Republic of Korea ROSC
I. Fiscal Transparency

SURVEY What do you think of Reports on the Observance of Standards and Codes?

Contents Executive Summary Introduction Description of Practice Clarity of Roles and Responsibilities Public Availability of Information Open Budget Preparation, Execution, and Reporting Independent Assurances of Integrity IMF Staff Commentary

Abbreviations and Acronyms
BAI	Board of Audit and Inspection
BOK	Bank of Korea
GFS	Government Finance Statistics
ITC	Investment Trust Company
KAMCO	Korea Asset Management Company
MOFE	Ministry of Finance and Economy
MPB	Ministry of Planning and Budget
OECD	Organization for Economic Cooperation and Development
SDDS	Special Data Dissemination Standard
SME	Small and medium enterprises

I.  Introduction¹

1.  This report provides an assessment of fiscal transparency practices in the Republic of Korea. The assessment has two parts. The first part is a description of practices in relation to the requirements of the IMF Code of Good Practices on Fiscal Transparency--Declaration on Principles, prepared by the IMF staff on the basis of the authorities' response to the IMF fiscal transparency questionnaire and additional information provided by the authorities. The second part is an IMF staff commentary on fiscal transparency in the Republic of Korea.

II.  Description of Practice

A.  Clarity of Roles and Responsibilities

2.  The boundary between the government sector and the rest of the economy is, for the most part, clearly specified. There is a clear demarcation of roles between different levels of government with explicit tax powers and expenditure responsibilities specified in the Local Public Finance Act and accompanying legislation. Similarly the roles of the executive, legislative, and judicial branches are clearly described in constitutional and administrative law. However, the government's involvement in certain private sector activities, as well as the proliferation of extrabudgetary funds have obfuscated the limits of government activities.² The consolidated central government is made up of 1 general account, 5 public enterprise special accounts, 18 other special accounts, and 43 extrabudgetary funds.³ In addition, 18 funds, some of whose activities are of a fiscal nature, are excluded from the coverage of the consolidated central government and general government statistics. The government has reduced the number of extrabudgetary funds from 75 to 60 in the 2000 budget year.

3.  Government regulation of the private sector is, for the most part, transparent. The government's fiscal involvement in financial restructuring has, however, been somewhat nontransparent.⁴ The government owns 65 percent of the assets of the banking sector (made up of a majority stake in three major banks and minority stakes in two more) as well as four nonbank financial institutions.⁵ The government has, however, announced it is committed to the withdrawal of its involvement and ownership in the financial system that resulted from the 1997 financial crisis. The government also extends loans and guarantees for commercial operations through the budget, but it also provides such support outside the budget, which amount to hidden subsidies to loan and guarantee recipients. The government owns a number of financial institutions that concentrate lending to achieve specific policy goals; lending by these institutions is conducted at market rates and on a commercial basis. Intra-government transactions are also not always transparently conducted as is typified by nonmarket financing of the budget by extrabudgetary funds.

4.  The government is in the midst of a major privatization initiative to divest many of its private sector assets. Government equity holdings of commercial enterprises are sizable, employing 180,000 persons and accounting for 8 percent of GDP. Nonfinancial public enterprises are, on the whole, run on a purely commercial basis although certain public enterprises―for example, the Korean Highway Corporation or Korean Water Resources Development Corporation, etc.―perform roles that are essentially fiscal in nature (mainly in executing public infrastructure spending). The privatization program is implemented by the Ministry of Planning and Budget (MPB) following instructions from the Privatization Steering Committee and in coordination with the line ministry responsible for the state-owned enterprise. The privatization process is fair and transparent and is subject to internal financial and performance audits as well as oversight by the Board of Auditing and Inspection.

5.  The responsibility for the management of budgetary and extrabudgetary activities is split between the MPB and the Ministry of Finance and Economy (MOFE). MOFE is responsible for revenue projections and for constructing the macroeconomic framework, while the MPB is responsible for spending and privatization aspects of the budget. The proliferation of extrabudgetary funds, each managed by different line ministries, and the extensive use of earmarking of various revenue sources, have complicated the management of overall public finances.

