Statement by Heenam Choi, Executive Director for Republic of Korea, Joong Beom Shin, Senior Advisor to Executive Director, and Gwibeom Kim, Advisor to Executive Director, January 17, 2018

2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Korea


2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Korea

The Korean economy has performed well and gained renewed momentum despite geopolitical tensions. Average growth has returned to 3 percent levels in 3 years and is expected to maintain these levels throughout the year. The new government is pursuing a paradigm shift to tackle the structural problems of low growth and polarization while laying the foundations for sustained growth. As highlighted in the recent ‘2018 Economic Policy Direction,’ the three pillars of economic policy directions are: creating jobs and improving income, accelerating growth through innovation, and promoting fairness. The overarching goal is to improve the quality of life so that it better reflects the income level of per capita GDP US 30,000 dollars this year.

Latest Economic Development and Outlook

Growth has picked up significantly since the second half of last year. The Korean economy is estimated to grow 3.2 percent in 2017 as the recovery continues, centered on construction and facility investment which are boosted by robust global IT demand. Growth recovered significantly from the second half of 2017, when political turmoil and uncertainties subsided and the new government took office. In the third quarter of 2017, the quarter-on-quarter growth was the highest in seven years, 1.5 percent, thanks to the cyclical global economic upturn and the effects of the supplementary budget.

Going forward, growth momentum will continue in 2018. With the hosting of the Pyeongchang Winter Olympics in February and as the effect of the new government’s policies such as minimum wage increase and further job-creation materializes, domestic consumption will increasingly contribute to growth. Thus, the 2018 growth rate is projected to be 3.0 percent, broadly in line with staff’s forecast.

Meanwhile, inflation is expected to remain within the Bank of Korea’s target of 2 percent. In 2017, the consumer price index stabilized at 1.9 percent despite rising prices of agriculture and livestock products caused by abnormal temperatures, avian influenza, and higher oil prices. Consumer prices in 2018 are expected to be 1.7 percent which is lower than that of the previous year, as oil price rise moderates and prices for agricultural products stabilize.

Risk Assessment

The authorities agree with staff’s assessment that the risk is balanced in the short term. For the first time since the global financial crisis, global economic growth is expected to tilt upward for the second consecutive year, which will have a positive impact on the Korean economy. However, the interest burden of households and corporations may increase in accordance with the normalization of monetary policy in major central banks and spread of protectionism can hamper global trade. Staff viewed that the recent geopolitical tension would not affect the fundamentals of the Korean economy, given the resilience of its financial market.

Fiscal Policy

Fiscal policy continues to remain expansionary, as suggested by staff. The authorities have been implementing supplementary budgets for the past three years, including 2017. The most notable was the 2018 budget passed in the Parliament last December which was increased by 7.1 percent. This exceeded the growth rate of last year, the largest increase since 2010 and was significantly higher than the nominal GDP growth projection of 4.8 percent. In terms of composition, the budgets for education, health, welfare and labor were prominent with more than 11 percent of growth, which support the priorities of the new government’s economic policy. To this end, the taxation policy has also been adjusted to support job creation. For instance, tax incentive to promote employment is introduced to expand tax credit when employing youth as regular workers. Start-ups and SMEs launched by the youth are exempted from corporate income tax for 5 years.

The authorities have different views on the fiscal stance. They understand that Korea’s fiscal balance is assessed as surplus according to the IMF criteria. However, once social security funds—including national pension savings, which take up a significant portion of the surplus (around 2.5 percent of GDP) and are subject to disbursement in the future, are factored out, overall fiscal balance has been negative for decades. This bears further burden on public debt. This is because Korea’s social security funds still stand at the nascent stage where pension receipts far exceed the disbursement. In addition, considering the huge need to prepare for the welfare needs of the rapidly aging population, careful management would be inevitable to prevent a public debt spiral in the future. The Korean government is carrying out fiscal reform plans for fiscal sustainability while implementing more proactive fiscal policies.

Monetary Policy and Financial Sector

In line with staff’s recommendation, the authorities have maintained its accommodative monetary policy stance. As inflationary pressures are not projected to be significant, the monetary policy of 2018 is still likely to be accommodative. The Bank of Korea did raise the base rate by 0.25 percent point to 1.5 percent at the end of last November, but only as a preemptive measure considering domestic household and corporate debt burden due to normalization of the global interest rate.

