Transcript of a Press Briefing on 2010 Article IV Consultation with Korea by Subir Lall, Mission Chief for Korea, Asia and Pacific DepartmentSeptember 1, 2010
MR. LALL: Thank you all for being here. We are releasing the Article IV consultation documents this afternoon. And before I start on your questions I wanted to highlight briefly the main points from this year’s Article IV consultation with Korea.
We see growth as strong this year and our revised projections for GDP growth are 6.1 percent this year before easing to 4.5 percent next year. This will be primarily driven by investment and rebuilding of inventories, something that has been going on for a while. But essentially what we are seeing is a shift from the public sector sources of demand to the private sector. As a result of that, we expect the output gap, which is the difference between output and its potential, to close sometime over the next few months. That’s why, partly, we have built into our baseline scenario an easing of growth in the second half of this year. And that’s true not just for Korea, but for other countries in the region as well. So growth is expected to be strong.
There are a couple of risks to this baseline outlook and they really come from the external side. One is if there’s a larger than anticipated slowdown in the advanced economies, that would affect exports from Korea. And so we think that’s one of the risks to keep in mind. But as I mentioned, it’s not in our baseline.
And the other is, of course, if you have a tail event, like a repeat of the liquidity and financial troubles in late 2008. Again, it’s not something that we foresee. But the main risks, if anything, to the outlook come from the external side in Korea. We see domestic sources of growth as being quite strong.
Coming to policies, fiscal policy is already moving into a consolidation phase in Korea this year, and that is appropriate given the strong underlying growth and the shift of the momentum from public to private sector. We also think that monetary policy has been highly accommodative and supportive of the recovery, but now it might be time to continue with some of the tightening of monetary policy -- or I should say making it less loose than it is now while still remaining supportive of growth. And part of the reason is, looking forward to risks, what you want to do is be able to have the ammunition to respond to shocks if they were to occur in the future.
In Korea, as of now, real interest rates in the short term are negative, and so there’s not a whole lot of monetary ammunition left and this would be a good time to rebuild some of that ammunition and have the policy space needed to respond to any adverse events should they materialize in the future. Of course, with low public debt, Korea has ample fiscal ammunition, also, in terms of being able to head off any risks in the future.
One final comment I would make is we also have to look beyond the crisis to the medium term. And one of the things that the global crisis has highlighted is that relying on one engine of growth can subject the economy to shocks. And in the case of Korea, being a highly export-dependent economy, it is highly vulnerable to demand shocks elsewhere in the world, particularly in the advanced economies. And so we recommend that decisively policy move towards creating a second additional engine of growth to reduce the vulnerabilities of the economy. And this means, in particular, making the non-tradable sector more vibrant and this will, of course, require structural reforms along a number of fronts.
With that, I’d be happy to take your questions.
QUESTIONER: Bank of Korea has just increased its policy interest rate from 2.0 percent to 2.25 percent last month. But there have been pros and cons on that policy. An economic planning (inaudible) department and private sectors argued that the BOK should be more cautious, but the BOK said that the (inaudible) interest rate is too low. And where do you stand on that?
MR. LALL: The BOK, after keeping its interest rates low at 2 percent for a long time -- since February of last year -- raised it by 25 basis points in July and then stayed on hold in August. We agree with the BOK that this policy is highly accommodative. As I just mentioned, given the strong recovery underway and the closing of the output gap, we do see room for further tightening of policy interest rates going forward. Now, of course, it is up to the Monetary Policy Committee of the Bank of Korea to determine the exact timing and speed of that, but we see room.
If you think about the neutral interest rate, which would be the rate at which you support employment and activity without creating inflation, that is significantly higher than the current policy rate, so it may be around 4 percent. So there’s a lot of room for the BOK to raise rates and still maintain an accommodative monetary policy stance.
QUESTIONER: Three or four percent in the near term?
MR. LALL: I wouldn’t speculate on where it should go and how soon, but 2.25 percent, which is the current policy rate, is well below neutral and so there is room to cautiously raise rates. And, of course, we do know there are uncertainties, global uncertainties, so the reversal of monetary policy accommodation needs to be cautious.
QUESTIONER: Thank you.
QUESTIONER: I was wondering if you could (inaudible) a little more detail exactly why you downgraded the outlook for 2011.
MR. LALL: Two things we need to keep in mind in terms of the outlook for 2011. Essentially what we have done is moved some of the recovery forward to this year as opposed to next year, so the 6.1 is higher than actually a forecast we made not that long ago of about 5.7 percent. So essentially you’re seeing a bit more front-loading of the recovery and that’s why part of it is given up in terms of 2011 growth.
That being said, of course, we are moving beyond the recovery to the expansion phase. And so you cannot expect growth to be sustained at the rates we’ve seen in the last three or four quarters. Even so, we think the 4.5 percent we project for next year is slightly above the economy’s potential, so it’s still very robust growth for next year.
QUESTIONER: So the fact that you raised your forecast for this year, is there anything in particular?
And my other question is on the housing market. I think the government announced something last week. Are those welcome measures and how do you gauge the housing market right now?
MR. LALL: First, on the growth story, the first half growth numbers came out slightly stronger than what we had anticipated, for a couple of reasons. Of course, exports were very strong, but domestic demand also held up very well. And so the upgrading of the growth forecast really reflects what’s in a way already in the bag in terms of strong growth in the first half of the year. And we do expect a moderation in the second half of the year. And, again, this is not just a Korea story. In fact, in other countries in the region growth has surprised, in some cases, in the first half, so this is a reflection of a slightly broader trend.