6.  The main responsibility of the central bank is to achieve monetary objectives, primarily price stability. The Bank of Korea (BOK) is prohibited by the Central Bank Act from direct financing of the fiscal deficit. Although the BOK is legally independent, in practice its full autonomy remains in question as the government and MOFE continue to exert their influence.⁶

7.  Fiscal management is covered by comprehensive laws and rules that apply to budgetary and extrabudgetary activities.⁷ All commitments or expenditure of budgetary organizations have a clear legal authority. The budget contains a number of reserve funds amounting to 1 percent of budget spending that are managed by the MPB but which can only be appropriated with the approval of the Council of Ministers and the President. For extrabudgetary funds, the legal authority to use public funds is provided when funds are established but spending agencies do not need to get legislative approval for spending on an annual basis (a resolution of the State Council and approval of the President is sufficient). The 18 public funds outside the consolidated central government, however, require authorization for their spending only from the line ministry in charge of the fund. While resorting extensively to the use of supplementary budgets following the financial crisis, the Korean government now intends to move away from such recourse to supplementary budgets.

8.  As stipulated in Article 59 of the constitution, taxes, duties, fees and charges must have an explicit legal basis enacted by the National Assembly. Tax laws are accessible and a summary of tax legislation is provided by MOFE. The Basic Law for National Tax contains details of taxpayer rights, tax dispute procedures, and the application of tax laws. Taxpayers can contest rulings through internal dispute resolution procedures, recourse to the National Tax Tribunal, and finally to the judiciary. Tax service employees are bound by the Charter of National Taxpayer Services, which aims to protect taxpayer rights and ensure fair and legal treatment. Tax legislation is unnecessarily complex with a plethora of statutory tax preferences that serve to erode the tax base and decreases transparency. There is also extensive earmarking of revenue sources to the special accounts and extrabudgetary funds controlled by line ministries.

9.  Public officials are bound by a code of conduct that is outlined in the Ethics in Public Service Act and the Code of Ethics for Public Officials. The Code specifies an obligation of loyalty to the State, honesty and service to the people, creativity and responsibility in official duties, respect for colleagues, and professional and personal integrity.

B.  Public Availability of Information

10.  Coverage of the operations of the consolidated central government in the annual budget is partial; around 31 percent of spending is covered by extrabudgetary funds and not subject to ex ante legislative approval. In addition, the activities of 18 other public funds are not included in the consolidated central government but their activities are reported to the public or to the National Assembly annually. The budget does not contain information on the entire general government and covers only the consolidated central government (which makes up the majority of general government spending). The budget classification for any given year is provided in the annual "Guide to Budget Compilation" but budgetary information for previous years is not revised to make it comparable when there are significant changes to budget classifications or coverage (such as in the 2000 budget year).⁸ The budget contains fiscal data solely for the budget year and does not contain projections of key budget aggregates for years following the budget year.

11.  The budget does not include a statement of contingent liabilities, tax expenditures, or quasi-fiscal activities. However, MOFE began to report direct tax expenditures to the National Assembly from 1999 and plans to include indirect tax expenditures from 2000. In addition, information on the total size of government guarantees is reported separately to the legislature on an annual basis. There is no quantification of the likely liability resulting from such guarantees. Other implicit liabilities of the government, for example the debts of the occupational pension plans, are not disclosed.

12.  The government provides annual information on the level and composition of central government debt which is published in the press each May and posted on MOFE's website. While information on the financial assets of the public sector is available in various publications,⁹ a consolidated statement of the financial assets of the public sector is not produced.

13.  Consolidated central government fiscal data are available on MOFE's website on a monthly basis and within one month from the end of the reporting period. The annual outturn of individual local government fiscal accounts are approved by local assemblies around July, and aggregate local government accounts are published about four months after the assembly approval.¹⁰ Local government information, however, does not fully conform to GFS standards.¹¹ The government does not produce a consolidated general government presentation of the fiscal data.

14.  Korea has subscribed to the IMF's SDDS for the publication of fiscal data since 1998. Advance release calendars for the publication of fiscal data are available publicly and on the National Statistics Office website. The date calendars for budget preparation, settlement, and execution are provided in the Act on Budget and Accounting.

C.  Open Budget Preparation, Execution, and Reporting

15.  The budget contains a statement of objectives and priorities of major government programs. Nonetheless, the general form of the statement makes it difficult to assess, ex post, the extent to which the government's objectives have been achieved. The budget is guided by an underlying medium-term framework that is revised and published on an annual basis, although the budget itself does not contain medium-term projections of fiscal aggregates. The medium-term forecast covers the overall deficit of the consolidated central government for five years but does not provide details of either the macroeconomic framework underlying the forecast or fiscal aggregates other than the overall deficit. The budget document contains macroeconomic forecasts only for the budget year and the public does not have access to the macroeconomic model underlying those forecasts or the key parameters that influence the estimates of fiscal aggregates. Long-term forecasts or scenarios are not published beyond those contained in the medium-term economic forecast.

