## 1korea2019001

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### Context and recent economic developments
- GDP growth: 3.1 percent in 2017; 2.7 percent in 2018; expected around 2.6 percent in 2019.
- Potential growth: fallen to below 3 percent and projected to drop steadily in coming decades.
- Demographics: working age share peaked at 73.4 percent in 2016 and projected to drop to 51.3 percent in 2050.
- Productivity: TFP level about 65 percent of that in the U.S. in 2017; TFP growth has slowed.
- Income and inequality:
  - Gini coefficient slightly above OECD average.
  - 2018: average monthly income among bottom 20 percent dropped by 10.2 percent year-on-year; for top 20 percent increased by 9.6 percent.
  - Old-age poverty notably higher than rest of OECD.
- Growth drivers and drags (2018–early 2019):
  - Softening from contraction in equipment and construction investment; export growth deteriorated due to trade tensions and China slowdown.
  - Private consumption remained robust, supported by minimum wage increase and transfers; government consumption accelerated.
  - Equipment investment weakened, especially in semiconductors.
  - Exports: turned negative quarter-on-quarter in Q4 2018; continued decline in first two months of 2019.
- Labor market (2018–early 2019):
  - Employment growth: 1.2 percent in 2017 to 0.4 percent in 2018; rebound in February 2019 driven by public sector and temporary jobs.
  - Unemployment rate: 3.7 percent in February 2019.
  - Discouraged job-seekers outside labor force increased by 7.5 percent year-on-year.
  - Youth unemployment: 10.5 percent in 2018 (0.2 percentage higher than 2017).
  - Weakening concentrated in low productivity sectors and low-skilled workers; linked to slowing momentum and sharp minimum wage rises in 2018–19.
- Inflation:
  - Headline inflation: 0.5 percent year-on-year in February 2019.
  - Core inflation excluding food and energy: 1.1 percent year-on-year in February 2019.
  - Inflation undershot BOK’s 2.0 percent target except for a few short periods since 2012.
- External and markets:
  - Current account surplus: 4.9 percent of GDP in 2017; 4.7 percent of GDP in 2018; projected 4.6 percent of GDP in 2019.
  - Foreign exchange reserves: USD 399 billion end-2018 (24.6 percent of GDP); reserves increased by USD 14 billion (4 percent) in 2018.
  - REER: appreciated nearly 1 percent (2018 average vs 2017 average); staff assess external position moderately stronger than warranted with CA gap estimated at 1.7 percent of GDP (range 0.7 to 2.7 percent).
  - Portfolio inflows: rose ~21 percent to USD 21.1 billion in 2018.
  - Equity prices corrected around 20 percent in 2018; in 2019 debt outflows offset by equity inflows.

### Labor market slack, output gap, and inflation (Box 1)
- Output gap definition and method:
  - Output gap = actual minus potential output (Okun, 1962).
  - Estimated using an MVF linking output gap to labor market gap and a TFP gap.
- Measures of labor market slack considered:
  - (i) regular unemployment;
  - (ii) regular unemployment + discouraged workers;
  - (iii) regular unemployment + persons inactive for unspecified reasons.
- Output gap estimates:
  - Range for 2019: -0.4 to -1.1 percent.
  - All three measures give around -2 percent in 2009.
  - Dynamics by measure:
    - Regular unemployment measure: becomes positive in 2010-11; widens to around 0.7 in 2017 then starts to close.
    - Augmented with discouraged workers: zero in 2010-11; widens until 2015 then stabilizes around -1 percent.
    - Augmented with other inactive: hovers slightly below zero since 2011.
  - All gaps projected to close by end of projection period.
  - Substantial uncertainty due to model parameters, selection, and data.
- Policy links:
  - Labor market utilization linked to wage and inflation pressures.
  - Inflation projected to remain below BOK’s target in near term; headline inflation projected at 1.4 percent year-on-year in the short run due to oil tax cut and falling oil/food prices.
  - Core inflation to remain subdued owing to persistent slack.
  - Output gap estimates inform recommendations: fiscal easing, accommodative monetary stance, use macroprudential policies to preserve financial stability.

### Financial sector, household and corporate balance sheets
- Households:
  - Household credit growth: 5.8 percent year-on-year in 2018 Q4 (down from 8.1 percent in 2017 Q4).
  - NBFC lending to households: grew 3.1 percent in 2018 Q4 (vs 8.7 percent a year earlier).
  - Household debt-to-disposable income ratio: 162.1 percent in 2018 Q3 (from 159.8 percent end-2017).
  - About 69 percent of outstanding household debt is at variable rate.
  - Increased borrowing primarily used to accumulate assets.
  - Nationwide house price growth stable overall but sharp increases in certain areas until October.
- Corporates:
  - Bank credit growth to corporates around 5 percent.
  - NBFC lending to corporate real-estate activities growing just over 30 percent.
  - Aggregate corporate leverage around 101 percent of GDP; higher in construction and shipping.
  - Firm debt-to-equity ratio: 75.6 percent in June 2018 (about 1 percentage point lower than end-2017).
  - Shipbuilding firm debt-to-equity fell by -22.6 percentage points mid-2018 vs end-2017; shipping rose by 30.7 percentage points.
- Financial soundness:
  - Banking capital ratio: 16.1 percent in Q3 2018.
  - Loan-to-deposit ratio: 97.7 percent.
  - Bank non-performing loan ratio: 0.54 percent.
  - Bank return-on-assets: ~0.6 percent in 2017.
  - NBFC NPL ratios: around 2 percent.
  - Financial conditions index roughly unchanged by end-2018; credit-to-GDP gap negative in 2018.
  - Compressed risk premia imply small global changes could produce outsized market moves.

### Fiscal and monetary stance
- Fiscal outcomes:
  - Structural budget surplus increased by 0.4 percentage point to 2.9 percent of GDP in 2018.
  - Net lending surplus: 2.7 percent of GDP in 2018, up by 0.4 percentage point.
  - Supplementary budget of 0.2 percent of GDP in 2018 supported youth employment.
  - Revenue overperformance driven by corporate income taxation and taxes on property and equity assets.
  - Since 2016 revenue outturns significantly higher than budgeted, widening surpluses despite supplementary budgets.
- Monetary policy:
  - BOK raised policy rate by 25 basis points to 1.75 percent in November 2018; on hold since.
  - BOK regards stance as still accommodative; sees neutral real rate as declined but uncertain.
  - BOK noted cutting rate would reduce buffer against future severe negative shocks; underlying indicators excluding certain factors rose near 2 percent last year.
  - Staff recommend a firmly accommodative monetary stance (monetary easing suggested in staff appraisal given negative output gap and subdued inflation).

### Policy recommendations and structural reforms
- Near-term macro policy:
  - Staff recommend a supplementary budget of more than 0.5 percent of GDP this year; fiscal policy to remain expansionary medium-term.
  - Fiscal measures should prioritize social protection, female labor force participation, Active Labor Market Policies (ALMPs), and growth-enhancing structural reforms.
  - Staff caution against indefinite transfers to SMEs to preserve low-productivity jobs.
  - Staff simulations: childcare spending increase by 0.25 percent of GDP plus ALMPs increase by 0.5 percent of GDP, together with labor and product market reforms, would boost output by more than 6 percent in 10 years.
- Fiscal medium/longer term:
  - 2018-22 National Fiscal Management Plan envisages ~7 percent average annual increase in fiscal expenditure; staff project revenues to increase 4.7 percent on average per year.
  - Assuming a supplementary budget of 0.3 percent of GDP in 2019, structural balance projected to decline from 2.9 percent of GDP in 2018 to 0.9 percent of GDP in 2022.
  - Staff recommend further reducing structural balance toward zero in coming years.
  - Long-term aging pressures: outlays for pensions and healthcare set to rise by 10-16 percent of GDP by 2060.
  - VAT is 10 percent; staff suggest considering broadening the VAT base.
- Tax reform:
  - Reduce bias favoring debt over equity: effective marginal tax rate on equity financing estimated 40 percentage points higher than on debt.
  - Options include allowance for corporate equity system or a cash flow tax; consider adjusting progressive corporate income tax schedule.
- Labor market reforms — adopt "flexicurity" with three pillars:
  - (i) more flexibility for regular workers (ease dismissal rules for performance and economic reasons);
  - (ii) strong and inclusive safety net for unemployed (adequate unemployment benefits);
  - (iii) effective ALMPs focused on training, job services, and labor reallocation.
- Female labor force participation:
  - FLFP rate ~58.6 percent in 2017 (~20 percentage points below men).
  - Women earn 63 percent of what men earn; women occupy 10.5 percent of management positions (OECD average 31 percent).
  - Closing FLFP gap with men by 2035 would boost real GDP by more than 7 percent per staff assessment.
  - Recommended measures: increase early childhood education and care spending, shared parental leave, reduce working hours, promote flexible work.
- Youth employment:
  - Youth employment ~10 percentage points below OECD average.
  - Recommendations: strengthen vocational programs, work-study systems, internships with business collaboration and quality assurance.
- Public employment and minimum wage:
  - Government plans to expand public sector jobs by 810,000 by 2022; staff advise linking public job creation to services not provided by private sector and analyze public-private wage differentials to avoid crowding out private jobs.
  - Minimum wage increases: 16.4 percent in 2018; 10.9 percent for 2019. 2019 hike likely to raise minimum/average wage ratio to around 46 percent (above OECD average of 41 percent in 2017).
  - Staff recommend 2020 minimum wage increase be set below labor productivity growth and advocate targeted fiscal instruments (e.g., in-work tax credits) and phasing out subsidies to SMEs facing increased labor costs.
- Working hours:
  - Labor Standards Act amended in 2018 to lower maximum weekly working hours from 68 to 52.
  - Korea’s average hours worked per employee are second highest in OECD and ~19 percent above OECD average.
  - Monitor implementation for sectoral effects and productivity implications.
- Product and service market reforms:
  - Product market regulations remain restrictive relative to most OECD economies.
  - Suggested reforms: reduce legal barriers to entry, antitrust exemptions, high startup costs, barriers to trade and foreign investment.
  - Regulatory sandboxes introduced to speed approvals for new products.
  - Modeled impact of a 50 percent decline in barriers to entry (to OECD average):
    - Decreases unemployment by 0.5 percent.
    - Boosts output per worker by 7 percent in long run.
    - Consumption increases 6.6 percent in long run (falls short run due to higher investment).
    - Short-run weaker current account by up to 1.5 percent of GDP.
    - Tabled long-run effects: Output 6.8 percent; Consumption 6.6 percent; Real Wage 6.3 percent; Unemployment -0.5 pct points.
- Manufacturing diversification and corporate restructuring:
  - Manufacturing highly concentrated; electrical and electronic equipment industry contributed almost half of manufacturing growth since early 2000s.
  - Staff urge expedited diversification, promote fair competition, and foster SME innovation.
  - Rapid implementation of financial/operational restructuring for distressed firms critical to reallocate resources; social spending to cushion worker impacts.
  - Refocus SME subsidies toward innovation and firms with long-run productivity potential rather than firm size.