The authorities also agree with staff’s assessment that the overall financial system remains sound. Although household debt remains high, it is being managed well through recently intensified macro-prudential measures including lower loan-to-value (LTV) and debt-to-income (DTI) ratios in tandem with the measures to stabilize the housing market. With these measures, household debt growth is expected to slow down gradually in 2018.

External Sector

Current account surplus has continued to show a downward trend. It shrunk in 2017 mostly due to rising commodity prices and a decrease in foreign tourists. The authorities predicted that the current account surplus would continue to decline in 2018 with the recovery in consumption and solid investment, combined with rising oil prices. They also highlighted that the Korean won was the most appreciated currency among major Asian peers in 2017. According to the BIS’s statistics, the average REER from January to November was appreciated by 2.9 percent above the 2016 average, and by 2.6 percent in nominal terms. This was largely driven by an appreciation of the won against the dollar by 12.8 percent during the whole of last year.

The authorities expressed strong reservations about the external sector assessment. They indicated that the preliminary assessment of 2017 does not adequately reflect the changes made throughout the year. They also emphasized that the EBA methodology should be refined, measurement issues addressed, and country specific factors sufficiently incorporated. With Korea’s population aging fastest, OECD predicts that Korea will be the most aged country in the world in 2075. Korea need to prepare for future reunification as well, which would require a large amount of resources as past unification cases throughout the world has revealed. Also, as staff mentioned in the staff report and the selected issues paper, the rapid integration of Korea into global value chains has accounted for a significant portion of the CA surplus. Besides, the temporary effect of the super cycle in semiconductor—a major export item for Korea—is hard to ignore. The authorities noted these factors are all worth considering as factors specific to Korea. In addition, merchanting, global processing, and mandatory pension savings need to be considered as country specific factors as in the case for other countries’ External Sector Assessments. The authorities anticipated that the planned revamping of the external assessment would lead to more rigorous, even-handed, and candid assessments in the future.

Another concern lies in the staff’s view on the macro-prudential measures—a levy on non-deposit foreign currency liabilities and a leverage cap on FX derivatives. The authorities view that these prudential regulations helped prevent excessive build-up of short-term debt and lengthen the maturity structure of debt. These measures were not residence-based and never intended to limit the capital flows, just aiming to reduce the systemic risks in the financial market, thus they clearly need to be classified as MPM under the Fund’s Institutional View. Furthermore, the authorities reiterated the importance of the appropriate application of the Fund’s policy framework on this issue1 and urge staff to take a more even-handed approach.

Labor Market and Long-Term Challenges

The authorities broadly shared the view with the staff on labor market policies. From a mid to long-term perspective, they plan to actively support the expansion of youth employment and women’s participation in economic activities in response to the population onus, which would weigh on the economy down the road.

However, the temporary gap in labor market needs to be filled. The next five years is the time when the so-called “echo-generation”—the children of the baby boomers after the Korean War—enter the labor market in Korea, which makes the labor market much tighter for new entrants. Therefore, the expansion of employment in the public sector could act as a buffer to resolve the problem of youth unemployment that may deteriorate. Furthermore, public employment in much needed areas such as the police force and firefighters does not crowd out private sector jobs, especially given that Korea’s public employment accounts only for 8 percent of total, well below the OECD average of 21 percent. Rather, it would help prevent the hysteretic phenomenon of labor— productivity decline as youth unemployment continues to be neglected.

The authorities also welcomed a positive assessment of 2018 minimum wage increase.

They expect that rise in minimum wage will be a starting point of a virtuous cycle in which the augmented income conditions lead to an increase in consumption and production. More importantly, the minimum wage adjustment at the current price level is expected to help address income polarization without incurring inflation pressure.

Finally, the Korean authorities would like to express their appreciation to the IMF mission team for the constructive discussions and policy dialogue during the 2017 Article IV consultation.


The board paper (Increasing Resilience to Large and Volatile Capital Flows—The Role of Macroprudential Policies, emphasized, in para 48, that “there may be cases where an MPM that aims to limit the build-up of systemic risk stemming from capital flows could be misclassified as a CFM only because it could directly or indirectly limit the scale or influence the composition of capital flows, even if it is not designed to do so.”