Political instability and tariff shock from the United States are stifling domestic investment. In the first quarter of this year, total fixed capital formation decreased to a level similar to that immediately after the outbreak of the novel coronavirus (COVID-19), which had restricted external activities. Due to poor investment, the contribution of investment to economic growth deteriorated to its worst level in over six years.
Total fixed capital formation refers to the amount invested by economic agents in a country during a certain period, using goods and services produced but not consumed. It combines both tangible and intangible investments executed by a country's government and private sector and consists of construction investments, facility investments, and intellectual property production investments.
◇ Domestic investment down 4.1% in the first quarter... reverting to five years ago
According to the Bank of Korea's Economic Statistics System (ECOS) on the 17th, total fixed capital formation in the first quarter of this year amounted to 147.461 trillion won (based on 2020 prices, nominal series), a decrease of 4.1% compared to the same period last year. In monetary terms, this is the lowest level since the first quarter of 2020 (143.4024 trillion won), and the decline is the largest since the first quarter of 2019 (-7.3%).
The contribution of investment to economic growth also plummeted. In the first quarter of this year, total fixed capital formation pulled down the real gross domestic product (GDP) growth rate (-0.1%, year-on-year) by 1.2 percentage points (p). The GDP growth contribution of total fixed capital formation worsened from last year's second quarter (-0.3%p) to the fourth quarter (-0.6%p), and surpassed 1%p in the first quarter of this year. This is the worst performance since the first quarter of 2019.
By item, construction investment sharply decreased, leading the overall decline in total fixed capital formation. In the first quarter of this year, construction investment fell sharply by 12.2% year-on-year to 56.424 trillion won, marking the largest decrease since the fourth quarter of 1998 during the foreign exchange crisis (-17.7%). The contribution of construction investment to GDP growth recorded -1.5%p, also the lowest figure since the fourth quarter of 1998 (-3.8%p).
This is in stark contrast to the increasing investment in major advanced countries. According to the World Bank, the United States has seen total fixed capital formation increase every year over the past decade, excluding 2020 (-3.0%), and Japan experienced a three-year decline starting from 2020 (-3.6%) but switched to an increase in 2023 (+1.8%). The European Union (EU), where growth rates have stagnated, only saw a decrease in 2020 (-5.7%), while the rest showed increases.
The problem is that amidst the decline in investment, there is a massive outflow of corporate funds. According to the Export-Import Bank, the amount of investment capital that flowed out of the country last year was counted at $46.594 billion, marking the fifth highest since 1980, when related statistics began being compiled. The net outflow of investment capital is the value derived from domestic individuals' overseas direct investment (ODI) minus foreign direct investment (FDI) in the country.
◇ Investment contraction signals 'long-term recession'... "Supplementary budget and interest rate cuts are urgent"
Experts analyze that the decrease in total fixed capital formation is due to heightened domestic and external uncertainties since last year's emergency martial law. Professor Seok Byeong-hoon of Ewha Womans University noted, "The political unrest caused by martial law and early elections has dampened corporations' investment sentiment," adding, "The tariff issue has also slowed net exports, resulting in a vicious cycle where facility investments decrease as well."
Notably, the decline in construction investment has been assessed as larger than expected. Lee Jeong-hoon, a researcher at Eugene Securities, stated, "While a decrease in facility investments was anticipated due to its correlation with the export cycle, the drop in construction investment has been relatively steep," adding, "The excessive investment that occurred over the past 13 years due to the government's growth policies focusing on boosting the real estate market now seems to be undergoing adjustment."
The concern is that if the investment slump continues, it may lead to a long-term decline in growth rates. Professor Seok remarked, "A reduction in capital investment means that we have fewer production factors we can utilize," while also stating, "This can solidify the trend of low growth." Lee, the researcher, also noted, "With both consumption and investment showing sluggish performance, the momentum of domestic growth has significantly weakened," adding, "If this trend continues, it could lead to a long-term recession."
Experts unanimously agree that economic stimulation through fiscal and monetary policies is urgent. The researcher stated, "In the short term, a supplementary budget should be organized to stimulate domestic demand, and in the long term, government support for promising industries such as semiconductors should be increased," while advising, "Care should be taken to prevent government finances from flowing into the less productive real estate market during this process."
Professor Seok emphasized, "To activate investment, corporations that are struggling with high interest rates need breathing room," adding, "To this end, the pace of interest rate cuts should be accelerated to reduce corporations' interest burden." He also noted, "Particularly, if the issuance of government bonds increases during the supplementary budget formation process, causing market interest rates to rise, interest rate cuts should be expedited." Government bond interest rates move inversely to prices; thus, an increase in government bond supply causes prices to drop and interest rates to rise.