Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with the Republic of Korea on March 18, 2022.
Korea has recovered impressively from the COVID-19 pandemic, with activity surpassing pre-covid levels despite multiple COVID waves. The recovery was supported by the effective containment of the pandemic, including rapid vaccination in 2021, and pursuing proactive economic policy support, which helped minimize economic scarring, sustain income growth, and maintain financial stability. Given Korea’s high global integration, strong external demand also supported the recovery.
The economy has been growing above trend, but the recovery remains somewhat uneven. Technology exports and related investment have been a key drivers of growth, while the recovery in consumption has been slower. As a result, activity in some segments of the services sector still remain below pre-COVID levels. The labor market has been recovering well, but there is some remaining slack.
With continued strong exports and investment, growth is projected to remain above potential this year and next, closing any remaining output gap. Softer growth in the first quarter of this year due to omicron is expected to be temporary. Supply bottlenecks that impacted production in several sectors in 2021 are also normalizing. Inflation is projected to gradually return to target by next year. Risks to the outlook are tilted to the downside, principally arising from heightened global uncertainties and monetary normalization in advanced economies. Domestic risks are related to COVID developments and the elevated household debt and real estate prices. Risks to inflation are to the upside.
Given Korea’s relatively advanced cyclical but somewhat uneven recovery and heightened global uncertainties, the near-term policy challenge is balancing the appropriate pace of policy normalization against heightened global risks, while containing the buildup of risks from housing and household debt. Over the medium-term as the pandemic abates, the policy focus will need to shift to structural reform priorities centered around the Korea New Deal to reinvigorate potential growth and foster greater inclusion. This will require recalibrating policies to support productivity growth and innovation, providing transitory support amidst reforms to address product, services, and labor market rigidities, and ensuring that Korea’s human capital remains a central pillar of the transformation process.
Executive Board Assessment[2]
Executive Directors commended the authorities for their comprehensive policy response, which, along with strong economic fundamentals, has underpinned a remarkable post-pandemic recovery and limited long-term scarring. However, uncertainty surrounding the outlook is high, linked to global and COVID-related risks. Directors agreed that the pace of policy normalization should continue to weigh the strength of the recovery against these risks and uncertainty. Meanwhile, structural reforms remain important to foster more inclusive, greener growth.
Directors supported the ongoing monetary policy normalization, given rising inflationary risks. They noted that, if downside risks materialize, monetary policy has some room to provide stimulus, while enhanced communication would help anchor inflation expectations .
Directors agreed that the current fiscal policy appropriately supports policy normalization. They noted that Korea has ample fiscal space to provide targeted support to the economy in the event that stagflationary pressures arise. Over the medium term, implementing a rules-based fiscal framework would help anchor public finances and preserve countercyclical fiscal space, against pressures from demographics and reform needs. In this context, Directors recommended further strengthening automatic stabilizers and broadening the tax base. Pension reform is also needed to ensure its sustainability.
Directors welcomed the gradual withdrawal of lending support policies. They stressed the need to continue cautiously to reduce the risks of a sudden tightening in credit conditions, particularly for small and medium enterprises.
Directors noted that, while the financial system remains resilient, the rapid growth in household credit and house prices warrants close vigilance. They welcomed the recent tightening of macroprudential policies, and recommended complementing them with measures to improve housing supply. They also encouraged the authorities to stand ready to tighten macroprudential policies further as necessary.
Directors welcomed the authorities’ strategy to develop new growth drivers and promote inclusiveness in a post-pandemic world through the Korean New Deal. They encouraged further efforts to increase female labor force participation and close remaining gender gaps. Directors also saw merit in reducing entry barriers, fostering innovation, and tackling labor market rigidities. They welcomed Korea’s ambitious climate change mitigation objectives and underscored the importance of carbon pricing to provide robust incentives for green private investment.