### External, exchange rate, macroprudential, and data transparency policies
- Exchange rate and FX intervention:
  - Exchange rate to move flexibly; intervention limited to disorderly market conditions.
  - BOK posted net FX interventions for 2H 2018 in March 2019; subsequent posting schedule described.
  - Staff welcome FX intervention data publication.
- Macroprudential measures and household debt:
  - LTVs and DTIs lowered; DSR limit covering all forms of debt introduced for banks in mid-2018 and to be extended to NBFCs in 2019.
  - Stressed-DTI calculation: banks must add at least 100 basis points to market rates for new floating-rate mortgage applicants; banks cannot grant new mortgage if stressed-DTI exceeds 80 percent.
  - Cap on banks’ FX derivative positions and levy on non-deposit foreign currency liabilities seen as MPMs to prevent excessive short-term debt build-up.
  - Authorities target household debt growth in line with nominal GDP in mid-to-long-term.
- External policy recommendations:
  - Significantly more expansionary fiscal policy recommended to boost domestic demand and reduce imbalances given substantial fiscal space.
  - Recalibrate policy mix to reduce reliance on monetary policy.
  - Structural policies to rebalance toward services and support domestic demand: strengthen social safety net; address investment bottlenecks.
- Data reporting:
  - Staff encourage moving to SDDS Plus over medium term and improving timeliness of financial soundness indicators and general government operations reporting.

### Outlook, risks, and key indicators
- Outlook:
  - Growth forecast (headline figures): Real GDP percent change: 2.6 (2019), 2.8 (2020), 2.9 (2021), 2.8 (2022), 2.9 (2023), 2.9 (2024).
  - Nominal GDP (trillions of won): 1,852.8 (2019); 1,937.0 (2020); 2,026.1 (2021); 2,120.8 (2022); 2,225.8 (2023); 2,340.8 (2024).
  - Staff assume a supplementary budget of 0.3 percent of GDP and unchanged monetary policy in baseline.
  - Output gap for 2019 estimated around -0.4 to -1.1.
  - Potential growth projected around 2.7-2.6 through projection period.
- Key risks (selected from Risk Assessment Matrix):
  - Global: rising protectionism and retreat from multilateralism (High likelihood); China slowdown (High likelihood); sharp tightening of global financial conditions (Medium likelihood); weaker-than-expected global growth (Medium likelihood); cyber-attacks (Medium likelihood).
  - Domestic: high household debt (Medium likelihood); policy easing (upside risk, Medium likelihood); faster progress with North Korea (upside, Low likelihood).
- Policy responses to risks:
  - Use fiscal expansion and monetary easing where appropriate; maintain flexible exchange rate; rely on macroprudential tools to manage household debt.
- Selected headline indicators (preserve numeric series):
  - Current account balance (percent of GDP): 4.6 (2019), 4.5 (2020), 4.4 (2021), 4.4 (2022), 4.5 (2023), 4.5 (2024).
  - CPI inflation (average): 1.4 (2019), 1.6 (2020), 1.7 (2021), 1.8 (2022), 1.9 (2023), 2.0 (2024).
  - Gross international reserves (end period, excluding gold, billions USD): 422.2 (2019), 444.5 (2020), 467.2 (2021), 492.5 (2022), 519.9 (2023), 548.9 (2024).
  - Total external debt (end period, billions USD): 489.0 (2019), 531.2 (2020), 576.2 (2021), 623.1 (2022), 671.8 (2023), 722.4 (2024).
  - Central government debt (percent of GDP): 36.6 (2019), 37.3 (2020), 37.2 (2021), 37.4 (2022), 37.8 (2023), 38.0 (2024).

### Public debt sustainability (selected)
- Nominal gross central government debt (percent of GDP): 30.9 (2017); 36.3 (2018); 36.6 (2019); 37.3 (2020); 37.2 (2021); 37.4 (2022); 37.8 (2023); 38.0 (2024).
- Gross financing needs (percent of GDP): 5.8 (2017); 4.3 (2018); 4.4 (2019); 3.5 (2020); 3.9 (2021); 5.2 (2022); 5.7 (2023); 5.3 (2024).
- Baseline assumptions (selected): Baseline Real GDP growth 2.6 (2019) rising to 2.9 (2024); Baseline Primary Balance 0.3 (2019) to -0.9 (2024); Baseline Effective interest rate 3.0 (2019) to 4.5 (2024).
- Automatic debt dynamics contributions and identified debt-creating flows detailed in Annex III with year-by-year figures preserved in source tables.

*Source: IMF staff report — 1. Labor Market Slack and the Output Gap; Box 1; Korea Article IV consultation materials (as presented in the provided chapter excerpt).*

### 1. Labor Market Slack and the Output Gap ______________________________________________________ 13

### 1. Labor Market Slack and the Output Gap

### Context: cyclical and structural headwinds to growth
- Short-term growth slowed: GDP growth dropped to 2.7 percent in 2018 from 3.1 percent in 2017.
- Potential growth is declining: potential growth has fallen to below 3 percent and is projected to drop steadily in the coming decades.
- Demographics: Korea’s working age share peaked at 73.4 percent in 2016 and is expected to drop to 51.3 percent in 2050, depressing potential employment and growth.
- Productivity: Total factor productivity growth has slowed; the level was about 65 percent of that in the U.S. in 2017.
- Duality and inequality:
  - Significant divide between regular and non-regular workers; large productivity gap between manufacturing and services and between small and large firms.
  - Income inequality: Korea’s Gini coefficient is slightly above the OECD average. In 2018 average monthly income among the bottom 20 percent of households dropped by 10.2 percent year-on-year, while for the top 20 percent it increased by 9.6 percent.
  - Old-age poverty is significantly higher than in the rest of the OECD.
- Government focus: strengthening social safety nets, substantially raising the minimum wage, supporting SMEs to boost employment, expanding public sector jobs, revising regulation to support investment and start-ups, and designing measures to promote fair competition between chaebols and smaller firms.
- Political constraint: the President’s party lacks votes in parliament to pass laws unilaterally.

