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Is this darling economy in Asia losing its lustre?

Shoppers and pedestrians walk past stores in the Myeongdong shopping district in Seoul, South Korea.
SeongJoon Cho | Bloomberg via Getty Images
Shoppers and pedestrians walk past stores in the Myeongdong shopping district in Seoul, South Korea.

It was once the darling of Asia's newly industrialized economies, but following a less-than-stellar growth report card for the June quarter, economists are increasingly divided on South Korea's economic outlook.

"We don't see a drastic improvement in momentum in the second half of 2015 to compensate for this quarter's weak performance," HSBC said in a note Thursday. "Consumer woes will likely persist as high household debt levels weigh on consumption and tourist arrivals plunge. Exports are unlikely to pick up as growth momentum remains subdued."

The main culprit is the outbreak of Middle East Respiratory Syndrome (MERS) in the country of 50 million, which claimed the lives of 36 people and infected more than 186 following the first diagnosis on May 20. The spread of the deadly virus chilled consumer sentiment and a burgeoning tourism industry, exacerbating the woes of an already-fragile economy battling with struggling exports and prompting the government to announce a 22 trillion won ($19.8 billion) stimulus package, aimed at supporting businesses hurt by the MERS crisis.

"While difficult to quantify, the reach of the disease certainly diminishes interest in some economic activities and has cut down on foreign tourism," Tim Quinlan, an economist at Wells Fargo Securities, said in a note Thursday. "Sales from things like on-premise food sales and hotel stays are lost."

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Asia's fourth-largest economy expanded a meagre 0.3 percent on-quarter in the April-June period, the Bank of Korea (BOK) estimated on Thursday, down from 0.8 percent in the first quarter and slightly below a 0.4 percent increase tipped in a Reuters survey.

On a year-on-year basis, the economy grew 2.2 percent - the slowest pace in more than two years and below analyst forecasts of 2.3 percent. Following the data release, the won hit a fresh two-year low against the greenback.

Earlier this month, the central bank lowered its 2015 economic growth forecast for the third time this year, from 3.1 percent to 2.8 percent.

But, while analysts from top international banks have revised down their growth forecasts for 2015 following Thursday's GDP print, the degree of pessimism differs.

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Darkening outlook?

HSBC is perhaps the most bearish of the lot, cutting its full-year growth forecast to 2.4 percent from 2.8 percent.

"We aren't confident about an export-led recovery materializing. Even if the growth omentum in the U.S. and EU improves, Korea's exports are more levered to emerging markets and China in particular," it said.

Exports, which account for more than half of the economy, have fallen every month this year, partly due to the won's strength against a weakening Japanese yen and euro.

HSBC is also not counting on the government's fiscal stimulus, which is expected to have a "limited impact on growth after accounting for the fall in tax revenue."

As such, a drastic improvement in the second-half of 2015 will be unlikely, paving the way for "one last interest rate cut" in September by the BOK, the report said.

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Recovery on the way?

By contrast, economists from Mizuho and Barclays are forecasting better growth prospects in the last six months of 2015.

Mizuho's expectations for a "gradual acceleration in growth momentum in the next quarters" are premised on three factors: a recovery in confidence and consumption as the MERS outbreak recedes, the joint policy efforts of the government and BOK to bear fruit and cushion domestic demand, as well as the trickle-down effects of weak energy prices.

Meanwhile, Barclays' analysts expect "modest late-summer acceleration" in industrial production and exports - helped by inventory destocking in the electronics and auto sectors, and a stronger recovery in the U.S. and Europe - to underpin a pick-up in growth momentum.

Both Mizuho and Barclays share the same full-year growth forecast of 2.6 percent for South Korea and expect the central bank to keep interest rates unchanged at 1.50 percent through the year.

On the other hand, Citi is estimating an annual expansion of 2.7 percent for this year, as expansionary macro policies unveiled by the government and BOK keep the economy afloat.

However, analysts are not ruling out the probability of risks such as a delay or failure in the implementation of the supplementary budget or unfavourable external developments like a deeper slowdown in China's growth. If any of these factors slow South Korea's recovery pace to below 1 percent quarter-on-quarter in the second half, the BOK may be forced to act, Citi's note issued on July 23 said.