On your second question on the housing market, there have been concerns about the housing market in Korea lately. And so the authorities have announced some measures as of last week. And part of the reason is, I think, that you’ve seen very low volumes in the housing market in the last few months and that has raised concerns about whether the housing market is going to go into a protracted slump. So the measures should be helpful. They are extremely comprehensive and they cover a lot of ground in terms of the debt-to-income ratio, for example, support to lower income households, and other measures related to the housing corporation. They should help at the margin, but there is a broader constraint, which is that households in Korea are already highly indebted. So it remains to be seen how effective the measures will be given that the household indebtedness is already high and households themselves and consumers may not be willing to take on that much more household and mortgage debt under these constraints.
QUESTIONER: One more. (inaudible) there is a surge in the Chinese holdings of the Korean sovereign debts in recent days. And I think that could lead to the (inaudible) appreciation, the Korean won. And that could be the negative effects for the Korean economy to grow. What’s your thought on that?
MR. LALL: To put this in context, Korea has enjoyed large capital inflows as have many other countries in Asia in the last six months or even more, actually. And partly, this seems to reflect the fact that yields are very low in advanced economies and also that the growth story is very much in favor of Korea, or relative growth compared to other economies. And certainly Korea is one of the countries leading the global recovery.
In terms of the impact on the exchange rate, naturally, all else being equal, if capital inflows go up, they do exercise some upward pressure on the exchange rate. But the Korean authorities’ policy has been to allow the exchange rate to be flexible and that itself acts as an automatic stabilizer in some sense because it doesn’t create a one-way bet on the currency.
So coming back to your bigger question, would that -- if there is appreciation associated with capital flows -- and, of course, I would never speculate on what capital flows will do in the next three months or six months because, you know, you are as likely to be right as wrong. But that being said, supposing we are in a scenario where there’s further upward pressure on the exchange rate, Korean exporters have done extremely well in this crisis, and in our assessment the exchange rate has not played a major part in that.
Of course, Korea had a big depreciation in the immediate aftermath of the collapse of Lehman Brothers, and that certainly helped, but so did many other currencies. I mean, those of Korea’s competitors. But what did help was Korean large corporates have very strong balance sheets, so they were able to expand market share at the time when many other companies in other countries faced financing constraints and couldn’t do that.
Also, let’s look at the three main sectors, exports sectors, in Korea: shipbuilding, electronics, and automobiles. Shipbuilding had collapsed because the new orders that had dried up basically because of the collapse in global trade. And that has revived, so orders are picking up now.
In electronics, Korean companies are dominant in the global consumer electronics sector. And there, as well as in automobiles -- which I’d also like to talk about -- Korean companies have been very effective in diversifying beyond advanced economies to also emerging markets. And their share of their total exports going to emerging markets is very large.
So those are the factors we think that have really supported the Korean export sector rather than, you know, just focusing on the exchange rate. So, you know, if the exchange rate does move in response to capital flows that may be coming in, we don’t think that is going to hurt the Korean export sector because the strength of the export sector is really relying on more fundamental factors: the diversification of markets, solid balance sheets, and being able to gain market share.
In automobiles, of course, you know very well the cited statistic that, for instance, Hyundai was one of the few companies which actually did really well in the downturn, even in the United States, because it’s at the right price point and hitting the right market. And so there are other factors at play explaining Korea’s export resilience.
QUESTIONER: Just a follow-up. In the report you guys saw the exchange rate as being undervalued. I assume that’s still the case given it’s been under further pressure.
MR. LALL: We look at a range of models and the exchange rate, what would be an equilibrium exchange rate and where we are relative to that. So it appears to be, at the moment, based on the model we favor, slightly undervalued. But, of course, it is determined by market conditions. But it’s not substantially below where we think the models tell us it should be.
QUESTIONER: And then the Executive Board made some mention that they called for preserving exchange rate flexibility. Is that in any reference to the capital controls that Korea imposed?
MR. LALL: No.
QUESTIONER: Or is there no concern about that?
MR. LALL: No. In fact, the measures you talk about in June, we don’t see them as capital controls, but more as prudential measures designed to insulate the banking system from rapid outflows of capital, so they’re not, in our view, capital controls to begin with. And on exchange rates, the exchange rate has been flexible and this is just, in many ways, an affirmation that that policy has served Korea well and should continue to do so in the future. But this is just -- this is not in reference to any specific capital controls because there have been none imposed.
MR. LALL: All right?
MR. LALL: You must be writing a very big story then.
QUESTIONER: Yeah. You announced that you have some improvements on the PCL and the FCL system, right?
MR. LALL: Mm-hmm.
QUESTIONER: Do you think Korea is going to apply for that system?
MR. LALL: Well, I think you really should ask the Korean authorities for that. It’s not really in my position to speculate on that.
QUESTIONER: But we have, you know, a painful memory from the financial crisis in 1997, and we still have an IMF stigma, so that we are so reluctant to apply for that.
MR. LALL: That, again, is a question probably directed at your domestic audience rather than us in terms of what the implications are of these measures. So I’m afraid I don’t have an answer for you on that.
Thank you very much.