Tensions between South Korea and Japan are intensifying after Prime Minister Sinzo Abe administration imposed new restrictions on exports that could hit President Moon Jae-in country’ tech industry - Photo by SMCP

JAKARTA (TheInsiderStories) – As being removed from the White List will require export licensing approvals for hundreds of technology product types, the potential disruption to many manufacturing industry segments could be quite substantial if there are delays to the export licensing approvals, depending on how easily these products can be replaced by South Korean companies from other suppliers worldwide.

The South Korean export sector has already seen a sharp contraction in exports during the first half of 2019 due to weak Chinese demand and the downturn in global electronics orders. Any protracted disruption of Japanese exports of the key materials to South Korea could disrupt manufacturing supply chain, creating a negative shock for South Korean industrial production.

Both the KOSPI and the KRW are likely to be subject to negative investor sentiment in the short-term following Japan’s decision to remove South Korea from its White List. Global investors are likely to be concerned about the potential supply disruptions to South Korea’s manufacturing supply chain because Japan is a major supplier of intermediate components and materials to South Korea’s manufacturing sector.

South Korea is heavily reliant on imports of Japanese intermediate parts and materials for its manufacturing industry, with South Korea having recorded a bilateral trade deficit in parts and materials with Japan amounting to US$15.1 billion in 2018. The South Korean trade deficit with Japan in parts and materials accounts for around three-quarters of the total bilateral trade deficit.

The bilateral trade deficit is particularly large for imports of Japanese electronics parts and materials as well as chemical products. This highlights the vulnerability of South Korea’s manufacturing supply chain to Japanese intermediate goods, notably for electronics components and chemicals products.

If the supply chain disruption to South Korea’s manufacturing sector is severe, this could create a further negative shock to South Korea’s economy. The South Korean economy is already struggling due to the adverse impact of the US-China trade war, weakening global electronics new orders and moderating Chinese domestic demand on South Korean exports, which have fallen sharply in recent months.

The Bank of Korea has responded with a 25bps policy rate cut in July, in order to provide some monetary stimulus to the Korean economy. If being removed from Japan’s White list results in severe and protracted disruption to South Korea’s manufacturing supply chain, this could put additional pressure on the Bank of Korea to ease monetary policy further in H2 2019.

Public sentiment in South Korea swinging towards some forms of retaliatory measures, such as boycotting the Tokyo Olympics, and some South Korean retail stores already having stopped selling Japanese products. South Korea is a major source of international tourism visits to Japan, accounting for 24 percent of total international visitors to Japan in calendar 2018. South Korean visitor travel to Japan has begun to decline during recent months, with further declines likely during the second half of 2019 due to the escalating bilateral trade confrontation.

There is a danger of a protracted trade war unless some negotiated compromise can be found. An escalating bilateral trade dispute between Japan and South Korea will also endanger regional momentum for further trade liberalization. It is also likely to damage the further progress of negotiations between China, Japan, and South Korea towards establishing a new trilateral free trade agreement.

In the medium term, these Japanese government export controls on South Korea and potential risks of supply chain delays are likely to trigger trade diversion effects, as South Korean firms try to reconfigure their global supply chains to reduce their dependency on Japanese inputs and seek alternative supply sources for critical products. This could be damaging in the medium to long term to Japanese exporters, as South Korea may eventually substantially reduce its reliance on imports of Japanese parts and materials for its manufacturing supply chain.

Trade disputes and trade sanctions are throwing sand into the wheels of world trade flows, eroding the progress made by decades of trade liberalization under the General Agreement on Tariffs and Trade (GATT) and WTO. The use of trade sanctions as a negotiating lever in government-to-government negotiations has escalated over the past two years, with negative repercussions for world trade growth and new export orders.

Exports are a key growth engine for many Asian economies, and the shockwaves from increased trade sanctions are having a negative impact on many exporting companies across the APAC region. A larger number of countries are also using trade policy countermeasures in retaliation for trade sanctions against their countries.

The Japanese trade measures taken against South Korea will add to global trade tensions at a time when Asia’s export sector is already facing strong headwinds from the US-China trade dispute as well as the slowdown in global electronics sector new orders. With both Japan and South Korea suffering from contracting exports during the first half of 2019 due to the impact of a trade war, the additional impact of an escalating Japan-South Korea trade row is further bad news for the exporters of both nations.

The escalating trade frictions between Japan and South Korea could also impede the progress of negotiations for a trilateral free trade agreement between China, Japan, and South Korea. The three nations had agreed to accelerate the pace of negotiations in 2018, and the 15th round of talks was held on April 2019.

With Japan and South Korea also important players in other Asia-Pacific economic and trade co-operation frameworks, including in the Regional Comprehensive Economic Partnership trade negotiations among 16 APAC nations, the bilateral dispute could also have a negative impact on other regional trade liberalization initiatives.

To defuse the current trade confrontation, the only way forward will need to be high-level bilateral negotiations between Japan and South Korea. With the US-China trade war still escalating and creating negative shocks to Asia’s manufacturing supply chain and export sector, the last thing that the Asia-Pacific region needs is another trade war between Japan and South Korea.

Written by Staff Editor, Email: theinsiderstories@gmail.com