IMF Survey: IMF Presses Korea to Continue Rebalancing Economy

August 9, 2009

  • Korea should reorient economy away from dependence on exports
  • IMF supports continued expansionary fiscal, monetary policies
  • Recovery to be weighed down by household and small business debt

The International Monetary Fund expects the Korean economy to grow by 2½ percent in 2010 but called on the authorities to continue with efforts to reorient the economy from exports to the domestic service sector.

IMF Presses Korea to Continue Rebalancing Economy

Couple withdraw cash in Seoul, Korea. Korean households are facing record levels of debt (photo: Corbis/Reuters/Lee Jae-Won)


Korea is a heavily export-dependent economy and was severely hit by the global fall in demand following the worldwide slump. The country suffered its largest drop in exports on record and at the low point in January 2009, exports were down 35 percent from the previous year.

In its annual report on the state of the Korean economy, the IMF said the weak demand from Western consumers now, and into the foreseeable future, had increased the need for Asia’s fourth largest economy to move away from its export-led growth model.

"Looking ahead, a key medium-term challenge will be to rebalance growth toward nontradables and make the services sector an additional engine of growth, " said IMF mission chief for Korea Subir Lall.

Call to maintain expansionary policies

Following its Article IV consultation with Korean authorities that ended on July 7, the IMF commended their response to the crisis. Despite a brightening economic outlook, it called on Seoul to maintain its expansionary policy into 2010.

IMF Directors “agreed that macroeconomic policies should continue to focus on supporting growth until a self-sustained recovery is firmly established,” they said in a statement.

Following the financial stress, the Korean economy contracted by 5.1 percent in the last quarter of 2008 from the previous three months—among the sharpest contractions worldwide. Korean authorities responded by implementing a sizeable and frontloaded fiscal stimulus package and monetary easing.

The stimulus measures had a stronger than anticipated impact, boosting confidence and supporting economic activity. This, together with the depreciation of the South Korean currency, the won, has caused the IMF to adjust its growth projections for 2009 from -3 percent to -1 ¾ percent.

However, the report suggests the less gloomy outlook will be tempered as external demand remains sluggish and the impact from the stimulus measure and export gains from the depreciation of the currency begin to fade. The IMF forecasts the economy to grow at 2.5 percent in 2010.

Indebted business, households

The recent recession has posed the biggest economic challenge to this northeast Asian country since the 1997–98 Asian crisis. This time around, a recovery is likely to be dampened by highly leveraged households and small and medium-sized enterprises (SMEs) and the sluggish pace of global recovery.

Following the earlier downturn, many large corporations underwent major restructuring. Consequently, Korean banks increasingly channeled credit to SMEs and households. However, in many cases, the money borrowed by SMEs has not gone into productive investment. In its report, the IMF said Korean authorities should consider rolling back some of the support measures for SMEs introduced late last year.

Reducing employment protection for regular workers and expanding social protection for nonregular workers would help improve labor market flexibility.

Korean households are also facing record levels of debt. Following the Asian crisis, South Koreans were encouraged to borrow, propelled by government policies and cheap credit. According to Organization for Economic Cooperation and Development (OECD) figures, in just over two decades, the household savings rate in Korea has plummeted from a world-beating 25 percent to a projected 3.2 percent in 2010—the lowest among OECD countries.

If the projections are accurate, next year South Koreans will save roughly half the amount that Americans do.

In the face of the financial crisis, as banks limit access to credit, there is likely to be a rise in personal and small business bankruptcies. Analysts say this is likely to have repercussions on an eventual recovery through the negative feedback initially from the real economy to the financial sector and then back again as banks, worried about defaults, become reluctant to lend. In turn this could impede a revival in economic activity.

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