Statement at the Conclusion of the 2009 Article IV Consultation Mission to KoreaPress Release No.09/255
July 7, 2009
The following statement was issued today in Seoul, after the conclusion of an International Monetary Fund (IMF) staff mission to Korea for the 2009 Article IV Consultation:
“IMF staff conducted the annual Article IV review of the Korean economy during June 25-July 7. We would like to thank our Korean counterparts for the productive and open engagement.
“The Korean economy stabilized in the first quarter of 2009, after experiencing unprecedented capital outflows and a collapse in export demand late last year. The authorities’ rapid and comprehensive fiscal, monetary and financial policy response helped limit the depth of the downturn in the wake of the global financial turmoil. Recent indicators point to a recovery in industrial production and exports. However, the likely moderate pace of global growth is expected to limit the strength of exports going forward, while weak labor market conditions suggest private domestic demand is also likely to recover only sluggishly. Moreover, financial sector deleveraging will likely constrain credit growth. As a result, output is expected to contract by 3 percent for 2009 as a whole, before growth turns positive in 2010. Meanwhile, the substantial output gap and weak labor market conditions suggest inflation will continue to decline in the near term.
“The outlook is, however, subject to substantial uncertainty, although overall risks are now tilted slightly to the upside. The downside risks stem from a possibly more pronounced feedback loop between the real economy and the financial sector or an unexpected spike in oil prices. These are more than offset by the upside to growth from a stronger than projected impact of the policy stimulus and a faster-than-anticipated recovery in global growth.
“In this context, macroeconomic policies are appropriate in supporting the economic recovery. Fiscal stimulus has been effective and may need to be maintained in 2010 given the prospects for only a moderate recovery next year. Monetary policy has been appropriately accommodative and with little inflationary pressures, the current stance would need to be maintained until a self-sustained recovery is clearly established. 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.
“The financial system has weathered the impact of global financial turmoil well, supported by the authorities’ rapid provision of dollar and won liquidity and the substantial easing of monetary policy. Banks remain adequately capitalized, and conditions in financial markets have largely normalized. With a credit crunch avoided, the increased focus on corporate restructuring is welcome. In this context, a measured withdrawal of quasi-fiscal support for the Small and Medium Enterprise (SME) sector is appropriate to ensure that banks’ incentives to restructure ailing enterprises are maintained.
“Looking ahead, the authorities’ goal of medium term fiscal consolidation, especially in light of the challenges from an aging population, remains an important priority. In order to achieve budget balance (excluding social security) over the medium term, both revenue and expenditure measures will need to be identified. On the revenue side, these could include broadening of the base for personal and corporate income taxes, including for example by eliminating the investment tax credit, as well as increases in the VAT rate and social security contributions. On the expenditure side, there is scope for streamlining non-age-related outlays and further pension reform.
“More broadly, structural reforms that pave the way for more balanced growth and reduced reliance on exports are desirable. In addition to the ongoing restructuring of the SME sector, policies that reduce the bias towards exports and improve service sector productivity will also help put growth on a firmer footing. These policies need to be complemented with labor market reforms that improve flexibility while increasing the participation of the old, the young, and women.”