### Recent economic developments (2018–early 2019)
- Growth drivers and drags:
  - Softening driven by contraction in equipment and construction investment; export growth deteriorated on the back of trade tensions and China’s slowdown.
  - Private consumption growth remained robust, supported by the minimum wage increase and increased transfers; government consumption accelerated.
- Investment and trade:
  - Equipment investment weakened, partly due to the global trade slowdown, especially semi-conductors.
  - Export growth turned negative in Q4 2018 (quarter-on-quarter); exports continued to decline in the first two months of 2019.
- Job market:
  - Employment growth dropped to 0.4 percent in 2018 from 1.2 percent in 2017.
  - Employment rebounded in February 2019, driven mainly by the public sector and temporary jobs.
  - Unemployment rate was 3.7 percent in February 2019.
  - Discouraged job-seekers outside the labor force increased by 7.5 percent year-on-year.
  - Youth unemployment was 10.5 percent in 2018, 0.2 percentage higher than the year before.
  - Weakening was particularly severe in low productivity sectors and among low skilled workers, likely reflecting slowing momentum and the sharp rise in the minimum wage in 2018–19.
- Inflation:
  - Year-on-year headline inflation declined to 0.5 percent in February 2019.
  - Core inflation excluding food and energy was 1.1 percent year-on-year in February 2019.
  - Inflation has undershot the BOK’s 2.0 percent inflation target except for a few short periods since 2012.
- Current account and external:
  - Current account surplus was 4.7 percent of GDP in 2018, down from 4.9 percent in 2017.
  - Decline in the current account surplus is explained by a larger fall in the saving rate than in the investment-to-GDP ratio.
  - Reserves: foreign exchange reserves increased by USD 14 billion (4 percent) in 2018, reaching USD 399 billion end of year (24.6 percent of GDP).
  - Net intervention estimated limited; authorities’ data show Korea sold USD 187 million on a net basis in 2018H2 (spot and forward).
  - REER appreciated by nearly 1 percent (2018 average compared to 2017 average).
  - External position assessed as moderately stronger than warranted: current account gap estimated at 1.7 percent of GDP, with a range of 0.7 to 2.7 percent of GDP.
- Capital flows and markets:
  - Portfolio inflows rose by around 21 percent to USD 21.1 billion in 2018 compared to the previous year.
  - Equity prices corrected around 20 percent in 2018.
  - Beginning in 2019, trend reversed: outflow from debt securities more than offset by inflow in portfolio equities.

### Financial developments and household/corporate balance sheets
- Households:
  - Household credit growth was 5.8 percent year-on-year in 2018 Q4, down from 8.1 percent in 2017 Q4.
  - Lending from non-bank financial institutions (NBFCs) to households grew 3.1 percent in 2018 Q4 compared with 8.7 percent a year earlier.
  - Household debt-to-disposable income ratio increased to 162.1 percent in 2018 Q3 from 159.8 percent at end-2017.
  - About 69 percent of outstanding household debt is at variable rate.
  - Increased household borrowing has been primarily used to accumulate assets.
  - Nationwide house price growth stable and in line with implied long-run fundamentals, but increased sharply in certain areas until October.
- Corporate sector:
  - Bank credit growth to corporates moderate at around 5 percent.
  - NBFC lending to corporate real-estate related activities growing at just over 30 percent.
  - Aggregate corporate leverage around 101 percent of GDP; higher ratios in construction and shipping.
  - Firm debt-to-equity ratios declined to 75.6 percent in June 2018 (about 1 percentage point lower than end-2017).
  - Shipbuilding industry debt-to-equity fell by -22.6 percentage points in mid-2018 relative to end-2017, while shipping industry ratio rose by 30.7 percentage points.
- Financial system soundness:
  - Banking sector capital ratios at 16.1 percent in Q3 2018.
  - Loan-to-deposit ratio at 97.7 percent.
  - Non-performing loan ratio for banks at 0.54 percent.
  - Bank return-on-assets around 0.6 percent in 2017.
  - NPL ratios for NBFCs around 2 percent.
  - Financial conditions index roughly unchanged by end-2018; credit-to-GDP gap was negative in 2018.
  - Compressed risk premia imply small global changes could elicit outsized market responses.

### Fiscal and monetary policy stance
- Fiscal:
  - Fiscal policy was tight in 2018: structural budget surplus increased by 0.4 percentage point to 2.9 percent of GDP.
  - Net lending recorded a surplus of 2.7 percent of GDP in 2018, up by 0.4 percentage point.
  - A supplementary budget of 0.2 percent of GDP supported youth employment.
  - Revenue overperformance driven by corporate income taxation and taxes on property and equity assets.
  - Since 2016, revenue outturns significantly higher than envisaged in the budget, widening budget surpluses despite supplementary budgets.
- Monetary:
  - Bank of Korea increased main policy rate by 25 basis points to 1.75 percent in November 2018 and has been on hold since.
  - November 2018 hike cited financial imbalances; subsequent hold justified by subdued inflationary pressures and continued appropriateness of accommodative monetary stance.

### Outlook and risks
- Growth projection:
  - Growth expected to decline to around 2.6 percent in 2019.
  - Current account surplus projected at 4.6 percent of GDP in 2019.
- Drivers of outlook:
  - Slowing external demand will weigh on growth; domestic demand anticipated to pick up supported by fiscal policy.
  - Export growth projected weak due to deteriorating tech cycle and slowdown in China.
  - Potential trade diversion from China–U.S. tensions expected to only partially offset slowdown in exports to China.
  - Facility investment will face headwinds from weaker trade, especially demand for semiconductors.
  - Construction investment expected to stabilize toward long-term trends.
- Output gap and inflation:
  - Staff’s estimate of the output gap remains negative at around -0.4 to -1.1 for 2019.
  - Output gap closure expected gradual; labor market utilization will increase over forecast horizon, keeping downward pressure on prices.
  - Potential growth projected to be around 2.7-2.6 through the projection period.
- Policy assumptions in baseline:
  - Staff assume a supplementary budget of 0.3 percent of GDP and unchanged monetary policy in baseline growth projections.
- Risk considerations:
  - Substantial uncertainty around output gap estimates.
  - Compressed risk premia and global volatility could trigger sizeable market responses.
  - Household and corporate leverage, geographic housing price pressures, and concentrated corporate leverage in capital-intensive industries pose downside risks.

*Source: IMF staff report — 1. Labor Market Slack and the Output Gap.*

### Box 1. Labor Market Slack and the Output Gap

### Box 1. Labor Market Slack and the Output Gap

### Methodology
- The output gap is defined as the difference between actual and potential output, the maximum level of output an economy can produce without generating inflationary pressure (Okun, 1962).
- An MVF (multivariate filter) is used to estimate the output gap through a system of economic equations; the approach is consistent with literature using MVFs (see Blagrave et al. 2015).
- The MVF links the output gap to labor market utilization via a production function, with the output gap related to:
  - a labor market gap, and
  - a Total Factor Productivity (TFP) gap (the latter can inter alia measure the degree of capital utilization).

### Measures of labor market slack
- The analysis emphasizes that how labor market slack is measured matters; regular unemployment may not capture discouraged workers or other inactive persons ready and able to work.
- Three measures of labor market slack are used:
  - (i) regular unemployment,
  - (ii) regular unemployment augmented with discouraged workers, and
  - (iii) regular unemployment augmented with persons classified inactive for unspecified reason (i.e. reasons other than childcare, house-keeping, schooling, old age, or disability).

### Output gap estimates and historical patterns
- The estimation yields an output gap for 2019 in the range of -0.4 to -1.1 percent.
- All three measures deliver an output gap of around -2 percent in 2009.
- Dynamics by measure:
  - The measure based on regular unemployment:
    - becomes positive in 2010-11,
    - then widens to around 0.7 in 2017 and then starts to close.
  - The measure augmented with discouraged workers:
    - was zero in 2010-11,
    - widens until 2015 and then stabilizes around - 1 percent.
  - The measure augmented with other inactive:
    - hovers slightly below zero since 2011.
- All gaps are projected to close at the end of the projection period.
- The estimations are subject to substantial uncertainty in model parameters, model selection, and underlying data.

### Policy implications and links to inflation
- A labor market operating above potential is expected to create upward pressure on wages leading to inflation, and vice versa; thus labor market utilization helps assess whether the economy is above or below potential.
- The report notes that inflation is projected to remain below BOK’s target this year and the next; core inflation will remain subdued owing to persistent slack in the economy.
- Headline inflation is projected to be kept low, at 1.4 percent year-on-year, by the cut in oil consumption taxes as well as declining oil and food prices.
- Inflation will converge only gradually toward target in the medium-term, as the output gap closes.
- The estimations of the output gap feed into policy recommendations elsewhere in the report, including calls for fiscal easing, a firmly accommodative monetary stance, and the use of macroprudential policies to preserve financial stability given persistent slack.

*Source: Box 1. Labor Market Slack and the Output Gap, 1korea2019001*

### 35.      The exchange rate should continue to move flexibly, with intervention limited to

### The exchange rate should continue to move flexibly, with intervention limited to

### Foreign exchange policy and interventions
- The exchange rate should continue to move flexibly, with intervention limited to addressing disorderly market conditions.
- Data on FX interventions (in net trading volume) for the second half of 2018 were posted on the website of the BOK in March 2019.
- The next posting will be in September 2019, reporting net interventions in the first half of 2019.
- Afterwards, intervention records will be posted on a quarterly basis with a one-quarter reporting lag.
- Staff welcome the publication of data on FX intervention.
- Authorities clarified that intervention policy in foreign exchange market was limited to episodes of disorderly market conditions and that exchange rate flexibility would continue.

### AML/CFT assessment
- Korea will undergo a joint assessment of its AML/CFT regime by the Financial Action Task Force and Asia Pacific Group on money laundering in 2019.
- The assessment will examine, among other things, the transparency of legal persons and arrangements and whether the competent authorities can obtain adequate and accurate beneficial and legal ownership information in a timely fashion.

