Press Release No. 08/174

Press Release: Statement at the Conclusion of the 2008 Article IV Consultation Mission to Korea

July 11, 2008

The following statement was issued in Seoul on June 24, 2008, after the conclusion of an International Monetary Fund (IMF) staff mission to Korea for the 2008 Article IV Consultation:

"IMF staff conducted the annual Article IV review of the Korean economy during June 12-24. We would like to thank our Korean counterparts for the productive and open engagement.

"Korea's economy is facing challenging global circumstances. While exports have shown resilience, the global growth slowdown will likely limit further export gains and constrain investment during the rest of the year. High global food and fuel prices are expected to weigh on consumption and are contributing to rapidly rising prices. As a result, growth is expected to moderate to 4.1 percent this year, before picking up in 2009, while weaker domestic demand and stabilizing commodity prices should help slow inflation later this year. This outlook is subject to substantial uncertainty, with the possibility remaining of a deeper global slowdown, a return to more volatile global financial conditions, or still higher oil prices.

"In this context, macroeconomic policies should focus for now on controlling inflation. In particular, ensuring that inflation expectations remain well-anchored is critical for sustained strong economic growth. Should inflation begin to moderate and the economy remain soft in the coming months, there may be scope for more accommodative macroeconomic policies. Korea's flexible exchange rate regime, with intervention limited to smoothing excessive volatility, has served the country well in the past and continues to be appropriate.

"While the Korean financial system remains healthy, the ongoing global financial turmoil has raised some modest concerns. International credit market stresses have underlined that banks reliant on wholesale funding may be exposed to greater liquidity risk. Korean banks are beginning to diversify their funding sources and supervisors are increasingly focused on limiting such risks. International experience suggests that enhanced contingency planning would also help. Bank loan quality is strong but an economic slowdown could reveal some vulnerabilities, particularly in small- and medium-sized enterprise (SME) lending, which merits continued close attention. Short-term external debt has risen sharply in recent years, as a counterpart to hedging activity, and more recently, with foreign purchases of sovereign bonds. This debt should be monitored, but its sources and uses are very different from those a decade ago, and risks remain moderate.

"Looking ahead, structural changes to the financial sector will present both challenges and opportunities. Increased financial sector competition, in light of the legal framework taking effect in 2009, should contribute to growth, but will require financial oversight to meet new regulatory challenges, including risks from more complex institutions and products.

"The government appropriately aims to address structural challenges to Korea's impressive growth record, including through deregulation, privatization, and tax cuts. Plans for any tax cuts should be in the context of a broader tax reform plan that concretely addresses long-run fiscal pressures, notably those associated with an aging population."