South Korea, one of the world’s leading semiconductor producers, has been caught in the crossfire of trade and technology wars.
In 2018, semiconductor sales accounted for an astonishing 92 percent of Korea’s export growth, a dependence on a single product more like an oil exporter than a technology center. Amortization is now coming as trade friction, technology confrontation and a cyclical low in the semiconductor cycle exacerbate a slump in chip prices.
The perfect storm will cause Korean exports to fall in 2019. The ceasefire of the G20 trade war, the imminent interest rate cuts by the Bank of Korea and a weaker won will not boost export growth. Gross domestic product is expected to expand at the slowest growth rate of the year without a crisis ever.
South Korea’s classification as a commodity exporter is no mistake. The main export of the country, the memory chips, are the oil of the digital age. D-Ram and Nand chips are highly commoditized, largely fungible for all end products and available in dollars. Chips and related components account for 30 percent of Korea’s total exports. Over the past two years, however, their importance has increased to become the engine of export growth, which contributed more than 80 percent to Korea’s current account surplus in 2017 and 2018.
Prices for memory chips have doubled between 2016 and 2018. Rising demand for turbocharged global chip sales and Korean exports. During the boom, producers expanded production and end-users built up large inventories to protect themselves from future price increases.
The cycle turned in the third quarter of 2018, as the core drivers of semiconductor demand – mobile phones, computers and data centers – shrank at the same time. It led to an unprecedented cyclical downturn, exacerbated by the impact of the trade war on global sentiment and the flow of goods. The combination of a drop in demand and a supply overhang led to a fall in prices. Chip prices halved and lowered the dollar value of Korean chip exports, which have been shrinking at double-digit rates since November last year.
In terms of volumes, the Korean chip trade has recovered and is approaching pre-crash levels. However, the order of magnitude of semiconductor sales in 2018 is so large that total Korean export growth will decline in value terms in 2019 solely due to lower chip prices.
The growth rate of exports would be 60 percent higher this year if semiconductors were excluded from the total quantity. In the future, semiconductor sales will dampen already weak non-semiconductor exports. Chip prices will therefore determine Korea’s growth prospects for the rest of 2019.
The trade war is strongly distorting demand for technology cycles and price leading indicators. The emerging technology confrontation actually served to offset declining demand and support price levels in the first half of this year. In view of the US import restrictions, Huawei has actively sought to build up a semiconductor warehouse buffer. Huawei’s analysis, balance shows 75 percent increase in inventories last year. The broader semiconductor complex in the People’s Republic of China has joined this example. The size of the front load is difficult to quantify, but has certainly helped to lower prices.
China’s anti-cyclical inventory build-up limits the positive upward trend of the G20 peace. Huawei et al. will use the grace period of the G20 to further increase stocks. However, the incentive for Chinese semiconductor users to build up inventories and their ability to do so is decreasing in terms of trade finance, product development and storage. The permanent lifting or loosening of US export restrictions could lead to a decline in semiconductor sales due to the slowdown in inventory levels.
Without China, inventories will be reduced and forecasts for sales growth will begin to rise. The trend is supported by the Organisation of Semiconductor Exporting Companies – consisting of Micron, SK Hynix and Samsung. The trio accounts for 96 percent of Nand’s and 56 percent of D-Ram’s worldwide production. Osec has reduced its planned capital investment by 29 percent in 2019 and further reductions are planned for 2020. Micron and SK Hynix are also actively reducing production. However, Samsung is still producing chips and hopes to increase its market share.
Japan has added a new headwind to the Korean storm: Export restrictions on semiconductor raw materials. Japanese companies control world trade in a range of highly specialized goods, such as chemicals. Without them, Korea cannot produce memory chips. The restrictions pose a risk not only to Korean companies and exports, but also to the global technology sector, especially consumer electronics.
The weight of history increases the risk of escalation, but the economy will ultimately trump nationalism. A historically charged battle of words is likely in the coming weeks. However, the weak Korean economy will force President Moon Jae-in into negotiations. Japanese Prime Minister Shinzo Abe is clearly using the export ban to mobilise the conservative-nationalist vote in the upcoming Federal Council elections on 21 July. The resulting temporary supply shock could indeed help to accelerate the consumption of semiconductor stocks and thus trigger an early recovery in prices.
In summary, the outlook for Korean exports is poor. Chip prices have bottomed out and are not expected to recover until the end of the fourth quarter of this year. In addition to semiconductors, Korean exports have continued to decline as trade friction, soft growth and global inventories weigh on demand. On the peninsula, domestic growth drivers, investment and consumption are strengthening, while Seoul is increasing fiscal and monetary momentum. Nevertheless, Korea’s GDP growth rate for 2019 is likely to be the slowest growth rate without a crisis that has ever occurred.
Beyond the short-term downturn, the prospects for the semiconductor industry and thus also for Korea are positive. The emergence of 5G, coupled with the growing Internet of Things, heralds a structural shift in semiconductor demand.
The technological confrontation between China and the USA is also having a positive impact on East Asian semiconductor manufacturers.
Samsung will be one of the main beneficiaries of the decline of Huawei’s overseas smartphone sales. More importantly, the obstacles to China’s industrial modernization are positive for Korea. The “Made in China 2025” plan targets 75 percent of domestic chip production, a worrying prospect for Seoul. China threatens to do to Korea what the Asian tiger did to the Japanese semiconductor industry even in the 1980s. Attacks on China technology that hamper industrial modernization and secure East Asian market share are positive for Korea’s long-term growth.