Table 1. Korea: Selected Economic Indicators, 2019-22 | ||||||||
Estimates | Projections | |||||||
2019 | 2020 | 2021 | 2022 | |||||
Real GDP (percent change) | 2.2 | -0.9 | 4.0 | 3.0 | ||||
Total domestic demand | 1.5 | -1.5 | 3.3 | 3.4 | ||||
Final domestic demand | 1.5 | -0.9 | 3.6 | 3.1 | ||||
Consumption | 3.2 | -2.4 | 4.1 | 3.7 | ||||
Gross fixed investment | -2.1 | 2.6 | 2.5 | 1.8 | ||||
Stock building 1/ | 0.0 | -0.6 | -0.3 | 0.0 | ||||
Net foreign balance 1/ | 0.8 | 0.5 | 0.7 | 0.0 | ||||
Nominal GDP (in trillions of won) | 1,924 | 1,933 | 2,067 | 2,196 | ||||
Saving and investment (in percent of GDP) | ||||||||
Gross national saving | 34.8 | 36.2 | 37.0 | 36.8 | ||||
Gross domestic investment | 31.5 | 31.9 | 32.1 | 32.4 | ||||
Current account balance | 3.6 | 4.6 | 4.9 | 4.3 | ||||
Prices (percent change) | ||||||||
CPI inflation (end of period) | 0.7 | 0.6 | 3.7 | 2.5 | ||||
CPI inflation (average) | 0.4 | 0.5 | 2.5 | 3.1 | ||||
Core inflation (average) | 0.7 | 0.4 | 1.4 | … | ||||
GDP deflator | -0.8 | 1.3 | 2.8 | 3.2 | ||||
Real effective exchange rate | -4.5 | -1.9 | 0.1 | … | ||||
Trade (percent change) | ||||||||
Export volume | -1.1 | -0.5 | 9.8 | 6.3 | ||||
Import volume | -2.5 | -0.1 | 11.8 | 7.7 | ||||
Terms of trade | -4.1 | 3.8 | -2.8 | -0.5 | ||||
Consolidated central government (in percent of GDP) | ||||||||
Revenue | 22.9 | 23.0 | 25.5 | 24.5 | ||||
Expenditure | 22.6 | 25.2 | 26.2 | 25.7 | ||||
Net lending (+) / borrowing (-) | 0.4 | -2.2 | -0.6 | -1.2 | ||||
Overall balance | -0.6 | -3.7 | -2.0 | -2.0 | ||||
Excluding Social Security Funds | -2.8 | -5.8 | -4.0 | -4.0 | ||||
General government debt | 42.1 | 48.9 | 49.6 | 51.1 | ||||
Money and credit (end of period) | ||||||||
Overnight call rate | 1.4 | 0.6 | 1.4 | … | ||||
Three-year AA- corporate bond yield | 1.9 | 2.2 | 2.4 | … | ||||
M3 growth | 9.0 | 9.1 | 11.0 | 6.6 | ||||
Balance of payments (in billions of U.S. dollars) | ||||||||
Exports, f.o.b. | 556.7 | 517.9 | 650.0 | 721.5 | ||||
Imports, f.o.b. | 476.9 | 437.3 | 573.8 | 648.5 | ||||
Current account balance | 59.7 | 75.9 | 88.3 | 80.3 | ||||
Gross international reserves (end of period) 2/ | 404.0 | 438.3 | 458.3 | 482.3 | ||||
In percent of short-term debt (residual maturity) | 206.3 | 191.6 | 206.8 | 211.7 | ||||
External debt (in billions of U.S. dollars) | ||||||||
Total external debt (in percent of GDP) | 28.5 | 33.3 | 35.1 | 38.0 | ||||
Sources: Korean authorities; and IMF staff estimates and projections. | ||||||||
1/ Contribution to GDP growth. | ||||||||
2/ Excludes gold. | ||||||||
[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:https://www.IMF.org/external/np/sec/misc/qualifiers.htm.