16.  The government is not bound by any formal fiscal rules approved by the legislature although it can only issue debt up to the limits approved annually by the legislature and must return to the legislature to get approval for additional borrowing. However, as the recent injection of public funds into financial sector restructuring has shown, the government is able to finance significant sums through alternative channels without the approval of the National Assembly.¹²

17.  Budget documents do not explicitly distinguish the costs of continuing existing government programs from the costs of proposed new initiatives.¹³ There is also no statement of the changes in tax and expenditure policy from year to year or a quantitative evaluation of their fiscal effects. Projects over US$45 million can be included in the budget only if there has been a preinvestigation of the project's cost.

18.  The budget does not contain a statement of the major fiscal risks, and hence no attempt to quantify these risks. There is no sensitivity analysis provided to the public or the National Assembly to allow an assessment of the reliability of budget estimates. The budget does not contain an analysis or statement of fiscal sustainability and, in particular, an indication of the size of the actuarial imbalances in either the National Pension Service or the occupational pension schemes are not published.

19.  Central government budget classifications adhere to international standards of reporting (GFS) and budget data are reliable. General government data do not strictly adhere to such standards and only information on the economic classification for the consolidated central government is available monthly (a functional classification is available only annually). There is only sporadic information available on budget outputs and outcomes and there is no reporting of results relative to the objectives of major budget programs. The government has introduced in 2000, on a pilot basis, a "performance-oriented budget system" although no results are, as yet, available.

20.  The overall balance of the consolidated central government is the main summary indicator of the government's financial position. The deficit is measured on a cash basis. A statement describing the accounting basis is included in the final accounts for the extrabudgetary funds and public enterprise special accounts but not in the annual budget.

21.  The Treasury department has an effective accounting system that generates timely and reliable information on consolidated central government activities. Fully reconciled end-year reports are available with a delay of 5 months. The system contains checks and balances with separation of responsibilities between accounting officials, financial officers, disbursing officials, and cashiers. All transactions relating to the execution of the budget are recorded and are available for both internal and external audit.

22.  Standards for procurement and tendering are clear, comprehensive, open, and transparent and apply to the central government, local government, and government invested enterprises. Procurement procedures are strictly observed, appear to be in compliance with the WTO Agreement on Government Procurement for international tenders, and are subject to audit and inspection by the Board of Audit and Inspection. Procedures governing employment in the public service are clearly specified and accessible and there is competitive recruitment within the civil service.

23.  End-year budget outturns (the Statement of Revenue and Expenditure) for the consolidated central government are prepared, externally audited, and submitted to the legislature within 9 months of the end of the year. The year-end budget report does contain a general reconciliation between budget plans and actual outturns identifying deviations from the budget due to exogenous shocks, policy changes, and forecast errors. Mid-year reconciliation is also not provided to the legislature. Reports for aggregate local government accounts are available annually with a delay of 11 months from the end of the year with no intra-year reporting. There is no reporting of the consolidated general government position.

D.  Independent Assurances of Integrity

24.  The Board of Audit and Inspection (BAI), a constitutionally independent body reporting to the President and the National Assembly, provides audited annual reports of central government operations, and government-invested organizations to the National Assembly. The BAI has 892 staff members who are predominantly trained as lawyers, CPAs, and other social science professionals. The BAI is a member of INTOSAI and the head of the organization is appointed for four years by the President with the consent of the National Assembly and cannot be dismissed except under impeachable circumstances. The BAI's budget is included in the normal budget process but the MPB cannot adjust the BAI's budget proposal without the consent of the BAI.

25.  The BAI examines the final revenue and expenditure accounts of the State mainly for financial compliance but also for performance. If irregularities are found in the course of an audit the BAI can call for civil service disciplinary action, request corrective measures, or refer the case to the public prosecutor's office. The BAI also conducts various other financial compliance audits, regularity audits, and performance audits, with the scope and topic of the audit decided by the BAI's Council of Commissioners.