### Monetary policy and BOK views
- BOK regarded the current monetary policy stance as still accommodative.
- They agreed that the neutral real interest rate in Korea has declined as in other advanced economies, but underscored the high uncertainty in estimating the neutral rate.
- They stressed that their monetary policy stance has continued to be accommodative when judged against the range of their own neutral rate estimates.
- BOK presented a broad set of information, including their own financial conditions index, to support their view.
- BOK noted that cutting the policy rate would further reduce policy space to address possible future severe negative shocks.
- BOK viewed inflation expectations as well anchored, noting Korea’s undershooting of the inflation target for the past five years was primarily due to supply-side shocks (including the fall in oil prices) and institutional factors (such as the government’s stronger welfare policies affecting administered prices).
- The BOK’s underlying inflation indicators excluding these factors rose close to the 2 percent target last year.
- BOK stressed that their mandate included financial stability and emphasized using a mix of macroprudential and monetary policies to contain the build-up of financial imbalances and increased general risk-taking behavior across the economy.

### Authorities’ fiscal stance and plans (Authorities’ Views)
- The authorities viewed fiscal policy in 2019 as expansionary, emphasizing that the expenditure increase this year would be the highest since 2000.
- They plan to frontload spending in the first half of the year.
- The authorities did not expect significant revenue over-performance in 2019 and expanded the Earned Income Tax Credit.
- They committed to take necessary measures to achieve their growth target of 2.6-2.7 percent, including introducing a substantial supplementary budget to boost job creation, further enhance social safety nets, and address fine dust pollution.
- Part of the 2018 revenue overperformance will be transferred to local governments in 2019 for additional spending.
- The major public institutions will increase their investment by KRW 9.5 trillion (0.5 percent of GDP) in 2019.
- Government dividends from investment in corporations in the amount of KRW 1.5 trillion won (0.1 percent of GDP) will be reinvested.
- Private-public partnership will be strengthened further.
- The authorities agreed that the fiscal stimulus should be efficiently spent and aimed at enhancing potential growth.

### Household debt and macroprudential policy
- Banks are required to calculate the stressed-DTI ratio of each borrower by adding stressed interest rates—at least 100 basis points—to market interest rates should a borrower apply for a new floating rate mortgage loan.
- Banks are not allowed to grant a new mortgage loan if the stressed-DTI ratio breaches an 80 percent ceiling.
- The authorities were of the view that borrower-based macroprudential policies have been effective in reducing and containing household debt growth, but household debt continues to rise more than income.
- Their target is for household debt to grow in line with nominal GDP in the mid-to-long-term.
- The authorities considered the cap on banks’ foreign exchange derivative positions necessary and saw it crucial to contain any excessive increase in short-term foreign debts.

### Fiscal policy recommendations and long-term challenges
- Fiscal policy should maintain an expansionary stance over the medium term to support inclusive growth and reduce excessive external imbalances.
- The 2018-22 National Fiscal Management Plan envisages an increase in fiscal expenditure by about 7 percent per year, on average.
- Revenues are projected by staff to increase by 4.7 percent, on average, per year.
- Assuming a supplementary budget of 0.3 percent of GDP in 2019, the structural balance is expected to decline from 2.9 percent of GDP in 2018 to 0.9 percent of GDP in 2022.
- Staff recommend that the government further reduce the structural balance toward zero in the coming years.
- Additional fiscal spending should focus on fostering social protection, boosting long-term growth and supporting growth-enhancing structural reforms, including:
  - Strengthening social safety nets and buttressing job creation.
  - Increasing spending on targeted transfers to the vulnerable.
  - Focusing fiscal spending on training and job services, childcare and child benefits.
- Staff simulations indicate that an expansion in childcare spending by 0.25 percent of GDP, and an increase in Active Labor Market Policies spending by 0.5 percent of GDP, accompanied by labor and product market reforms would boost output by more than 6 percent in 10 years.
- Staff caution against using transfers to SMEs to preserve jobs indefinitely; recommend focusing support on firms likely to improve productivity and long-term profitability (e.g., young and innovative firms).
- Tax reform suggestions:
  - Increase neutrality of corporate income taxation with respect to financing sources; currently the effective marginal tax rate on equity financing in Korea is estimated to be 40 percentage points higher than that on debt financing.
  - Options include allowance for corporate equity system or a cash flow tax.
  - Consider adjusting the progressive corporate income tax rate schedule to avoid tax-induced fragmentation and under-reporting.
- Longer-term fiscal pressures from aging:
  - Outlays for pensions and healthcare are set to rise by 10-16 percent of GDP by 2060.
  - Korea’s tax revenue-to-GDP ratio is one of the lowest in the OECD.
  - Tax expenditure on personal income tax increased by more than 40 percent from 2012 to 2017 and was more than 25 percent of personal income tax revenues in 2017.
  - Tax expenditure on industry, including SMEs, represented about 30 percent of total tax expenditure in 2017.
  - VAT is relatively low at only 10 percent; broadening the VAT base could be considered.

### Labor market reforms and employment policies
- Adopt “flexicurity” as the basis for labor market policies, involving three pillars:
  - (i) more flexibility for regular workers;
  - (ii) a strong and inclusive safety net for the unemployed;
  - (iii) Active Labor Market Policies (ALMPs).
- For regular workers, regulations are stricter than the OECD average, with particularly tight restrictions on dismissal; easing dismissal rules for performance and economic reasons is recommended to strengthen job creation.
- Increased flexibility should be accompanied by adequate unemployment benefits and enhanced ALMPs focused more on training and employment services and labor reallocation.
- Encourage female labor force participation and leadership:
  - Korea’s FLFP rate was around 58.6 percent in 2017, almost 20 percentage points below that of men.
  - The gender pay gap: women earning only 63 percent of what men earn.
  - Women occupy just 10.5 percent of management positions, compared to the OECD average of 31 percent.
  - If FLFP were to rise to close the gap with Korea’s male labor force participation by 2035, women work would boost real GDP by more than 7 percent.
  - Suggested measures: increase spending on early childhood education and care, promote shared parental leave, implement reduction in working hours, foster flexible-working arrangements.
- Boost youth employment: Korea’s youth employment is about 10 percentage points below the OECD average; strengthen vocational programs, work-study systems, and internships with business collaboration and quality assurance.
- Caution on public employment expansion:
  - Government plans to expand public sector jobs by 810,000 by 2022, partly by converting non-regular public-sector workers into regular employment.
  - Public sector job creation should be linked to services not provided by the private sector and consider impact on public sector productivity; analyze public-private sector wage differentials to minimize crowding out private jobs.

### Minimum wage and working hours
- Minimum wage:
  - Minimum wage was raised by 10.9 percent for 2019, following a 16.4 percent increase in 2018.
  - The 2019 hike is significantly larger than the expected labor productivity increase.
  - This will likely bring the ratio of minimum to average wage to around 46 percent, above the OECD average of 41 percent (in 2017), likely hurting employment of low-skilled labor.
  - Job Stabilization Fund subsidies to eligible SMEs cost about KRW 2.5 trillion (0.1 percent of GDP) in 2018, and KRW 2.8 trillion (0.1 percent of GDP) expected for 2019.
  - A new minimum wage determination mechanism is being designed; staff recommend the 2020 minimum wage increase be set below labor productivity growth.
  - Recommend targeted fiscal instruments (such as in-work tax credits) for addressing in-work poverty and phasing out subsidies to SMEs facing increased labor costs.
- Working hours:
  - In 2018, Korea amended the Labor Standards Act to lower maximum weekly working hours from 68 to 52.
  - Korea’s average hours worked per employee are the second highest in the OECD and about 19 percent above the OECD average.
  - The reduction in working hours could support well-being and possibly contribute to higher productivity, employment and fertility; implementation should be monitored for sectoral effects and implications for firms and productivity.

*Source: IMF staff discussion and authorities' views as presented in the provided chapter excerpt.*

### 54.      Policy efforts to diversify the manufacturing sector should be expedited. Korea’s

### Policy efforts to diversify the manufacturing sector should be expedited. Korea’s

### Manufacturing concentration and vulnerabilities
- Korea’s manufacturing sector is highly concentrated, particularly compared to peers.
- The electrical and electronic equipment industry has contributed almost half of the growth in the manufacturing sector since early 2000s.
- Dominant industries:
  - Are highly interconnected with other domestic industries via upstream/downstream linkages, and with foreign markets via export/import linkages.
  - Are dominated by few large firms.
- Staff analysis suggests that tighter vertical and trade linkages have increased the vulnerability of the economy to domestic and external shocks.
- Authorities’ ongoing efforts to promote fair competition between large corporations and smaller firms and foster innovation especially in SMEs are welcome initiatives to reduce these vulnerabilities.

