Public Information Notice: IMF Concludes 2002 Article IV Consultation with Korea

March 6, 2003

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On March 3, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Korea.1


Korea's excellent economic performance in 2002 reflects the benefits of the far reaching economic reforms implemented since the 1997-98 crisis. The rebuilding of the banking system enabled domestic demand to lead the recovery in the face of a sharp decline in external demand in 2001, and to continue to sustain strong growth in 2002. High export growth in 2002 also benefited from the substantial restructuring of the corporate sector. Overall, the Korean economy has significantly outperformed other IT-specialized Asian countries in recent years. Medium-term prospects are bright.

Economic growth rose to about 6 percent in 2002 from 3 percent in 2001. Buoyant consumption and residential construction spending underpinned the recovery beginning in late 2001, then in 2002 exports rebounded strongly in spite of a weaker-than-expected recovery in the global economy. Unemployment has eased to near pre-crisis levels, while wage rises have been matched by productivity growth. Core CPI inflation remained at the center of the target range of 2-4 percent, although headline CPI inflation has been volatile, mostly due to weather-related

swings in food prices. The current account surplus declined slightly from 2 percent of GDP in 2001 to 1.3 percent of GDP in 2002 and the won appreciated against the U.S. dollar by some 10 percent, largely moving in tandem with the yen.

In terms of macroeconomic policies, the fiscal surplus was substantially higher than budgeted, resulting in a contractionary fiscal stance in 2002. This was broadly offset by the moderately accommodative stance of monetary policy, which has been on hold since a 25 basis point rate hike in May 2002. The rise in household lending and housing prices has slowed in recent months, following prudential measures introduced in October 2002, reducing concerns about the development of a residential real estate bubble.

The outlook is for growth to moderate to about 5½ percent in 2003, as domestic demand growth eases, mainly due to private consumption. Inflation is projected to increase slightly, and a further decline in the current account surplus is expected. Risks to the outlook come mainly from the external front and are predominantly on the downside. Volatility in international financial markets suggests an increased risk of a weaker-than-expected global economic recovery, which could be combined with a spike in oil prices. The impact of a weaker external demand on Korean growth would likely be exacerbated by reduced confidence and a cutback in investment. Over the medium term, growth is expected to average 5½ percent, in line with potential, with somewhat higher growth in total factor productivity than before the crisis—reflecting the benefits of structural reforms and more foreign investment—partly offsetting a slower pace of physical capital accumulation.

The health of the banking system in Korea has continued to improve. The share of loans classified as substandard or below was sharply down to 2.3 percent in December 2002, while the average capital adequacy ratio stood at 10½ percent. Profitability has also improved, with the banking system earning a profit (net of provisions) in 2001 for the first time since 1997; operating income also grew strongly in 2002, although increased provisioning on household loans and credit card receivables, as well as on loans to ailing firms, dampened the growth in net profits. In contrast to the banking sector, progress in restructuring the nonbank financial institutions has been relatively slow. The government has recently started to address problems in the nonbank financial sector by suspending operations of 125 credit unions. The recovery of public funds injected for financial sector restructuring has continued, partly due to renewed momentum in reprivatizing commercial banks. One-third of the public funds has been recovered, and the government estimates it will collect a total of 56 percent, which compares favorably with the experience of other countries in the region.

In the corporate sector, debt-equity ratios have fallen to levels below the United States and Japan—although debt remains high relative to sales—and aggregate profitability has improved. However, the proportion of firms in poor health rose and their performance deteriorated, with almost 10 percent of companies exhibiting persistent weaknesses that point to the need for restructuring. A number of steps to strengthen corporate governance and regulation were taken in 2002, including the publication of a draft insolvency law, an updated coverage of chaebol regulations, and stepped-up enforcement of accounting and disclosure standards.

Executive Board Assessment

Executive Directors commended the Korean authorities for their sustained implementation of deep and wide ranging reforms in the financial and corporate sectors during the five years since the financial crisis. Together with sound macroeconomic policies, these reforms have produced a remarkable economic recovery and transformation of the Korean economy, and have contributed to a strong economic performance in 2002-in a difficult external environment. Korea is therefore a clear example of how quickly strong reforms can pay off. Building on these achievements, Directors encouraged the new administration to continue to implement reforms that will enhance the market foundations and growth potential of the Korean economy, and to further strengthen the medium-term framework for macroeconomic policy, while remaining vigilant to downside risks in the global environment.

Directors considered that prospects for continued robust growth of the Korean economy are good, while the track record of sound macroeconomic policies provides the authorities with room for maneuver to respond to changes in the outlook. Directors therefore saw no urgency to alter the current stance of macroeconomic policies, although they urged the authorities to fully implement the expenditure plans in the budget, and to be prepared to respond promptly to a deterioration in external conditions.

Directors recommended that-given already moderately accommodative monetary conditions-a judicious fiscal easing would be the preferred first line of defense in the event of a significant weakening of the growth outlook. While the automatic fiscal stabilizers will provide an initial support to activity, most Directors encouraged the authorities to stand ready to use the available scope for discretionary spending or revenue measures if needed, although it was stressed that the impact of such measures should be largely temporary.