26.  Macroeconomic forecasts are discussed with public agencies and quasi-public research institutes (such as the BOK, Korea Development Institute, and Federation of Korean Industries) in an effort to build consensus on the public sector's forecasts and assumptions. While final macroeconomic forecasts are released periodically, the models or key assumptions underlying the forecasts are not available to the general public since the authorities are concerned about the reliability of their forecasting models following the 1997 financial crisis. In addition, MOFE and the MPB do not produce a public assessment of the performance of their macroeconomic or fiscal forecasts but do have an internal mechanism for the quality review of such forecasts. The Central Statistics Office is statutorily independent and the fiscal statistics comply with the standards for integrity and quality set out in the SDDS.

III.  IMF Staff Commentary

27.  Korea meets international best practices in fiscal transparency in many areas. Expenditure appropriations and taxation have a clear legal authority and there is a clear demarcation between the roles of the various levels of government. The government has a modern budget process, an effective accounting system and produces timely statistics for the consolidated central government that conform to international standards. In addition, Korea has clear standards for procurement and public employment as well as an independent, active and professional national audit office. Despite these achievements, Korea still falls short in some key areas of fiscal transparency;¹⁴ some recommendations are contained below.

28.  The government should take the opportunity, now that the effects of the financial crisis are waning, to reassess and more clearly define its fiscal role by:

• reducing public sector direct involvement in the corporate and financial sectors, cutting the subsidy component of the activities of the credit guarantee funds and allowing the corporate and financial sectors to be run purely on a commercial basis. The fiscal consequences of any remaining government participation in the financial and corporate sector should be clearly reported and have an explicit budgetary authorization;

• clearly distinguishing the BOK's monetary policy activities from the activities of the fiscal authorities. The BOK should be operationally independent and have full autonomy in the setting of monetary policy. All quasi-fiscal activities of the central bank―such as sterilization of foreign exchange intervention as well as refinancing at below market rates for financial institutions that lend to SMEs― should be identified and reported as a fiscal activity. In cases where there are technical difficulties in identifying the specific costs of sterilization activities, a best estimate should be provided;

• conducting all intra-government lending on market-based terms. The recent legislation prohibiting direct lending from the National Pension Fund to finance budgetary activities is a welcome development and should be adhered to. As the nonmarket security holdings of the pension fund mature the assets should be reinvested in marketable instruments; and

• reducing the current extensive recourse to lending from the budget at subsidized rate and the offering of loan guarantees for commercial purposes. Such activities obscure the boundaries of the government's fiscal activities. The subsidy component of all remaining budgetary loans and guarantees should be reported as an explicit budget subsidy.

29.  The government should take steps to affirm the universality of the budget as the principal instrument of fiscal control by:

• significantly rationalizing the use of extrabudgetary funds and special accounts and integrating all fiscal activities into the state budget so that they are subject to the same scrutiny and prioritization of expenditures as other state budget entities. The fiscal activity of funds that are currently excluded from the measurement of the government should either be eliminated or included as part of central or general government. For those funds that are retained, their budget allocations should be subject to the same discipline and rules over the use and reporting of appropriated monies as are required for the state budget. This would imply ex ante budget approval of their expenditure activities and ex post reporting to the legislatures of budget outcomes. By reducing the compartmentalization of the budget, the government will improve transparency, accountability, as well as allocative efficiency. The rationalization of the budget structure should be accompanied by improved coordination between MPB and MOFE to help improve overall fiscal management;

• moving away from frequent recourse to supplementary budgets as a tool of fiscal policy. Supplementary budgets are often not reviewed in the context of their expected overall impact on the fiscal outcome and tend to reduce transparency both in terms of aggregate control and strategic priority setting; and

• as part of the reduction in the use of extrabudgetary funds, the government should also move to eliminate the extensive use of earmarking, which complicates budgetary management and reduces budget accountability and transparency. To this end, the recent proposals to eliminate the telephone tax and phase out the rural development and transportation tax are welcome developments.

30.  There are a number of improvements that can be made to the annual budget documents that are submitted to the National Assembly and subsequently published:

• the budget should include a more specific statement on objectives and should be cast in a form that facilitates ex post evaluation against measurable budget outcomes (rather than an evaluation based solely on financial compliance). In order to better assess the degree to which the budget has achieved its stated objectives, the government should provide more information on budget outputs and extend the recent pilot projects on results-oriented budgeting and accounting;

• the budget documents should provide information that consolidates the general account of the central government with extrabudgetary funds and special accounts, i.e., consolidated central government fiscal accounts. In addition, the document should present fiscal information on a comparable basis for the two years preceding the budget year and explicitly highlight in the budget any material changes in budget coverage or classification that have occurred between years. In addition, budgetary projections should be included for the two years following the budget year as well as information on the forecast errors of past budgets;

