would beef up its research and development operations in China. Hyundai, meanwhile, will soon break ground on a third plant there.

"The corporates that will do well in China are those that can target China's middle class, exporting rather cheap goods. In that respect, Koreans are better placed than the Japanese," said Dominique Dwor-Frecaut, an economist with Royal Bank of Scotland in Singapore.

Whither Exports?

South Korea's success over the past five years has not been fueled by Chinese consumers, but rather by its position as a cog in China's exporting juggernaut.

Geographic proximity, cultural affinity and its own recent experience of economic development provided South Korea with a platform to reach out to China. Its companies -- notably, electronics makers such as LG Electronics (066570.KS) and Samsung -- adapted their business models to send intermediate goods to China for assembly before selling the finished products abroad.

Such manufacturing inputs account for roughly half of all of Chinese imports. So as China's export factories revved up production, South Korea and Taiwan, the two countries most integrated in their supply chain, reaped huge dividends.

Exports to China were 10.4 percent of South Korea's GDP in 2008, whereas in Japan they held just a 3.4 percent share, according to UBS estimates.

But the collapse of global demand after the financial crisis and China's own efforts to cut reliance on exports are diminishing this symbiotic Korean-Chinese relationship.

"Industrial relocation will lose steam, in our view, although China will remain a competitive location for global production," Merrill Lynch economists said in a recent note. "Korea and Taiwan, which have flourished on this trend, could see a smaller boost from the new phase of Chinese growth going forward."

Korea also faces stiff competition to hang onto its edge in sophisticated manufacturing from China itself.

In electronics, Haier (1169.HK) and Hisense (600060.SS) have developed wide product lines while automakers from BYD (1211.HK) to Geely (0175.HK) have started to attract attention overseas.

The challenge is perhaps most acute in shipbuilding. South Korea is the world's biggest shipbuilding nation, but China wants to usurp that position by 2015. The two are already driving down each other's margins as they flood the market with new ships.

Not Overnight

China's climb up the value chain, though, will take years.

"It will probably happen, just like the Koreans are trying to catch up with the Japanese in car manufacturing, but we are talking very, very long term," Kapur said.

In the meantime, South Korea need look no further than China's sizzling property market to see how its giant neighbor can be a crucial ally in economic growth.

With housing-related goods about 20 percent of its exports to China, Korea's ability to piggy-back off the Chinese real estate sector will be an important factor distinguishing its economic performance from Japan's -- and economists reckon this could persuade its central bank to let the won appreciate.

While Credit Suisse sees the yen broadly unchanged at 90 to the dollar in 12 months, it expects the won to hit 1,000 versus the dollar, an appreciation of roughly 16 percent.

"Korea has had one of the faster turnarounds in exports, certainly within Asia. And the view we are taking is this is going to continue," said Olivier Desbarres, a currency strategist with Credit Suisse in Singapore.

"This wasn't a pipe dream. This wasn't a flash in the pan."

Additional reporting by Shin Ji-eun in SEOUL and and Rie Ishiguro in TOKYO; Editing by Kim Coghill

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