IMF Executive Board Concludes 2019 Article IV Consultation with the Republic of Korea

May 13, 2019

On May 8, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with the Republic of Korea.

Korea’s economy has strong fundamentals, but short-term growth is moderating. GDP growth fell to 2.7 percent in 2018, down from 3.1 percent in 2017. A global slowdown in trade and in the demand and prices for semi-conductors took a toll on equipment investment. Export growth deteriorated on the back of trade tensions and China’s growth slowdown. The job market weakened, with employment growth dropping to 0.4 in 2018 from 1.2 percent in 2017, due to sluggish job creation by the private sector. Inflation pressures are weak. The year-on-year headline inflation rate declined to 0.5 percent in February 2019 and core inflation excluding food and energy was subdued, recording 1.1 percent year-on-year in February this year. Household leverage keeps increasing, albeit at a slower pace, creating concerns about financial risk. Imbalances in the economy—particularly weak domestic demand—have led to large current account surpluses. Fiscal policy was tight in 2018. The structural budget surplus is estimated to have increased by 0.4 percentage point compared to 2017, to 2.9 percent of GDP. The BOK increased its main policy rate by 25 basis points to 1.75 percent in November 2018 and has been on hold since.

Growth is projected to slide to around 2.6 percent in 2019. This slowdown is driven by an expected deterioration in external demand, while internal demand is anticipated to pick up, supported by fiscal policy. Export growth is projected to be weak reflecting a deteriorating tech cycle, and a slowdown in demand from China. Domestic consumption is expected to accelerate, helped by the fiscal stimulus embedded in the 2019 budget and a supplementary budget. Facility investment will continue to face headwinds from weaker trade, especially in demand for semiconductors. Construction investment is expected to stabilize to a level more in line with long-term trends. Economic slack will dissipate only gradually.

Potential growth has slowed down and its prospects are hampered by unfavorable demographics and slowing productivity growth, driven by structural weaknesses. Income equality and polarization are worsening, partly reflecting inadequate social protection as well as labor and product market duality. The government has focused on supporting income, creating jobs, and promoting innovation. It has strengthened social safety nets, substantially raised the minimum wage, supported SMEs to boost employment, and expanded public sector jobs.

Executive Board Assessment [2]

Executive Directors noted that Korea’s economy has strong fundamentals, supported by robust policy frameworks and a resilient financial system. Nevertheless, cyclical and structural headwinds amid the challenging global environment have hampered growth prospects with risks to the downside. Directors underscored the need for policies aimed at promoting balanced, private sector-led growth; fostering inclusion; and enhancing productivity.

Directors generally concurred that fiscal policy should remain expansionary into the medium term to support growth, job creation, and external rebalancing. They noted that Korea has ample fiscal space for additional stimulus, and in this context, broadly welcomed the planned supplementary budget and the authorities’ readiness to take further action as necessary to achieve the growth target and strengthen social safety nets. Directors also saw a role for fiscal policy in promoting women and youth employment, enhancing active labor market policies, and supporting growth-enhancing structural reforms. In the longer term, tax reforms that aim to promote innovation and efficiency in resource allocation could further support growth. Directors also stressed the need for greater revenue mobilization to prepare for the aging population.

Directors agreed that monetary policy should remain accommodative. With inflation projected to remain below target and signs that inflation expectations have started to decline and the output gap remains negative, most Directors saw room for a further easing of monetary policy, while a few Directors emphasized the importance of preserving policy space and financial stability. Directors encouraged the authorities to rely more on targeted macroprudential policies to manage financial stability risks, including from the still high household indebtedness and possible house price corrections. They welcomed ongoing efforts to strengthen the regulatory and oversight frameworks.

Directors welcomed the continued commitment to a flexible exchange rate and the recent step to enhance transparency in foreign exchange policy. Policies and structural reforms that promote domestic demand and private investment would contribute to a further reduction of the current account surplus.

Directors emphasized that reforms in the labor and product markets are key to boosting potential growth. They encouraged measures to enhance flexibility and security (flexicurity) in the labor market to mitigate duality and create jobs in the private sector. They also recommended linking minimum wage increases to labor productivity growth and phasing out compensatory subsidies to small- and medium-sized enterprises. Directors encouraged further diversification of the manufacturing sector and liberalization of the services sector, including by easing the regulatory burden on firms, lowering barriers to entry, and reducing protection of existing firms.

It is expected that the next Article IV consultation with the Republic of Korea will be held on the standard 12-month cycle.


Korea: Selected Economic Indicators, 2017–20

Projections

2017

2018

2019

2020

Real GDP (percent change)

3.1

2.7

2.6

2.8

Total domestic demand

5.1

1.7

2.8

3.3

Final domestic demand

4.7

1.6

2.6

3.9

Consumption

2.8

3.5

3.5

3.6

Gross fixed investment

8.6

-2.2

0.7

4.5

Stock building 1/

0.4

0.1

0.2

-0.5

Net foreign balance 1/

-1.7

1.2

-0.4

-0.3

Nominal GDP (in trillions of won)

1,730.4

1,782.3

1,852.8

1,937.0

Saving and investment (in percent of GDP)

Gross national saving

36.0

34.9

34.2

33.7

Gross domestic investment

31.1

30.2

29.6

29.3

Current account balance

4.9

4.7

4.6

4.5

Prices (percent change)

CPI inflation (end of period)

1.4

1.3

1.4

1.6

CPI inflation (average)

1.9

1.5

1.4

1.6

Core inflation (average)

1.5

1.2

…

…

GDP deflator

2.3

0.3

1.4

1.7

Real effective exchange rate

3.1

0.9

…

…

Trade (percent change)

Export volume

5.3

7.2

2.3

2.7

Import volume

8.5

1.5

3.0

2.9

Terms of trade

-0.8

-6.5

0.9

0.7

Consolidated central government (in percent of GDP)

Revenue

23.2

24.2

24.7

24.7

Expenditure

20.8

21.5

22.7

23.1

Net lending (+) / borrowing (-)

2.3

2.7

1.9

1.6

Overall balance

1.4

1.7

0.9

0.6

Excluding Social Security Funds

-1.1

-0.6

-1.4

-1.7

Money and credit (end of period)

Overnight call rate

1.6

1.9

…

…

Three-year AA- corporate bond yield

2.7

2.3

…

…

M3 growth

6.6

7.2

…

…

Balance of payments (in billions of U.S. dollars)

Exports, f.o.b.

580.3

625.4

638.5

660.3

Imports, f.o.b.

466.7

513.6

523.4

538.9

Oil imports

59.6

80.4

69.8

71.9

Current account balance

75.2

76.4

76.0

78.1

Gross international reserves (end of period) 2/

384.5

398.9

422.2

444.5

In percent of short-term debt (residual maturity)

227.2

226.8

232.8

237.9

External debt (in billions of U.S. dollars)

Total external debt (end of period)

412.0

440.6

489.0

531.2

Of which : Short-term (end of period)

116.0

126.6

128.1

133.5

Total external debt (in percent of GDP)

26.9

27.2

29.5

30.5

Debt service ratio 3/

8.2

8.8

9.8

10.9

Sources: Korean authorities; and IMF staff estimates and projections.

1/ Contribution to GDP growth.

2/ Excludes gold.

3/ Debt service on medium- and long-term debt in percent of exports of goods and services.


[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

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