ECONOMIC HEALTH CHECK
Korea: Robust Expansion, But Further Tightening Needed
IMF Survey online
August 4, 2011
- At 4 1/2 percent, Korea set to grow above potential
- Need to contain risks of overheating
- Policy framework should improve resilience, ensure sustainable growth
After weathering the global economic crisis, Korea’s economy is now expanding above potential.
But the robust performance of this heavily export-dependent country is giving rise to worries about risks from overheating.
To mark the publication of the IMF’s annual assessment of the Korean economy—the Article IV report—Subir Lall, the IMF’s mission chief for Korea, reviews the performance of this northeast Asian economy over the past year, and identifies the challenges ahead.
IMF Survey online: What you do see as the near-term outlook for Korea?
Lall: The growth outlook for Korea is robust over the near term. Korea has been at the forefront of the recovery from the global crisis, and in the second half of 2010 the recovery transformed into an expansion. So we have a growth forecast of 4.5 percent for 2011. This is above Korea’s potential growth, which we estimate at about 4 percent. Next year, we expect growth to remain slightly above its potential.
IMF Survey online: Many emerging countries—however well they weathered the crisis—are now suffering the risk of overheating and rising inflation. Is that a danger for Korea?
Lall: Indeed, one of the key policy recommendations we have coming out of this year’s Article IV consultation is that monetary policy now needs to move decisively to reduce the risk of overheating. The economy is performing above potential, and monetary conditions still remain highly accommodative.
Let me put this in context. When the crisis hit, obviously it was important for monetary, fiscal, and financial policies to help cushion the downturn and set the stage for the recovery that followed. Fiscal stimulus was withdrawn last year and the fiscal stance is broadly neutral this year, but monetary policy remains accommodative. And real interest rates are actually negative. So we are of the view that policy rates need to rise further so the economy again operates at potential, and inflation expectations remain tightly anchored.
IMF Survey online: So the Article IV for Korea has just been released and obviously you’ve presented it to the authorities. What would you like to convey to them as the headline message for the Article IV?
Lall: There are two main messages; one is for the immediate future and one is for the medium term. The near-term message is what I just mentioned, that the macroeconomic policy stance now needs to reflect the underlying strength of the economy’s expansion, which means having a tighter monetary policy stance.
Over the medium term, the key message is that policies need to be stepped up to enhance the economy’s resilience and pave the way for sustainable and equitable growth. This means that macroeconomic and financial policies need to be placed in a framework that fully recognizes the linkages across sectors to avoid the buildup of vulnerabilities.
It also means that efforts need to be stepped up to reduce the economy’s reliance on a single engine of growth. In the case of Korea, the high dependence on exports makes the economy vulnerable to shocks happening elsewhere in the world, and eventually it affects all Koreans through its impact on employment and incomes.
So strengthening the nontradables sector, and improving the incomes of those who work in the nontradables sector, will be important both to create a second engine of growth and make the economy more resilient. It will also help ensure that the economy’s underlying growth potential remains relatively high as society ages.
IMF Survey online: When you say “nontradables sector,” obviously you are emphasizing the services sector. That’s also a hint at the need to boost domestic consumption, isn’t it?
Lall: The challenge of rebalancing in Korea is slightly different from many other countries because households already have a high level of debt and so boosting consumption is not that easy. In the case of Korea, because of high household indebtedness, boosting incomes of lower income households would be an important part of boosting domestic demand. Rising incomes would allow people to consume more without substituting away from savings, because savings rates for households in Korea are already low.
This means that for most people who are indeed employed in the nontradables sector, their incomes need to rise. Revitalizing the nontradables sector would help increase household incomes and, through that, help them consume more. That’s the longer term challenge for the economy in terms of rebalancing.
IMF Survey online: Finally, one issue that is on the minds of many authorities—whether in advanced countries, emerging markets, or low-income countries—is the pursuit of inclusive, sustainable growth. What does this mean for Korea and how can the Koreans achieve this?
Lall: Rising inequality has been a pattern seen across many, if not most, countries in the world over the past two decades, and it is a reflection of many factors, including technological change, globalization, and other factors. So what we see in Korea is not atypical in that sense.
To address inequality in Korea comes back to the issue of rebalancing the economy because productivity and incomes in the nontradables sector are lower than that in the manufacturing exports sector or the tradables sector.
So to reduce inequality and make growth more inclusive means creating more jobs opportunities—including for the elderly and women—and higher-paying job opportunities in the nontradable sectors, and that will require greater policy efforts.
Rebalancing the economy, and creating a second engine of growth, would go a long way toward addressing the inequality issue by ensuring that incomes continue to grow at a healthy pace, and addressing some of the challenges that Korea will face as one of the most rapidly aging societies in the Organization for Economic Cooperation and Development.