• existing expenditure commitments should be clearly distinguished from new policies in the annual budget. The budget should contain a clear identification of the costs of continuing existing government programs as well as a rigorous costing and an analysis of the fiscal effect of any new budget initiatives;

• the medium-term economic framework should be enhanced with a more detailed projection of macroeconomic and fiscal aggregates, an explicit forecast of budgetary aggregates in the absence of policy action, and a description of policy actions that will need to be taken to achieve the government's medium term fiscal objectives;

• the government should provide within the budget, and to the public, a statement and, insofar as is possible, a quantification of their quasi-fiscal activities. Such activities would include the subsidy component of public financial institution and budgetary lending, the implicit subsidies resulting from government guarantees, the fiscal costs of central bank sterilization activities, the refinancing at below market rates for financial institutions that extend loans to SMEs, and any other material quasi-fiscal activity conducted by the central bank, publicly owned financial institutions, or nonfinancial public enterprises;

• the budget should report information on the structural or cyclically adjusted balances and consider, over the medium-term, providing information in budget documents on accrual-based and generational accounts. The budget should contain an explicit assessment of fiscal sustainability―including the sustainability of the occupational and national pension schemes―and the statement on tax expenditures currently reported to the legislature should be included as part of the budget documentation;

• the budget should contain a comprehensive identification and quantification of the major fiscal risks. The statement should provide clear information on the effect of variations in economic assumptions as well as the parameters used to arrive at the fiscal forecast. Such a statement will facilitate an assessment of the reliability of budgetary forecasts under varying economic scenarios;

• the budget should contain a report on government contingent liabilities as well as on potential future obligations the budget will be required to meet, such as the actuarial imbalances in the occupational pension schemes. The report on contingent liabilities (including but not limited to government guarantees) would include an indication of the nature of each contingent liability, its beneficiaries, and the expected cost of each liability. In addition, there should be a clear reporting of those contingent liabilities that have resulted in expenditure during the previous year's budget; and

• the government's ex post reconciliation between actual fiscal performance and the budget plan should highlight any changes to be made to budget forecasting methodology as a result of the analysis of past outturns. In addition, any discrepancy between the government accounts and banking accounts should also be disclosed.¹⁵ The government should consider reporting a less detailed report, comparing the budget and actual performance of the fiscal position, to the National Assembly at mid-year.

31.  Although information on the consolidated central government balance is widely available with only minimal delay there are areas in the reporting of fiscal information that can be improved. The government should:

• improve the quality of information on local governments and reduce delays in the availability of data. The government should begin producing an annual presentation of consolidated general government fiscal statistics. In addition, reporting on the position of the general government should include information on the activities of the extrabudgetary funds held at the local government level. The government should aim to more widely disseminate general government information (such as by publishing the information in budget documents and also on MOFE's website);

• like the majority of other OECD countries, Korea should attempt to regularly publish consolidated information on its financial assets in order that the public can assess the net indebtedness of the public sector. Such publication would include comprehensive information on valuation methods and should consider including information on the maturity structure of the debt stock (which is currently available in the annual report to the National Assembly). Gross and net debt figures should be made available, in both Korean and English, on MOFE's website on a quarterly basis with no more than one-quarter delay; and

• while information on government macroeconomic and fiscal projections are available to the public, working methods and assumptions underlying the fiscal forecasts should also be made available and should include a statement making it clear who has produced the forecasts. Key elements and assumptions of the underlying macroeconomic models should be placed in the public domain and there should be an independent ex post assessment of past fiscal and macroeconomic forecasts with a clear explanation for any failings in the forecasting methodology.

32.  The Korean taxation system has much to commend it―taxes are levied under strict legal authority and tax legislation is widely available. Nevertheless, the government could make some improvements by:

• significantly simplifying the tax system through the elimination of a number of taxes, reduction in the amount of earmarking, and a rationalization of tax reliefs, preferences, exemptions, and privileges. This simplification of the tax system will make it easier to understand and also improve the transparency of the incidence of taxation in Korea; and

• the government should continue to expand on its initiatives to improve taxpayer services which include providing tax forms and information on the tax service's website, expanding access to electronic filing and allowing for electronic payment of taxes, and providing greater counseling to taxpayers by telephone, over the internet, and in tax offices.

Korea ROSC