Korea, Navigating through the Global Headwinds

An article by Anoop Singh, Director, Asia and Pacific Department, International Monetary Fund
Published in Yonhap News Agency (Korea)
February 2, 2009

As is now well understood, the global economy is in the midst of its most difficult period in the post-war period. Financial markets have come under increasingly acute strain over the past year or so, as financial systems in the United States and other advanced economies fell into deep distress. In the advanced economies, the financial crisis also severely weakened consumer and business confidence. As a result, in a closely integrated world, countries across the globe have come under intense pressures, with exports and industrial production plummeting, as external demand fell and credit flows were seriously impeded. And this ongoing slowdown in economic activity is likely to have further adverse consequences for financial institutions, including through a rise in bad loans.

Given its open economy, it is not surprising that Korea is being severely affected by this global crisis. Indeed, we have already seen a sharp slowdown in growth in the fourth quarter. But we remain fundamentally optimistic about Korea's recovery and its medium term prospects. The country's much improved economic fundamentals have allowed it to mount a vigorous countercyclical response to the external crisis that should help buffer the domestic economy and leave Korea well-placed to resume solid growth once the global economy begins to recover.

According to the most recent IMF World Economic Outlook update, the global economy is projected to grow by just ½ percent in 2009, the slowest pace since World War II. Expressed at market exchange rates, global growth will be negative in 2009. Helped by continued policy actions to ease credit strains and expansionary monetary and fiscal policies across a wide range of countries, the global economy is expected to experience a gradual recovery in 2010. However, the uncertainty surrounding this outlook is unusually large, with the risk that the pernicious feedback loop between real activity and financial markets will intensify unless financial strains are forcefully addressed.

The Korean economy is one of the most globally integrated in the world, and while this integration has been a key factor behind Korea's remarkable economic history, there is little doubt that the country is now particularly affected by the global crisis. Korean financial markets were hit particularly hard by the external shocks during October and November, as both domestic and foreign exchange liquidity tightened for banks with large wholesale financing requirements, and foreign investors retrenched from very liquid markets such as Korea. According to preliminary data, the economy contracted by 5.6 percent in the last quarter of 2008, over the previous quarter. Exports declined sharply with plummeting global demand, and this fed through to weaker consumption and investment as well.

Although the carryover effects of the very weak fourth quarter of 2008 mean that the headline growth number for 2009 will be substantially negative, we project that the economy should begin to recover during the second half of this year. A clearer picture for the performance of the economy this year can be seen by the fact that growth in the last quarter of 2009 compared with the last quarter of 2008 is expected to be positive 1 percent. This is broadly in line with projected global growth and above growth for all major advanced economies. Indeed, the Korean economy should return to potential in 2010.

What underpins the projected recovery in Korea? First, fundamentals are strong-the banking system is well capitalized, nonperforming loans are still low, and balance sheets of large corporates are generally healthy, and second, Korean policymakers have taken a comprehensive and forward-looking approach to the global turmoil to maintain these fundamentals. With inflation well under control, monetary policy has appropriately been loosened, while the 2009 budget incorporates important fiscal stimulus. The government has been proactive in ensuring that liquidity in the banking system remains ample despite the tightening of external financing conditions, and has undertaken numerous initiatives to bolster the financial and corporates sectors and to avoid the sharp deleveraging process seen elsewhere, such as through bilateral currency swap arrangements with the U.S., Japan and China.

The coming year will undoubtedly be a difficult one for the global economy and Korea. There is considerable uncertainty about precisely when global growth will begin to recover, but once it does—most likely by the second half of this year—Korea appears well positioned for a solid recovery.



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