### Deregulating the non-manufacturing sector and product market reforms
- Product market regulations in Korea are more restrictive relative to most other OECD economies despite past deregulation.
- Remaining frictions and barriers:
  - Some incumbents are protected through legal barriers to entry and antitrust exemptions.
  - Startups face relatively high entry costs and some administrative burden.
  - Explicit barriers to trade and foreign investments are high relative to peers.
- Potential gains from additional reforms:
  - Could significantly boost GDP and productivity and increase the contribution of the non-manufacturing sector to growth, increasing diversification.
  - Could help reduce the current account surplus through higher investments.
- Recent and proposed measures:
  - Government initiative to create regulatory sandboxes (i.e. speeding up the process of obtaining approval to launch new products).
  - Suggestions to reduce the tax costs of firm entry and remaining administrative burdens and legal barriers for entry in some industries.
  - Consideration to enhance foreign competition by reducing tariffs and domestic co-financing requirements for foreign investments.

### Box 5 — Advancing Growth Through Product Market Reforms (selected findings)
- Product market regulations in Korea remain among the strictest compared to OECD peers despite recent liberalizations:
  - Barriers to international trade and foreign investment (relatively high tariffs, restrictions on foreign startups, and regulation).
  - High state control over SOEs and involvement in business operations through regulation.
  - Korea is among OECD countries with the highest degree of price controls.
  - Remaining barriers to entrepreneurship: administrative procedures, complex licensing and permit system, relatively high startup costs.
- Channels through which product market reforms raise productivity:
  - Improve allocative efficiency between firms (better alignment of output prices with marginal costs).
  - Improve resource efficiency within firms (induce firms to reduce slack).
  - Spur innovation (induce faster adoption of recent technologies).
- Firm-level evidence:
  - Past product market liberalizations in Korea have been associated with (i) higher employment, (ii) higher labor productivity, and (ii) higher spending on Research and Development.
- Modeling exercise (DSGE model with product market frictions calibrated to Korea) — impact of a 50 percent decline in barriers to entry, bringing the level in line with the OECD average:
  - Decreases unemployment by 0.5 percent.
  - Boosts output per worker by 7 percent in the long run.
  - Consumption increases by 6.6 percent in the long run; consumption falls in the short run due to higher investment.
  - In the short run, higher firm profitability attracts foreign capital, leading to a weaker current account of up to 1.5 percent of GDP.
- Tabled model results (Long Run Effect of a 50 percent Decline in Barriers to Entry):
  - Output (in percent) 6.8
  - Consumption (in percent) 6.6
  - Real Wage (in percent) 6.3
  - Unemployment (in pct points) -0.5

### Corporate restructuring and support measures
- Rapid implementation of the strategy for financial and operational restructuring of distressed firms is critical to allow reallocation of resources toward more productive and profitable sectors.
- Social spending should cushion the impact on affected workers and help reallocate them to other activities.
- Review and refocus subsidies and tax expenditures to SMEs:
  - Should spur innovation rather than protect jobs with very low productivity.
  - Subsidies should not be given based on firm size, but rather on firm age and scope for long-run productivity increases.

### Data reporting enhancements
- Staff encourage authorities to enhance aspects of data reporting:
  - Over the medium term consider moving to SDDS Plus.
  - Improve the timeliness of financial soundness indicators and general government operations data reporting.

### Authorities’ views (summarized)
- Fiscal priorities:
  - 2018-22 National Fiscal Management plan envisages a 10.3 percent annual increase in welfare, health and employment spending.
  - Specific annual increases: basic livelihood security 17.3 percent, vulnerable groups 15.8 percent, the elderly 15.4 percent, women/family/youth 11.2 percent.
  - Programs to support SMEs should be regularly reviewed; additional measures being designed to promote productivity growth in SMEs.
- Taxation:
  - Agree on the need to reform the tax system and increase revenues in the longer term.
  - Favor streamlining existing tax reductions and exemptions rather than introducing an allowance for corporate equity or reducing the number of corporate income tax rates.
  - Plan to broaden the tax base very gradually.
- Public employment and labor market:
  - View expansion of public employment as necessary; public employment is 9 percent of total employment compared to OECD average of 21.3 percent.
  - Support “flexicurity”: introduce further Active Labor Market Policies; monitor minimum wage impacts; a bill submitted to improve minimum wage setting framework.
  - Support temporary compensation for small businesses for minimum wage increases.
- Regulatory burden:
  - Welcome regulatory sandboxes for selected sectors and emphasize boosting innovation in start-ups.

### Staff appraisal and policy recommendations
- Near-term macro stance:
  - A supplementary budget of more than 0.5 percent of GDP should be introduced this year; fiscal policy should remain expansionary in the medium-term.
  - Fiscal measures should focus on strengthening social protection, boosting female labor force participation, enhancing Active Labor Market Policies, and supporting growth-enhancing structural reforms.
  - Caution against using transfers to SMEs to preserve jobs indefinitely.
  - In the longer term, fiscal challenges from the aging population will necessitate greater revenue mobilization.
- Monetary and financial policy:
  - Monetary policy should be eased: inflation projected to remain below the inflation target at least this year and the next, inflationary pressures are weak, inflation expectations have started to decline, and the output gap is negative.
  - Exchange rate should be allowed to move flexibly, with intervention limited to addressing disorderly market conditions.
  - Manage financial risks through macroprudential policies rather than monetary policy; keep macroprudential policies tight to contain household debt risks and sustain financial sector resilience.
- Labor market reforms:
  - Adopt “flexicurity”: more flexibility for regular workers; a strong and inclusive safety net for the unemployed; effective Active Labor Market Policies — implementing all three pillars is critical.
  - Link public sector job creation to providing services that cannot be provided by the private sector.
  - Minimum wage increase for next year should be below labor productivity growth to lessen adverse effects on employment.
  - Phase out compensatory subsidies to SMEs.
  - Focus policies on strengthening female labor force participation and leadership.
- Structural reforms to diversify and liberalize:
  - Expedite policy efforts to diversify the manufacturing sector and promote service sector liberalization.
  - Ease the regulatory burden for firms by further lowering barriers to entry and reducing protection of incumbents.
  - Lower startup costs and legal barriers for firm entry; reduce administrative burdens for firms.
  - Enhance foreign competition via further trade and investment liberalization, including through reducing tariffs and domestic co-financing requirements for foreign investments.

*Source: IMF staff report (Republic of Korea).*

### 69.      Staff recommend that the next Article IV consultation be held on the standard 12-

### 69.      Staff recommend that the next Article IV consultation be held on the standard 12-month cycle.

### Recommendation
- Staff recommend that the next Article IV consultation be held on the standard 12-month cycle.

### Selected Economic Indicators (2017–24) — headline figures
- Real GDP (percent change): 3.1 (2017), 2.7 (2018), 2.6 (2019), 2.8 (2020), 2.9 (2021), 2.8 (2022), 2.9 (2023), 2.9 (2024)
- Total domestic demand: 5.1 (2017), 1.7 (2018), 2.8 (2019), 3.3 (2020), 3.1 (2021), 3.1 (2022), 3.3 (2023), 3.3 (2024)
- Final domestic demand: 4.7 (2017), 1.6 (2018), 2.6 (2019), 3.9 (2020), 3.1 (2021), 3.1 (2022), 3.3 (2023), 3.3 (2024)
- Consumption: 2.8 (2017), 3.5 (2018), 3.5 (2019), 3.6 (2020), 3.2 (2021), 3.3 (2022), 3.5 (2023), 3.5 (2024)
- Gross fixed investment: 8.6 (2017), -2.2 (2018), 0.7 (2019), 4.5 (2020), 2.8 (2021), 2.8 (2022), 2.9 (2023), 2.9 (2024)
- Stock building (contribution to GDP growth): 0.4 (2017), 0.1 (2018), 0.2 (2019), -0.5 (2020), 0.0 (2021), 0.0 (2022), 0.0 (2023), 0.0 (2024)
- Net foreign balance (contribution to GDP growth): -1.7 (2017), 1.2 (2018), -0.4 (2019), -0.3 (2020), 0.0 (2021), -0.1 (2022), -0.2 (2023), -0.2 (2024)
- Nominal GDP (in trillions of won): 1,730.4 (2017), 1,782.3 (2018), 1,852.8 (2019), 1,937.0 (2020), 2,026.1 (2021), 2,120.8 (2022), 2,225.8 (2023), 2,340.8 (2024)

### Saving, Investment, Current Account, Prices
- Gross national saving (percent of GDP): 36.0 (2017), 34.9 (2018), 34.2 (2019), 33.7 (2020), 33.4 (2021), 33.2 (2022), 33.0 (2023), 32.7 (2024)
- Gross domestic investment (percent of GDP): 31.1 (2017), 30.2 (2018), 29.6 (2019), 29.3 (2020), 29.0 (2021), 28.8 (2022), 28.5 (2023), 28.3 (2024)
- Current account balance (percent of GDP): 4.9 (2017), 4.7 (2018), 4.6 (2019), 4.5 (2020), 4.4 (2021), 4.4 (2022), 4.5 (2023), 4.5 (2024)
- CPI inflation (end of period): 1.4 (2017), 1.3 (2018), 1.4 (2019), 1.6 (2020), 1.7 (2021), 1.8 (2022), 1.9 (2023), 2.0 (2024)
- CPI inflation (average): 1.9 (2017), 1.5 (2018), 1.4 (2019), 1.6 (2020), 1.7 (2021), 1.8 (2022), 1.9 (2023), 2.0 (2024)
- GDP deflator: 2.3 (2017), 0.3 (2018), 1.4 (2019), 1.7 (2020), 1.7 (2021), 1.8 (2022), 2.0 (2023), 2.2 (2024)

