IMF Executive Board Concludes 2007 Article IV Consultation with the Republic of Korea

Public Information Notice (PIN) No. 07/118
September 24, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On September 12, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Korea.1


Korea is enjoying its longest uninterrupted period of economic expansion—17 consecutive quarters—since the Asian crisis. Growth reached 5 percent in 2006, buoyed by strong exports, and is only expected to slow marginally to 4¾ percent this year. Inflation has remained below the Bank of Korea's target range of 2½ to 3½ percent over the last year, and unemployment has fallen to a four-year low. The current account is expected to remain broadly in balance, with strong exports being offset by a higher oil import bill and a further widening of the services deficit. Gross capital inflows have increased since 2006, reflecting hedging by exporters and arbitrage activities, but are expected to moderate.

On the policy front, the fiscal stance remains neutral, although this year's budget has been front-loaded in response to the late 2006 slowdown. On the other hand, after a lengthy pause, monetary tightening has recently resumed, with the Bank of Korea twice raising its target rate by 25 basis points, to 5 percent, in response to concerns about rapid money and credit growth. After having appreciated for several years, the won has stabilized in 2007, and appears broadly appropriately valued. To smooth volatility and prevent the won from appreciating too rapidly, the authorities have at times intervened in the foreign exchange market in modest amounts.

The impact of the ongoing global financial turbulence has so far been manageable but downside risks to the outlook have increased, with the nascent consumption recovery vulnerable to a downturn in asset markets, a hard landing in the United States, or the possibility of further hikes in oil prices. The financial sector is generally in good health, and risks appear modest. Housing prices have stabilized in recent months, and any decline would not affect the financial system significantly given low nonperforming loans(NPLs) and loan-to-value ratios. At the same time, while lending to small- and medium-sized enterprises(SMEs) has accelerated, vulnerability appears limited given improvements in risk management practices.

Over the medium term, Korea faces more daunting challenges. A rapidly aging population will generate strong fiscal pressures through large outlays for pensions and health care. In addition, the expected decline in the labor force, combined with the ongoing erosion of its low-skilled manufacturing base and sluggish service sector productivity, could affect growth and threaten external stability.

Executive Board Assessment

Executive Directors welcomed the strong recovery that Korea has made since the Asian crisis and its success in adapting to the changing global landscape, which have been supported by the authorities' forward-looking and prudent economic policies. In recent years, growth has been buoyed by strong exports and resilience in domestic demand. Notwithstanding some increase in volatility in the Korean equity market, Korea has thus far weathered well the ongoing turbulence in the global financial system.

Directors observed that Korea's near-term outlook is favorable, with growth likely to remain robust and inflation contained. However, they cautioned that the risks in the global environment have increased, as indicated by recent world market developments.

Directors considered that, with inflation pressures well contained, there is scope for loosening monetary policy were downside risks to materialize. They encouraged the authorities to further develop the money market to strengthen the monetary transmission mechanism, which would help limit further recourse to reserve requirements. Directors saw less room for maneuver on the fiscal side, in light of Korea's considerable medium-term fiscal challenges. The broadly neutral fiscal stance therefore remains appropriate.

Directors agreed that the won appears broadly appropriately valued. External competitiveness remains strong despite the large appreciation of the won vis-à-vis most major currencies over the last few years. Going forward, Directors agreed that the exchange rate should continue to be market determined, with intervention in the foreign exchange market limited to smoothing volatility.

Directors welcomed the progress that has been made in recent years in strengthening Korea's financial sector, as reflected in improvements in financial soundness indicators, risk assessment practices, and credit information. As a result of these reforms, vulnerabilities are low and the financial sector appears to be well-placed to deal with shocks. However, there remain pockets of domestic risk that bear close watch. A decline in housing prices could affect consumption, in particular as a sizable share of households still hold short-term bullet-type mortgages. Also, notwithstanding recent improvements in risk management practices at banks, the recent rapid growth in lending to small- and medium-sized enterprises could lead to an increase in nonperforming loans, particularly if the economy were to slow. Directors saw the further development of the mortgage market and continued upgrading of banks' risk assessment models, in line with the introduction of Basel II, as effective ways of mitigating these risks.

Directors considered that further financial sector development would support Korea's economic performance over the longer term, as well as assist in dealing with potentially volatile capital flows. In this respect, they welcomed the recent passage of the Capital Market Consolidation Act, which should contribute significantly to the emergence of strong investment banks and a resilient capital market.

Directors observed that Korea will confront the burden of an aging society in coming decades, as have many industrial countries. Addressing the resulting fiscal pressures will require action on a number of fronts, notably increasing tax revenues through base broadening and improved tax administration, further pension reform, and reorientation of public spending toward high-priority areas. Directors appreciated the authorities' ongoing efforts to address these challenges, and stressed that comprehensive and timely reforms would ease adjustment. At the same time, they commended the authorities' efforts to inform the public of long-term fiscal pressures through their Vision 2030 initiative. Some called for the regular publication of a comprehensive long-term fiscal report.

Directors noted that Korea's manufacturers are likely to face increasingly intense competition from lower-wage countries, while services sector productivity remains relatively low. To maintain competitiveness in global markets and sustain high rates of growth over the long term, Directors encouraged the authorities to continue taking steps to liberalize the services sector, enhance labor market flexibility, and improve the investment climate, notably for foreign direct investment. They supported the authorities' intention to use free trade agreements to help achieve some of these goals, while remaining committed to multilateral trade liberalization initiatives.

Korea: Selected Economic Indicators


2003 2004 2005 2006

IMF Staff

IMF Staff

Real GDP (percent change)

3.1 4.7 4.2 5.0 4.8 4.8


-0.3 0.4 3.9 4.5 4.2 3.7

Gross fixed investment

4.0 2.1 2.4 3.2 5.4 3.3

Net foreign balance 1/

2.5 3.3 1.3 1.6 0.6 1.3

Prices (percent change)


Consumer prices (end of period)

3.4 3.0 2.6 2.1 2.8 2.5

GDP deflator

2.7 2.7 -0.2 -0.4 -0.8 1.2

Labor market (in percent)


Unemployment rate

3.6 3.7 3.7 3.5 ... ...

Wage growth, manufacturing

8.7 10.0 7.8 5.6 ... ...

Consolidated central government

(In percent of GDP)


Revenues 2/

23.7 22.9 23.6 24.7 25.6 26.0


21.1 20.7 21.7 22.9 23.8 23.5

Balance 2/

2.7 2.2 1.9 1.8 1.9 2.5

Money and interest rates (In percent)


Overnight call rate

3.8 3.3 3.7 4.5 ... ...

M3 growth

4.7 7.1 7.4 10.5 ... ...

Yield on corporate bonds

5.6 3.7 5.5 5.2 ... ...

Balance of payments


Current account balance


(In billions of U.S. dollar)

11.9 28.2 15.0 6.1 1.4 -3.4

Current account balance


(In percent of GDP)

2.0 4.1 1.9 0.7 0.2 -0.3

Won per U.S. dollar


(Period average)

1,192 1,146 1,024 955 ... ...

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

1/ Contribution to GDP growth.

2/ Excluding privatization receipts and rollover of KDIC/KAMCO bonds.

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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