Korea Faces Stagflation Risk as Oil Prices Threaten Growth

As the war between the United States, Israel, and Iran shows signs of prolonging, warnings of "stagflation"—a simultaneous occurrence of economic recession and rising prices—are emerging in the market. Concerns are growing that if international oil prices and exchange rates surge sharply while Korea's real economy recovery remains weak, soaring inflation could weigh heavily on growth rates.

Unusual signs are already appearing in financial markets. Typically, when war breaks out, global capital flows into U.S. Treasury bonds—a representative safe-haven asset—causing bond prices to rise and yields to fall. However, in the early stages of the U.S.-Iran conflict, inflation fears driven by surging oil prices are overwhelming the flight to safety, creating the unusual pattern of falling bond prices and rising yields.

The yield on the U.S. 2-year Treasury note rose 11 basis points from 3.37% on September 27—the day before airstrikes began—to 3.48% on October 2. The 10-year Treasury yield also climbed by the same margin to reach 4.03%. Korean government bond yields rose in tandem with U.S. Treasuries. The 3-year Korean Treasury bond yield closed at 3.180%, up 13.9 basis points from the previous day, while the 10-year yield finished at 3.594%, up 14.8 basis points.

While it is difficult to predict how long this rising rate trend will continue, if interest rates climb while prices are already rising due to high oil costs and exchange rate increases, consumer sentiment could deteriorate sharply. The Bank of Korea projected Korea's growth rate this year at 2.0%, up from the previous 1.8% forecast, with private consumption contributing 0.05 percentage points—an initial shock could materialize if this contribution declines.

"President Donald Trump has set a four-week timeline to achieve military operation objectives, but we cannot rule out the possibility of a prolonged conflict," said Yoo Myung-gan, a researcher at Mirae Asset Securities. "If the Strait of Hormuz is blocked and high oil prices become entrenched, stagflation concerns in the United States could intensify."

Korea is particularly vulnerable to stagflation threats due to its high dependence on crude oil. According to the Hyundai Research Institute, Korea ranks 12th globally by economic size as of 2024, but seventh in crude oil consumption. Among OECD member countries, Korea ranks first in crude oil consumption per $10,000 of GDP at 5.63 barrels.

"Korea's economy has much higher oil dependence compared to major competitors, making it relatively more susceptible to inflationary pressure when international oil prices rise," said Joo Won, head of the research division at Hyundai Research Institute. "If exchange rates also surge and import prices rise, the accompanying decline in current account balance would have significant negative effects on economic growth."

The Hyundai Research Institute estimates that if the annual average international oil price (Dubai crude basis) reaches $100 per barrel this year, inflation would rise by 1.1 percentage points. Economic growth would fall by 0.3 percentage points, and the current account balance would decrease by $26 billion. Under an "oil shock" scenario with prices soaring to $150 per barrel, inflation would spike 2.9 percentage points while growth would plunge 0.8 percentage points. The institute noted that annual growth could potentially remain around 1% in such a case—effectively meaning the Korean economy could fall into stagflation.

Forecasts from overseas institutions are even more pessimistic. Citi projected that if international oil prices (Brent crude basis) exceed $82 per barrel and persist at that level for an extended period, Korea's economic growth rate would decline by 0.45 percentage points. Consumer price inflation would rise by 0.6 percentage points this year and 0.12 percentage points next year.

Academia is also warning of stagflation possibilities. "If prices jump due to rising crude oil costs, real consumption could contract further," said Kim Jung-sik, professor of economics at Yonsei University. "Export damage from expanding global uncertainty could accelerate the growth slowdown."

Experts advise that Korea should focus on securing stable supply chains for crude oil and raw materials in preparation for prolonged Middle East risks, while centering macroeconomic policy on price stabilization and real economy recovery. "Policies to reduce exchange rate volatility are urgent," said Seok Byung-hoon, professor of economics at Ewha Womans University. "We need measures to prepare for potential volatility expansion from increased margin calls due to rising leveraged stock market investments."