July 5 (Bloomberg) -- South Korean business confidence fell in June to its lowest in almost three years as consumer demand slumped in Asia's third-largest economy and higher oil prices eroded earnings.

The business confidence index fell to 86.4 points, its lowest since October 2001, from 92.1 points in May, according to a Federation of Korean Industries survey. A reading below 100 indicates most respondents are pessimistic. A separate report showed producer prices rose at their fastest pace in five years.

Korean Air Co., the nation's largest carrier, said last month profit will lag forecasts on rising fuel costs, while Kookmin Bank, the biggest lender, said efforts to cut credit-card defaults will curb earnings. Sliding consumer spending is hampering government efforts to double economic growth this year, from 3.1 percent in 2003, even as domestic demand rebounds in Japan, Taiwan and Singapore.

``While everyone else is enjoying the strong upturn in exports, sentiment seems quite depressed in Korea,'' said David Cohen, an economist at Action Economics in Singapore. ``It's presumably the consumer-debt crisis that's still weighing upon domestic consumer demand.''

One in 13 South Koreans was three months or more behind on debt payments at the end of May, the Korea Federation of Banks said last month. Consumer confidence in May dropped for a third time in four months and wholesale and retail sales, a gauge of consumer spending, fell 1.2 percent from April, marking a fourth straight drop, the statistics office said last week.

Sluggish Demand

LG Card Co., the nation's largest credit-card company, will probably post a loss of more than 500 billion won ($434 million) this year because of bad-loan write-offs, Korea Development Bank said last month. The bank is managing LG Card on behalf of creditors.

Combined sales at the nation's top three department store chains dropped 5.5 percent from a year earlier in May and were expected to slide 4.1 percent in June, the commerce ministry said last month. Domestic sales at the nation's four biggest automakers dropped 10 percent in June, according to figures released Thursday by the companies.

``Sluggish domestic demand has reached a point where we can't influence it even if we hold sales and other promotions,'' said Lee Sun Dae, spokesman at Lotte Department Store Co., the country's biggest department store chain. ``We try to get customers spending but overall demand is weak.''

Weak Sentiment

Bonds ended the day higher, with the yield on three-year government bonds closing 3 basis points lower at 4.21 percent, according to the Korea Securities Dealers Association. A basis point is 0.01 percentage point.

``The confidence survey reflects how weak sentiment is among businesses,'' said Jang Chang Su, an economist at Tong Yang Investment Bank in Seoul. ``A pickup in domestic demand and corporate investment will determine how strong economic growth will be in the second half.''

Finance Minister Lee Hun Jai said last month he expects growth this year to be in line with the central bank's 5.4 percent forecast. Earlier in the year, Lee said the government was targeting a 6 percent expansion for 2004.

While South Korea's prospects are deteriorating, the economic outlook is getting brighter elsewhere in the region.

Record Exports

In Japan, manufacturers' confidence is the highest it's been since the nation's asset-price bubble burst in 1991, the Bank of Japan's quarterly Tankan survey showed. Taiwan's economy grew in the first quarter at its fastest pace in 3 1/2 years and the government predicts private investment will rise 23 percent this year. Singapore in May raised its 2004 economic growth forecast by two percentage points to as much as 7.5 percent.

These three economies and South Korea are benefiting from surging electronics sales to China, the U.S. and Europe. South Korean exports climbed to a record in June, while Japan and Taiwan both reported all-time highs in May and Singapore recorded its best-ever overseas sales in March.

South Korea's ``economy isn't recovering overall, despite strong exports, because of continued sluggishness in domestic demand, higher oil costs hurting profitability and weak corporate investment,'' the Federation of Korean Industries said. Rising interest rates in the U.S. and a clampdown on industrial expansion in China may damp exports in coming months, it added.

China, U.S.

Weak business confidence and concern about the outlook for exports to China and the U.S., South Korea's two biggest overseas markets, may make companies including Hyundai Motor Co. and LG Electronics Inc. less inclined to expand in coming months. A central bank survey published this month showed manufacturers' confidence is the lowest in 11 months.

Finance Minister Lee Hun Jai said last week he expects consumer spending and corporate investment to rebound ``gradually'' this half. Corporate investment in plant and machinery increased 1.3 percent from a year earlier in May, marking its first gain in three months.

To help revive the economy, the government is cutting taxes and boosting spending, and the central bank last month held its key interest rate at a record low for an 11th straight month. Policy makers may be becoming less inclined to hold rates down amid signs inflation is picking up.

Producer prices rose 6.8 percent from a year earlier in June after climbing 6.3 percent the previous months, the central bank said in a statement in Seoul. That's their biggest increase since November 1998, when prices jumped 11 percent, and follows strong gains in oil prices over the past year.

The price of crude oil for August delivery, which settled at $38.39 a barrel on Friday on the New York Mercantile Exchange, closed at a record $42.33 per barrel on June 1, 38 percent higher than a year earlier.

Inflation

Bank of Korea Governor Park Seung and his six fellow policy makers will meet to decide interest rates on Thursday. They left borrowing costs unchanged for an 11th straight month on June 10 and Park said rates would stay where they are until the economy improves and inflation gathers pace.

Consumer prices rose 3.6 percent from a year earlier in June, marking their biggest gain in eight months, and Finance Minister Lee Hun Jai forecast inflation may exceed 4 percent this month. From May, consumer prices were unchanged in June, a government report showed last week.

The Federation of Korean Industries, which represents the nation's biggest industrial groups, surveyed the nation's 600 largest companies by sales on their outlooks for exports, domestic sales and capital investment for the month ahead. The survey was conducted in June.

To contact the reporter on this story: Seyoon Kim in Seoul at skim7@bloomberg.net

Last Updated: July 5, 2004 03:47 EDT