Statement at the Conclusion of the 2011 Article IV Consultation Mission to the Republic of KoreaPress Release No. 11/238
June 17, 2011
The following statement was issued today in Seoul, after the conclusion of an International Monetary Fund (IMF) staff mission to Korea for the 2011 Article IV Consultation:
“An IMF mission led by Mr. Subir Lall visited Seoul during June 2–17, 2011 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’s rebound from the global crisis has transitioned into a robust and self-sustaining expansion. Growth is projected at 4½ percent in 2011, above the economy’s underlying potential, before easing to 4.2 percent next year. The recent soft patch in activity is expected to dissipate in the second half of 2011, with the underlying growth momentum reasserting itself, supported by both exports and domestic demand. On the domestic front, with stretched capacity utilization and robust business confidence, facilities investment is projected to strengthen in the second half of the year in line with exports. As employment strengthens further, and with the stabilization of food and fuel prices, household income growth is expected to support consumption.
“Near-term risks to this baseline appear broadly balanced. Downside risks relate primarily to the global outlook, including financial spillovers from Europe, lower external demand in advanced economies, or a worsening of geopolitical tensions with North Korea. The key domestic risks relate to the ongoing weaknesses in the construction sector and the impact of higher-than-expected inflation on consumption. These are balanced by upside risks of stronger growth in emerging economies given Korea’s diversified exports.
“In light of the strong underlying growth dynamics of the Korean economy, the focus of macroeconomic and financial policies on addressing inflation pressures and limiting the further buildup of vulnerabilities is appropriate. The timely withdrawal of fiscal stimulus and the monetary policy rate hikes thus far are welcome. However, monetary conditions remain loose for this stage of the cycle. To ensure a soft landing, further steady monetary tightening is necessary. Exchange rate flexibility is also an essential component of the response to inflation. Administrative price stabilization measures imposed this year have been effective to some extent, but over a longer horizon, they cannot address underlying aggregate demand pressures or contain inflation expectations.
“The commercial banking system remains sound, liquid and well capitalized. The isolated problems in mutual savings banks (MSBs) do not pose a systemic risk to the rest of the financial system. The recent plans to address MSB weaknesses are welcome.
“Over the medium term, notwithstanding the impressive rebound from the global financial crisis, ensuring the resilience of the Korean economy remains an enduring policy priority. One essential step toward securing this objective is to further enhance the already strong policy frameworks. This can be achieved by more closely internalizing in policy making the linkages between the financial sector and the economy, and the cross-sectoral impact of macroeconomic and macroprudential policies (MaPPs).
“In particular, while overall price stability should remain the primary objective of monetary policy, making the Bank of Korea’s policy rate more responsive to systemic financial stability considerations would help prevent the buildup of leverage and dampen the propagation of financial shocks to the real economy. This could take the form of actively monitoring financial stability indicators and reacting with appropriate interest rate adjustments to mitigate incentives for excessive risk taking.
“Acknowledging that macroeconomic policies alone cannot address all financial stability concerns, MaPPs are a necessary complement in the policy toolkit. For example, MaPPs to address concerns about volatile capital flows or the housing market can be more effective if supported by appropriate macroeconomic policy settings. While capital flow volatility is a valid concern for Korea, capital flow measures will be more effective if accompanied by further two-way exchange rate flexibility. Housing policies should focus on containing the excessive buildup of leverage. Implementation of MaPPs should also remain alert to the incentives of the financial system to shift activities outside the regulatory perimeter.
“We commend Korea’s long-standing commitment to fiscal prudence. In this regard, we welcome the plan to achieve balance in the budget (excluding social security) by 2013–14. More details on the planned measures needed to achieve this consolidation would further cement credibility.
“Finally, in light of increasing export-dependence and the associated vulnerability to external shocks, and rising inequality, strengthening the nontradable sector as a second engine of growth is essential. In this regard, maintaining two-way flexibility of the exchange rate is necessary to invigorate the nontradables sector and support household income growth for those sectors. It is important to open the nontradables sector to more competition and level the playing field by eliminating the preferential treatment given to the manufacturing sector. Increasing employment opportunities in the nontradables sector would also help address dualities in the labor market. Transitioning from the seniority to performance-based pay system would extend the duration of formal employment for the elderly which together with extending the coverage of social safety nets would reduce old-age poverty. There is also room to increase the labor force participation rate of females. Recent efforts in these areas are welcome.”