Political Economist

South Korea sought to lessen the pressure on its rapidly appreciating currency Tuesday by saying it would cut many of the rules that have hindered domestic companies and funds from investing overseas and that have contributed to the won’s rise.

Kwon O-kyu, finance minister, said the rules would be changed so South Korean companies and investors were not at a disadvantage when making portfolio investments or building production facilities overseas. The government is meanwhile preparing to announce new guidelines on foreign investment regulation reforms this month.

“The government is aware of complaints by the business community and prospective investors about existing limitations that effectively tie their hands,” Mr Kwon told reporters Tuesday, signalling that tax rules and “unreasonable” regulations were among those that could be changed. No date for the changes was given.

Manufacturers in Asia’s third largest economy – such as Samsung Electronics and Hyundai Motor – are struggling with the won’s 9 per cent rise against the dollar last year, which is casting a shadow over the export-dependent economy.

“This year, the future for us isn’t that bright,” Lee Kun-hee, the Samsung Group chairman, said in his New Year address. “Instability on the Korean peninsula arising from North Korean nuclear issues, oil prices and the exchange rate will continue haunting South Korea’s economic growth.”

At the same time they are coping with these challenges, South Korean companies and institutions face an array of regulatory challenges to investing abroad.

South Korea has long encouraged companies to invest at home and has placed restrictions on capital movements to try to keep its wealth in the country but, as well as limiting corporate growth, this has led to a mismatch between supply and demand in the foreign exchange markets and has added to upward pressure on the won.

While trying to minimise volatility in the foreign exchange markets and deter investors who may be betting on the won’s continued strength, financial authorities are also trying to engineer a longer-term solution to make the won more liquid and to reduce the capital account surplus.

The finance ministry is making efforts to gradually liberalise foreign exchange markets and make the South Korean won a “global currency”, allowing South Koreans to buy property abroad and foreigners to more readily borrow in won.

The Bank of Korea last month forecast that the stronger currency and slowing exports were likely to drag growth down from 5 per cent last year to 4.4 per cent in 2007. The finance ministry will deliver its revised predictions Wednesday.

The South Korean economy, meanwhile, faces a significant domestic risk from rising house prices.

The closely watched house price index compiled by Kookmin Bank, South Korea’s largest mortgage lender, showed Tuesday that prices rose 1.9 per cent in December, taking the annual rate of increase to 11.6 per cent.

Politicians and policymakers in Seoul, concerned about a looming house price bubble coinciding with a presidential election year, have labelled containing property price rises a key priority for 2007.

Prominent Democratic economists on Wednesday challenged President George W. Bush’s pledge to present a budget next month that would cut the federal government deficit to zero by 2012 while making tax cuts permanent.

Jason Furman, director of the centrist Hamilton Project, said: “There will be a lot left out and I would bet it relies on deep, unspecified and improbable cuts in future discretionary spending.”

He challenged Mr Bush to state specifically which programmes would bear the cost of spending cuts in all the years to 2012.

Jim Horney, a senior fellow at the Center on Budget and Policy Priorities, said the White House budget would not deal with the need to pay for a fix to the alternative minimum tax (AMT), which is catching a growing number of middle-class families. And he warned that it would not make adequate allowance for uncertain future costs in fighting the “war on terror”.

The sceptical response follows the president’s commitment in an article in the Wall Street Journal on Wednesday to set out a plan to “balance the federal budget by 2012 while funding our priorities and making the tax cuts permanent”.

A White House spokesman told the FT on Wednesday “it is an achievable goal” and pointed out that the Bush administration had achieved its previous promise of halving the deficit by 2008 a year early.

The year 2012 is an obvious medium-term target for balancing the budget, because it already shows the narrowest deficit on current forecasts: $54bn according to projections by the non-partisan Congressional Budget Office.

However, the CBO estimates that the deficit in 2012 would be $284bn higher if the Bush tax cuts are made permanent, even before allowing for any higher debt interest payments.

Economists on both sides of the political divide, and people close to the administration, expect the Bush proposal will bridge this gap by:

•Proposing real-terms cuts for much of non-security related discretionary spending.

•Budgeting for a gradual reduction in spending on the wars in Iraq and Afghanistan, compared with the CBO baseline.

•Assuming slightly slower growth in spending on Medicare, which has come in lower than expected over the past year.

•Upgrading revenue forecasts in the light of the surprisingly high growth in tax receipts over the past two years.

In addition, there is unlikely to be any provision for fixing the AMT in the later years.

The White House spokesman refused to comment on any specifics, but said Mr Bush believed it would be possible to support his policy priorities with “limited growth in new spending” by redirecting resources from other programmes.

He said the president continued to view defence spending as his “number one priority” and something “that should receive the fullest funding”.

A former budget official said only the detail of the president’s budget proposal would show whether he was serious about cutting the deficit.

This would require putting forward policies that could be passed by a Democratic Congress in the remaining two years of the administration, rather than relying on deficit reduction under his successor as president.