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South Korea will feel the pain of troubles at Samsung, Hyundai

South Korea's central bank kept its key interest rate unchanged Thursday at a record low 1.25 per cent after assessing such risks to the recovering economy as slowing export demand, soaring household debt and a likely rate hike later this year by the U.S. Federal Reserve.

One other deepening worry loomed over the policy meeting: The sea of troubles engulfing Samsung and Hyundai. South Korea's two largest conglomerates account for at least one-third of Asia's fourth-biggest economy. So any serious corporate woes are bound to have an outsized impact.

Samsung's flagship electronics arm, the biggest and most profitable of some 80 companies in the sprawling group, has been forced to eliminate its Note 7 smartphone, which has a nasty habit of overheating and bursting into flames even when turned off.

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Recalling more than 2.5 million of the dangerous phones and abandoning production of a model introduced just two months after a splashy global launch comes at a huge cost.

Operating profit will plummet by one-third to 5.2-trillion won ($6.1-billion) for the third quarter alone. The company expects to take a further hit of more than 3-trillion won by the end of its current fiscal year in March, 2017. And the damage to its reputation is bound to hurt sales of other models.

"We expect Samsung Electronics' decision to stop sales and production of Note 7 to affect negatively the economy and exports," Bank of Korea Governor Lee Ju-yeol told reporters after the rate decision.

That's already happening. Exports of mobile phones and components fell by slightly more than a third in September from a year earlier.

The central bank included the expected fallout from the massive recall – though not the subsequent decision to stop making the phone – in its slightly lower economic outlook for next year.

The bank now pegs growth in 2017 at 2.8 per cent, down a tick from an earlier forecast of 2.9 per cent, as improved domestic demand led by construction spending is expected to mitigate the export weakness. That's higher than estimates by other economy watchers and could turn out to be wildly optimistic if automotive heavyweight Hyundai Motor Group doesn't soon resolve the labour strife that has dramatically cut production.

South Korean vehicle shipments plunged by nearly 25 per cent in September after a series of about two dozen work stoppages morphed into a full-fledged strike. Production slid by about 140,000 cars – 3 per cent of annual output – between the first walkouts in mid-July and the end of last month.

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Hyundai reached a tentative settlement last week, which workers were set to ratify on the weekend.

The damage to the broader economy from the two leading players illustrates how closely South Korea's fortunes remain tied to a handful of sprawling chaebols, as the family-dominated groups are called, which are no longer the innovative world-beaters they once were.

When leading Japanese car makers Toyota and Honda took huge hits to their balance sheets and reputations over global product recalls, policy makers didn't wring their hands over the potential damage to Japan's already sluggish economy.

And while Volkswagen has lost billions and done untold damage to its image over its emissions scandal, the economic fallout isn't causing much of a hiccup for the German economy. VW is by far Germany's biggest vehicle producer, a vital part of the German export machine and employer of more than one-third of the domestic automotive work force. But the entire automotive sector accounts for less than 3 per cent of GDP.

The unrelated problems at Samsung and Hyundai, the two largest chaebols, and the collapse of Hanjin Shipping, part of a third member of the club, have fuelled fresh demands to rein in their influence.

Meanwhile, Mr. Lee, the central bank chief, expressed confidence that Samsung would soon put the crisis behind it thanks to its effective response to the mess and the popularity of its other products with consumers.

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For the sake of the broader South Korean recovery, he'd better be right.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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