### Trade and External Accounts (selected)
- Export volume (percent change): 5.3 (2017), 7.2 (2018), 2.3 (2019), 2.7 (2020), 3.8 (2021), 3.6 (2022), 3.5 (2023), 3.5 (2024)
- Import volume (percent change): 8.5 (2017), 1.5 (2018), 3.0 (2019), 2.9 (2020), 4.0 (2021), 4.0 (2022), 4.0 (2023), 4.0 (2024)
- Terms of trade: -0.8 (2017), -6.5 (2018), 0.9 (2019), 0.7 (2020), 0.3 (2021), 0.3 (2022), 0.2 (2023), 0.4 (2024)
- Exports, f.o.b. (billions of U.S. dollars): 580.3 (2017), 625.4 (2018), 638.5 (2019), 660.3 (2020), 691.6 (2021), 724.2 (2022), 756.9 (2023), 795.2 (2024)
- Imports, f.o.b. (billions of U.S. dollars): 466.7 (2017), 513.6 (2018), 523.4 (2019), 538.9 (2020), 563.6 (2021), 590.4 (2022), 618.6 (2023), 650.3 (2024)
- Oil imports (billions of U.S. dollars): 59.6 (2017), 80.4 (2018), 69.8 (2019), 71.9 (2020), 73.0 (2021), 74.6 (2022), 77.1 (2023), 80.1 (2024)
- Current account balance (billions of U.S. dollars): 75.2 (2017), 76.4 (2018), 76.0 (2019), 78.1 (2020), 79.8 (2021), 85.1 (2022), 91.2 (2023), 95.8 (2024)
- Gross international reserves (end of period, excluding gold) (billions of U.S. dollars): 384.5 (2017), 398.9 (2018), 422.2 (2019), 444.5 (2020), 467.2 (2021), 492.5 (2022), 519.9 (2023), 548.9 (2024)
- Gross reserves minus gold (memorandum): 363.2 (2015), 366.3 (2016), 384.5 (2017), 398.9 (2018), 422.2 (2019), 444.5 (2020)

### External debt and vulnerability indicators
- Total external debt (end of period, billions of U.S. dollars): 412.0 (2017), 440.6 (2018), 489.0 (2019), 531.2 (2020), 576.2 (2021), 623.1 (2022), 671.8 (2023), 722.4 (2024)
- Short-term external debt (end of period, billions of U.S. dollars): 116.0 (2017), 126.6 (2018), 128.1 (2019), 133.5 (2020), 139.8 (2021), 146.1 (2022), 152.1 (2023), 158.0 (2024)
- Total external debt (percent of GDP): 26.9 (2017), 27.2 (2018), 29.5 (2019), 30.5 (2020), 31.5 (2021), 32.3 (2022), 33.0 (2023), 33.6 (2024)
- Debt service ratio (percent): 8.2 (2017), 8.8 (2018), 9.8 (2019), 10.9 (2020), 11.2 (2021), 11.5 (2022), 12.0 (2023), 12.4 (2024)

### Balance of Payments (Table 2) — 2015–20 key aggregates
- Current account balance (billions of U.S. dollars): 105.1 (2015), 97.9 (2016), 75.2 (2017), 76.4 (2018), 76.0 (2019), 78.1 (2020)
- Goods balance (billions of U.S. dollars): 120.3 (2015), 116.5 (2016), 113.6 (2017), 111.9 (2018), 115.1 (2019), 121.5 (2020)
- Services balance (billions of U.S. dollars): -14.6 (2015), -17.3 (2016), -36.7 (2017), -29.7 (2018), -29.7 (2019), -33.7 (2020)
- Primary income (billions of U.S. dollars): 4.5 (2015), 4.6 (2016), 5.3 (2017), 2.8 (2018), 1.8 (2019), 2.4 (2020)
- Secondary income (billions of U.S. dollars): -5.0 (2015), -5.8 (2016), -7.0 (2017), -8.5 (2018), -11.2 (2019), -12.0 (2020)
- Financial account balance (billions of U.S. dollars, excludes reserves and related items): 90.7 (2015), 92.2 (2016), 80.1 (2017), 53.0 (2018), 52.9 (2019), 56.0 (2020)
- Portfolio investment (billions of U.S. dollars): 49.5 (2015), 67.0 (2016), 57.9 (2017), 43.9 (2018), 42.7 (2019), 44.0 (2020)
- Direct investment (billions of U.S. dollars): 19.6 (2015), 17.8 (2016), 16.2 (2017), 24.4 (2018), 26.1 (2019), 27.8 (2020)
- Reserves and related items (increase +, billions of U.S. dollars): 12.1 (2015), 7.6 (2016), 4.4 (2017), 17.5 (2018), 23.3 (2019), 22.3 (2020)
- Nominal GDP (U.S. dollars, billions): 1,382.8 (2015), 1,414.8 (2016), 1,530.8 (2017), 1,619.8 (2018), 1,656.7 (2019), 1,744.4 (2020)

### Central Government Operations (Table 3) — 2017–20 (trillions of won and percent of GDP)
- Revenue (trillions of won): 400.7 (2017), 431.6 (2018), 457.2 (2019), 478.9 (2020)
- Tax revenue (trillions of won): 265.4 (2017), 293.6 (2018), 311.0 (2019), 325.8 (2020)
- Social contributions (trillions of won): 69.7 (2017), 73.1 (2018), 76.0 (2019), 79.5 (2020)
- Expenditure (trillions of won): 360.5 (2017), 383.6 (2018), 421.3 (2019), 447.4 (2020)
- Expense (trillions of won): 350.7 (2017), 375.2 (2018), 413.1 (2019), 439.4 (2020)
- Net lending (+) / borrowing (-) (trillions of won): 40.2 (2017), 48.0 (2018), 35.9 (2019), 31.5 (2020)
- Policy lending (trillions of won): 16.1 (2017), 16.8 (2018), 18.5 (2019), 19.6 (2020)
- Overall balance (trillions of won): 24.0 (2017), 31.2 (2018), 17.5 (2019), 11.9 (2020)
- Overall balance excluding Social Security Funds (trillions of won): -18.5 (2017), -10.6 (2018), -26.7 (2019), -32.1 (2020)
- Revenue (percent of GDP): 23.2 (2017), 24.2 (2018), 24.7 (2019), 24.7 (2020)
- Expenditure (percent of GDP): 20.8 (2017), 21.5 (2018), 22.7 (2019), 23.1 (2020)
- Net lending (+) / borrowing (-) (percent of GDP): 2.3 (2017), 2.7 (2018), 1.9 (2019), 1.6 (2020)
- Overall balance (percent of GDP): 1.4 (2017), 1.7 (2018), 0.9 (2019), 0.6 (2020)
- Central government debt (trillion won): 627.4 (2017), 651.8 (2018), 678.5 (2019), 710.6 (2020)
- Central government debt (percent of GDP): 36.3 (2017), 36.6 (2018), 36.6 (2019), 36.7 (2020)
- General government debt (trillion won): 688.0 (2017), 714.2 (2018), 743.4 (2019), 778.4 (2020)
- General government debt (percent of GDP): 39.8 (2017), 40.1 (2018), 40.1 (2019), 40.2 (2020)
- Memorandum: A supplementary budget of 0.3 percent of GDP is assumed in 2019.

