Statement at the Conclusion of the 2010 Article IV Consultation Mission to Korea

Press Release No 10/282
July 6, 2010

The following statement was issued today in Seoul, after the conclusion of an International Monetary Fund (IMF) staff mission to Korea for the 2010 Article IV Consultation:

“An IMF mission led by Mr. Subir Lall visited Seoul during June 23-July 6, 2010 to discuss with the authorities and other key counterparts recent economic developments and the outlook for Korea. The mission team would like to thank their counterparts for the productive and open engagement.

“The Korean economy has staged an impressive recovery since early 2009 thanks to the authorities’ supportive macroeconomic and financial policies, and the normalization in global trade. Growth is expected to rebound to 5¾ percent in 2010 and moderate to 5 percent in 2011, with economic activity increasingly led by the private sector. In particular, the recovery is expected to be led by the rebound in fixed investment and the turning of the inventory cycle. Net exports are also expected to contribute positively to growth.

“Near-term risks to this baseline appear broadly balanced. Downside risks relate to the global outlook, including an intensification of the financial stresses in Europe and a worsening of geopolitical tensions on the Korean peninsula. These are broadly balanced by the potentially faster recovery in domestic facilities investment and stock-building.

“In light of the strong economic recovery, a carefully calibrated exit from supportive macroeconomic policies is appropriate. The gap between the economy’s output and its potential is expected to close in coming months. While the 2010 budget is estimated to subtract around 1 percentage point from growth, monetary policy remains highly accommodative, somewhat beyond what is necessary to support the recovery. It is now appropriate for the Bank of Korea (BOK) to start gradually raising the monetary policy rate to avoid falling behind the curve. Beginning to raise the policy rate would still leave monetary policy highly supportive of the recovery that is being anticipated in the baseline. Preserving flexibility of the exchange rate is also a key element of this exit strategy. Intervention should, therefore, remain limited to smoothing excessive volatility in the foreign exchange market.

“The announced steps to scale back the amount and coverage of small and medium-sized enterprise (SME) guarantees to pre-crisis levels and expiration of bank guidance to roll over maturing SME loans are welcome. With financial conditions having normalized, the bank recapitalization fund, the corporate restructuring fund, the bond market stabilization fund and other remaining financial sector support measures can also be unwound without putting the recovery at risk.

“Given the strong recovery that is underway, it is also appropriate to now shift the focus from crisis management to the medium term strategy to sustain growth and enhance the economy’s resilience, reflecting on the key lessons from the recent crisis. In this context, the authorities’ plan for fiscal consolidation over the medium term, aiming to achieve a balanced budget (excluding social security funds) by 2013-14, is welcome. More details on the planned measures needed to achieve this consolidation would further enhance credibility.

“The global crisis demonstrated how ‘benign neglect’ in monetary policy may have allowed for a buildup of asset price bubbles and excessive leverage in some economies. While overall price stability should remain the BOK’s primary objective, it may be appropriate to consider broadening the monetary policy framework to allow for discretionary policy responses in the event of emerging price pressures in asset markets, should it be judged to have a bearing on the inflation outlook and/or macroeconomic and financial stability.

“Korea’s crisis management framework has served the economy well. It is now appropriate to consider how to further upgrade macroeconomic policy and regulatory frameworks to enhance the resilience of the economy during normal times. A key lesson of the global crisis has been the need to better internalize macro-financial linkages and strengthen the coordination process among all the relevant agencies charged with financial stability. Financial instability could, for example, be exacerbated by loose monetary policy settings. At the same time, policy rates may be a blunt tool for addressing financial instability emerging in specific sectors, which may initially require a macro-prudential response. Another key lesson from the global crisis is the need to strengthen supervisory and regulatory frameworks across the world, and we welcome the Korean authorities’ pre-emptive steps in that direction and their readiness to adopt new measures that will emerge from international consensus.

“Korea’s vulnerability to the potentially destabilizing effects of volatile international capital flows remains an important area of focus. Considering Korea’s economic and financial integration with the rest of the world, which has served the economy well, the recently introduced foreign currency related measures may, however, not substantially reduce the economy’s vulnerability to sudden stops given the welcome commitment to an open capital account. For an export-dependent economy with an open capital account, the best line of defense remains a flexible exchange rate to avoid generating expectations of one way bets. In addition, measures to further deepen foreign exchange markets and strengthen the financial sector would also enhance the ability of the economy to cope with externally generated shocks.

“Finally, the crisis has exposed the risks of an open economy relying on a single engine of growth. Strengthening domestic sources of growth would reduce Korea’s vulnerability to economic downturns elsewhere in the world. In this context, reducing the policy bias towards exports and bolder reforms to increase productivity in the non-tradable sector would be welcome. This would require reducing preferential treatment of manufacturing, broadening deregulation in the non-tradable sector, and continuing with SME restructuring to strengthen their capacity to invest and create employment. More labor market flexibility and increased social protection would facilitate the reallocation of labor to new growth sectors while minimizing adjustment costs. Continuing efforts to increase labor market participation are also welcome.”



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