Going forward, Directors encouraged the authorities to further enhance the role of the budget as a macroeconomic policy instrument, and they welcomed, in this regard, the authorities' plans to formally introduce a medium-term fiscal strategy. Efforts should aim at improving budgetary transparency, and at addressing the procyclical bias of fiscal policy during economic downturns caused by large expenditure shortfalls. Some Directors encouraged the authorities to further develop the social safety net, which would also strengthen the automatic stabilizers. A few Directors also saw scope for reviewing the effectiveness of the tax system. Directors supported the authorities' medium-term goal of maintaining a balanced budget excluding the social security funds-while allowing for cyclical deviations-which will lower public debt and help prepare for longer-term fiscal challenges, including the aging of the population. They also welcomed the priority which the authorities intend to give to pension reform. Directors encouraged the authorities to consider the inclusion of collective action clauses in future sovereign debt issuances.

Directors commended the authorities' skillful management of monetary policy in the face of an uncertain external environment. While flexibility will continue to be warranted in the period immediately ahead, they agreed that, once these uncertainties are resolved, gradually moving monetary policy to a more neutral stance would be appropriate. If the global recovery should be stronger than expected, a tightening of macroeconomic policies should come from the monetary side. To give monetary policy a more transparent anchor, many Directors saw merit in a revision of the Bank of Korea Law, which would formally replace the current one-year inflation target with a medium-term target. However, some Directors noted that the benefit of revising the horizon of the formal inflation targets needs to be carefully assessed against the possible cost of reopening an arrangement which is currently working well in practice. Directors encouraged the authorities to continue to limit foreign exchange intervention to smoothing purposes, a policy that has served Korea well in recent years.

Directors commended the authorities for their timely adoption of prudential measures to ensure that risks associated with the rapid growth in household lending and the sharp rises in housing prices were adequately recognized and contained. Continued close monitoring of developments in household indebtedness is, however, warranted, and the authorities should consider further prudential steps if needed.

Directors welcomed the progress made in bank privatization in 2002, and supported the priority which the new economic team is according to maintaining the momentum in this area. This will help recover public funds used in financial restructuring, while restoring private ownership of the banking system. They also welcomed recent steps to address problems in the credit unions, but emphasized the need for broader efforts to resolve weaknesses in the nonbank financial sector in a timely manner.

Directors welcomed the findings of the Financial Sector Stability Assessment (FSSA), which confirm the high degree of compliance with international standards and codes that has been achieved by recent reforms, as well as the substantial strengthening of financial supervision. They encouraged the authorities to follow through with the early implementation of FSSA recommendations, and to ensure that supervision continues to keep pace with new developments in financial markets. In this respect, Directors supported the authorities' recent initiatives to enhance the monitoring of the rapidly growing markets in derivatives. To ensure the efficiency and stability of the Korean financial system in the medium term, Directors encouraged the authorities to review the adequacy of the arrangements for supervisory independence, and to address the remaining barriers to financial market development, including the development of longer-term debt markets and mortgages. Directors commended Korea's participation in the international effort to combat money laundering and the financing of terrorism, and looked forward to the enactment of the Anti-Terrorism Bill.

Directors observed that overall corporate sector performance has continued to improve in 2002. A significant proportion of Korean corporations nevertheless display persistently weak capacity to service their debts. Directors underscored, in this context, the importance of approving the insolvency reform to help complete corporate restructuring, although some Directors regretted the shortcomings remaining in the draft legislation. Directors welcomed the strengthened enforcement of accounting and disclosure standards and supported the ongoing efforts towards achieving compliance with international best practices in corporate governance. This will include the adoption of the proposed accounting reforms, the enhancement of the rights of minority shareholders, and the further strengthening of disclosure requirements. Directors agreed that special monitoring and regulation of the activities of the largest chaebol should continue until effective market discipline is sufficiently strong.

Directors welcomed Korea's progress toward trade liberalization, including the recent finalization of a bilateral free trade agreement with Chile. They noted, however, that Korea's trade barriers remain relatively high-especially for agriculture-and urged the authorities to seek further progress in trade liberalization, particularly in the context of the current round of multilateral trade negotiations. Directors welcomed Korea's participation in the Heavily Indebted Poor Countries initiative.

Korea: Selected Economic Indicators





Staff Est.

Staff Proj.

Real GDP (percent change)












Gross fixed investment






Net foreign balance 1/







Prices (percent change)


Consumer prices (period average)






GDP deflator







Labor market (in percent)


Unemployment rate 2/






Wage growth, manufacturing







Consolidated central government (percent of GDP)


Revenues 3/












Balance 3/ 4/







Money and interest rates (in percent)


M3 growth






Yield on corporate bonds 2/







Balance of payments


Current account balance (billion US$)






Current account balance (in percent of GDP)







Won per U.S. dollar (period average)






Sources: Data provided by the Korean authorities; and IMF staff estimates and projections.

1/ Contribution to GDP growth.
2/ Latest available data for 2003.
3/ Excluding privatization receipts.
4/ Prior to 2000, the civil service pension fund is excluded.

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. 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.


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