### Financial Soundness Indicators (selected)
- Credit to Private Sector (growth rate, percent): 7.4 (2014), 7.6 (2015), 7.3 (2016), 6.8 (2017), 6.8 (2018)
- Loans to Households (growth rate, percent): 6.7 (2014), 11.0 (2015), 11.6 (2016), 7.9 (2017), 6.4 (2018)
- Bank Loans to Households (growth rate, percent): 8.0 (2014), 8.5 (2015), 9.5 (2016), 7.0 (2017), 7.8 (2018)
- Regulatory Capital to Risk-Weighted Assets (percent): 14.0 (2014), 13.9 (2015), 14.8 (2016), 15.2 (2017)
- Regulatory Tier 1 Capital to Risk-Weighted Assets (percent): 11.4 (2014), 11.3 (2015), 12.5 (2016), 13.2 (2017)
- Non-performing Loans Net of Provisions to Capital (percent): 2.8 (2014), 2.1 (2015), 2.9 (2016), 1.7 (2017)
- Non-performing Loans to Total Gross Loans (percent): 0.5 (2014), 0.5 (2015), 0.5 (2016), 0.4 (2017)
- Return on Assets (percent): 0.5 (2014), 0.5 (2015), 0.4 (2016), 0.7 (2017)
- Return on Equity (percent): 6.0 (2014), 6.5 (2015), 4.5 (2016), 8.5 (2017)
- Liquid Assets to Total Assets (Liquid Asset Ratio, percent): 37.9 (2014), 34.4 (2015), 33.7 (2016), 29.9 (2017)
- Liquid Assets to Short Term Liabilities (percent): 122.0 (2014), 105.5 (2015), 99.0 (2016), 101.3 (2017)

### External Position and Assessments
- Net international investment position (NIIP): 25.5 (2018, percent of GDP)
- Gross assets: 93.8 (percent of GDP)
- Debt assets: 27.6 (percent of GDP)
- Gross liabilities: 68.3 (percent of GDP)
- Debt liabilities: 25.4 (percent of GDP)

Assessment highlights:
- Background: NIIP positive since 2014 and reached about 25 percent of GDP in December 2018; gross liabilities totaled 68 percent of GDP with about 27 percent of GDP gross external debt.
- Assessment: Positive NIIP strengthens external sustainability; currency mismatch risks lower than pre-GFC due to decline in short-term external liabilities of banks.
- Overall external position in 2018 assessed as moderately stronger than warranted by medium-term fundamentals and desirable policy settings, reflecting excessive saving (including precautionary) and relatively weak private investment.

### Current Account (2018 assessment)
- Actual CA: 4.7 (percent of GDP)
- Cyclically adjusted CA: 4.4 (percent of GDP)
- EBA CA Norm: 2.7 (percent of GDP)
- EBA CA Gap: 1.7 (percent of GDP)
- Staff adjusted: 0.0
- Staff CA Gap: 1.7 (percent of GDP)

Diagnosis:
- Narrowing of CA in 2018 from 4.9 percent of GDP in 2017 to 4.7 percent in 2018 driven by: (i) decline in goods trade balance due to worsened terms of trade, and (ii) decline in income balance reflecting increased dividend payouts. Services balance increased due to less negative transportation balance and rebound in tourist arrivals.
- From saving-investment perspective, narrowing driven by larger fall in savings rate than in investment-to-GDP ratio.
- Identified policy gaps: significantly tighter than desired fiscal policy and relatively low social spending contribute to CA gap by increasing precautionary savings.

### Real Effective Exchange Rate (REER)
- REER appreciation: 1.0 percent in 2018; cumulative appreciation about 10 percent since 2013.
- As of February 2019, REER weakened by about 1.2 percent relative to 2018 average.
- EBA REER regression model gaps: -5.2 (REER-Level model) to +3.4 (REER-Index model).
- Staff assessment: REER in 2018 undervalued in the range 2 to 8 percent (derived applying semi-elasticity of 0.36 to staff-assessed CA gap).

### Capital and Financial Account, FX Intervention and Reserves
- Net capital outflows: decreased to 4.3 percent of GDP in 2018 from 5.5 percent of GDP in 2017.
- Non-resident portfolio inflows: surged to $21.1 billion in 2018; non-residents sold USD 6 billion net of equities in 2018.
- FX intervention: Korea operates a floating exchange rate; staff estimates two-sided intervention since early 2015 with limited net intervention in 2018; total reserves increased by $14.4 billion in 2018 including valuation effects.
- End-2018 total reserves: $404 billion (24.9 percent of GDP).
- Assessment: Intervention limited to addressing disorderly market conditions since 2015; foreign exchange reserves around 110 percent of IMF composite reserve adequacy metric at end-2018.

### Potential Policy Responses (External and Structural)
- Significantly more expansionary fiscal policy to boost domestic demand in the short and longer run to reduce imbalances, given substantial fiscal space.
- Recalibration of policy mix to reduce reliance on monetary policy.
- Structural policies to facilitate rebalancing toward services and support domestic demand growth, including:
  - Strengthening the social safety net to lessen incentives for precautionary savings.
  - Addressing bottlenecks to investment.
- Exchange rate to remain market determined; intervention limited to addressing disorderly market conditions.

### Risk Assessment Matrix — selected risks and policy responses
- Global Risks:
  - Rising protectionism and retreat from multilateralism (High likelihood): Potential impact — weaken export growth, greater equity market volatility, capital outflows, currency weakening. Policy response — additional fiscal expansion and a cut in the monetary policy rate; maintain flexible exchange rate; support multilateral trade efforts.
  - Sharp tightening of global financial conditions (Medium likelihood): Potential impact — higher debt service and refinancing risks, capital account pressures. Policy response — rely on flexible exchange rate; ease macroprudential policies if needed.
  - Weaker-than-expected global growth (Medium likelihood): Potential impact — weaker Korean exports, spillovers. Policy response — maintain accommodative fiscal and monetary policies and a flexible exchange rate; diversify export markets and manufacturing base via structural policies.
  - China slowdown (High likelihood noted in text): Potential impact — significant spillovers given China is Korea’s largest trading partner. Policy response — fiscal expansion and monetary easing; maintain flexible exchange rate; diversify export markets.
  - Cyber-attacks (Medium likelihood): Potential impact — financial market volatility, capital outflows. Policy response — maintain accommodative fiscal and monetary policies and flexible exchange rate.

- Domestic Risks:
  - High household debt (Medium likelihood): Potential impact — weaker domestic demand, higher delinquencies, financial stress. Policy response — maintain accommodative fiscal and monetary policies; use macroprudential policies to limit banking system risks.
  - Policy easing (upside risk, Medium likelihood): Additional fiscal and monetary stimulus would support growth.
  - Faster progress in relations with North Korea (upside risk, Low likelihood): Potential impact — positive for investment and consumer sentiment. Policy response — prepare plans to support North Korea in cooperation with international community.

*Source: IMF staff estimates and projections as presented in the Korea Article IV consultation material.*

### Annex III. Public Debt Sustainability Analysis

### Annex III. Public Debt Sustainability Analysis

### Debt and Market Indicators (central government, in percent of GDP unless noted)
- Nominal gross central government debt: 30.9 (2017); 36.3 (2018); 36.6 (2019); 37.3 (2020); 37.2 (2021); 37.4 (2022); 37.8 (2023); 38.0 (2024)
- Gross financing needs: 5.8 (2017); 4.3 (2018); 4.4 (2019); 3.5 (2020); 3.9 (2021); 5.2 (2022); 5.7 (2023); 5.3 (2024); 5.9 (cumulative)
- Real GDP growth (percent): 3.1 (2017); 3.1 (2018); 2.7 (2019); 2.6 (2020); 2.8 (2021); 2.9 (2022); 2.8 (2023); 2.9 (2024); 2.9 (projection)
- Inflation (GDP deflator, percent): 2.0 (2017); 2.3 (2018); 0.3 (2019); 1.4 (2020); 1.7 (2021); 1.7 (2022); 1.8 (2023); 2.0 (2024); 2.2 (projection)
- Nominal GDP growth (percent): 5.2 (2017); 5.4 (2018); 3.0 (2019); 4.0 (2020); 4.5 (2021); 4.6 (2022); 4.7 (2023); 4.9 (2024); 5.2 (projection)
- Effective interest rate (percent, interest payments divided by prior-year debt stock): 3.8 (2017); 2.4 (2018); 3.0 (2019); 3.0 (2020); 3.2 (2021); 3.6 (2022); 4.0 (2023); 4.3 (2024); 4.5 (projection)
- Sovereign spreads: EMBIG (bp) -60; 5Y CDS (bp) 32
- Ratings: Moody's Aa2 / Aa2; S&Ps AAAA; Fitch AA- / AA-

### Changes in Debt and Identified Debt-Creating Flows (in percent of GDP)
- Change in gross central government debt: 1.5 (2017); 0.2 (2018); 0.3 (2019); 0.7 (2020); 0.0 (2021); 0.2 (2022); 0.4 (2023); 0.2 (2024); 0.01 (cumulative); 1.4 (cumulative)
- Identified debt-creating flows: -0.4 (2017); -1.8 (2018); -2.1 (2019); -0.6 (2020); -0.5 (2021); 0.0 (2022); 0.4 (2023); 0.5 (2024); 0.7 (cumulative); 0.5 (cumulative)
- Primary deficit (excluding Social Security Fund): 1.0 (2017); 0.0 (2018); -1.1 (2019); -0.3 (2020); 0.0 (2021); 0.3 (2022); 0.7 (2023); 0.8 (2024); 0.9 (cumulative); 2.4 (cumulative)
- Primary (noninterest) revenue and grants: 16.8 (2017); 17.8 (2018); 18.8 (2019); 19.2 (2020); 19.3 (2021); 19.2 (2022); 19.1 (2023); 19.1 (2024); 19.1 (projection); 115.1 (cumulative)
- Primary (noninterest) expenditure: 17.8 (2017); 17.8 (2018); 17.7 (2019); 18.9 (2020); 19.2 (2021); 19.5 (2022); 19.8 (2023); 19.9 (2024); 20.0 (projection); 117.5 (cumulative)

### Automatic Debt Dynamics (contributions, in percent of GDP)
- Automatic debt dynamics: -1.4 (2017); -1.9 (2018); -1.0 (2019); -0.3 (2020); -0.5 (2021); -0.4 (2022); -0.2 (2023); -0.2 (2024); -0.2 (cumulative); -1.9 (cumulative)
- Interest rate/growth differential: -1.4 (2017); -1.8 (2018); -1.1 (2019); -0.3 (2020); -0.5 (2021); -0.4 (2022); -0.2 (2023); -0.2 (2024); -0.2 (cumulative); -1.9 (cumulative)
  - Of which: real interest rate contribution: -0.5 (2017); -0.8 (2018); -0.1 (2019); 0.6 (2020); 0.6 (2021); 0.7 (2022); 0.8 (2023); 0.8 (2024); 0.8 (cumulative); 4.2 (cumulative)
  - Of which: real GDP growth contribution: -0.9 (2017); -1.0 (2018); -0.9 (2019); -0.9 (2020); -1.0 (2021); -1.0 (2022); -1.0 (2023); -1.1 (2024); -1.1 (cumulative); -6.1 (cumulative)
- Exchange rate depreciation contribution: 0.0 (all years shown)
- Other identified debt-creating flows: 0.0 (all years shown)
- Net privatization proceeds (negative): 0.0 (all years shown)
- Contingent liabilities: 0.0 (all years shown)
- Residual, including asset changes: 1.8 (2017); 2.1 (2018); 2.4 (2019); 1.3 (2020); 0.5 (2021); 0.2 (2022); -0.1 (2023); -0.4 (2024); -0.6 (cumulative); 0.9 (cumulative)

### Baseline and Scenario Assumptions (selected underlying assumptions, in percent)
- Baseline Real GDP growth: 2.6 (2019); 2.8 (2020); 2.9 (2021); 2.8 (2022); 2.9 (2023); 2.9 (2024)
- Baseline Inflation: 1.4 (2019); 1.7 (2020); 1.7 (2021); 1.8 (2022); 2.0 (2023); 2.2 (2024)
- Baseline Primary Balance: 0.3 (2019); 0.0 (2020); -0.3 (2021); -0.7 (2022); -0.8 (2023); -0.9 (2024)
- Baseline Effective interest rate: 3.0 (2019); 3.2 (2020); 3.6 (2021); 4.0 (2022); 4.3 (2023); 4.5 (2024)
- Constant Primary Balance Scenario Primary Balance: 0.3 (2019); 0.3 (2020); 0.3 (2021); 0.3 (2022); 0.3 (2023); 0.3 (2024)

### Composition of Public Debt and Alternative Scenarios (high-level)
- Gross Nominal Public Debt trajectory (in percent of GDP) shown for Baseline, Historical, Constant Primary Balance from 2017 through 2024 with projected range near 36–38 percent of GDP by 2024.
- Public Gross Financing Needs (in percent of GDP) projected in the 3.5–5.9 range across years shown.
- By maturity: breakdown into short-term and medium-and long-term shown historically and projected through 2024.
- By currency: local currency-denominated and foreign currency-denominated composition shown historically and projected through 2024.

### Key methodological notes (as specified in source)
- Public sector defined as central government; data exclude the Social Security Fund (SSF) for balances because SSF accounts are in surplus and accumulate assets.
- Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.
- Automatic debt dynamics formula derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; e = nominal exchange rate depreciation.
- Interest rate/growth differential contribution details and exchange rate contribution defined as per footnotes in the source.

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*Source: IMF staff. As of March 29, 2019.*

### 11.      The authorities have put in place measures to safeguard financial stability and reduce

### 11.      The authorities have put in place measures to safeguard financial stability and reduce

### Macroprudential and housing measures
- LTVs and DTIs were lowered.
- A debt service ratio (DSR) limit covering all forms of debt was introduced for banks in mid-2018 and will be extended to NBFCs in 2019.
- The risk-weighting of loans with LTVs above 60 percent was increased from 35 to 50 percent in June 2018.
- Policy goals: managing household debt growth, supporting vulnerable borrowers, and improving household loan structures from floating-rate interest-only to fixed-rate amortizing payment.
- The authorities intend to maintain household debt growth at around the rate of nominal GDP growth over the mid-to-longer term.
- The government will continue targeted measures by region to suppress speculative demand and support occupiers purchasing their own house.

### Foreign exchange policy transparency and FX macroprudential measures
- Data on FX interventions (in net trading volume) for the second half of 2018 were posted on the website of the BOK in March 2019; the next posting will be in September 2019 reporting net interventions in the first half of 2019.
- Afterwards, intervention records will be posted on a quarterly basis with a one-quarter reporting lag.
- From July 2018 to June 2019, biannual data for net purchases of foreign assets will be revealed with a time lag of 3 months; from July 2019 quarterly data will be provided within 3 months.
- The authorities view a levy on non-deposit foreign currency liabilities and a leverage cap on FX derivatives as macroprudential measures (MPMs) designed to prevent excessive short-term debt build-up and lengthen debt maturities; they emphasize these measures are not residence-based and were not intended to limit capital flows.

### Fiscal measures and social policy
- A supplementary budget of KRW3.8 trillion (0.2 percent of GDP) was approved in May 2018; the extra spending was used to boost youth employment through business subsidies.
- Welfare spending was expanded further in the 2019 budget.
- A tax revision bill was approved, which included an expansion of earned income tax credit to the bottom 32.5-50 percent of earners and an expansion in the eligibility of child tax credit.
- The authorities submitted a supplementary budget bill of KRW 6.7 trillion or 0.4 percent of GDP to the National Assembly; combined with grants already disbursed to local governments in early April (10.5 trillion KRW), additional fiscal support beyond the original budget would amount to around 0.9 percent of GDP.
- The increase in expenditure of 9.5 percent in the 2019 budget is at the highest level since the global financial crisis; the government committed 61 percent of the budget in the first half of 2019.
- Government spending increased by 18 percent (Q on Q) in Q4 of 2018.
- The authorities consider fiscal sustainability could be strengthened with additional revenue mobilization, mainly by broadening tax bases; they take a cautious position on increasing neutrality of corporate income taxation, preferring a holistic review of the tax system.

### Growth outlook, risks, and policy stance
- External uncertainties include US-China trade tensions and a global slowdown in the tech cycle, especially for semi-conductors which account for about 21 percent (customs clearance basis in 2018) of Korea’s exports.
- Growth in Q1 of 2019 unexpectedly dipped 0.3 percent (Q on Q), partly driven by temporary drop in government investment and base effects from large Q4 2018 spending.
- The authorities maintain this year’s growth target of 2.6-2.7 percent and expect a steady rise in export volumes from the second half of the year.
- Policy responses include expansionary fiscal spending and multi-pronged investment stimulus measures; the BOK will take a data-dependent approach to monetary policy, viewing the current policy rate as supportive and accommodative.
- The BOK has conjectured that the output gap has been slightly negative; differences with IMF estimates are attributed to IMF overestimation of potential GDP for 2010.

### Financial sector resilience and supervision
- Korea’s financial system has implemented the Basel III framework and conducts regular stress tests for the financial market.
- The BOK and the Financial Supervisory Services have implemented regular stress tests to monitor loss-absorbing capacity given financial institutions’ interconnectedness.
- The authorities emphasize combining MPMs with monetary policy to more effectively address overall financial stability risks.

### Structural and labor policies
- Regulatory sandbox law implemented (pre-permissive and post-regulatory) to promote innovation.
- Policy focus on four major service sectors: tourism; healthcare; smart-logistics; arts and entertainment contents (K-contents); increased R&D in driverless cars and artificial intelligence; tax benefits for private 5G network investments.
- Support for restructuring insolvent companies based on three principles—holding large shareholders responsible, sharing the burden among stakeholders, and ensuring companies make tough decisions to survive on their own.
- Labor market policies: transforming irregular workers to regular, strengthening the social safety net (including expanded unemployment benefits and active labor market policies), encouraging performance-based pay, and endorsing 52 working-hours per week as beneficial for well-being, productivity, female labor supply, and fertility.
- Minimum wage policy: temporary financial support to self-employed and SMEs to cushion adverse impacts; a bill to introduce a new minimum wage setting mechanism with two sub-committees (range-setting committee of experts and a decision-making committee) is under discussion.
- Plan to increase public employment, particularly in understaffed areas like security and welfare; public employment share in Korea is lower than half of the OECD average.
- Tackling low fertility and aging: the third basic plan released in February expands maternity benefits and a subsidy for shortening working hours for childcare, plans to increase paid parental-leave days for spouses at childbirth, establish more workplace daycare centers, and create a task force to investigate demographic change impacts across employment, budget, welfare, education, and industrial structure.

*Source: REPUBLIC OF KOREA — STAFF REPORT FOR THE 2019 ARTICLE IV CONSULTATION — INFORMATIONAL ANNEX (As of March 31, 2019; April 22, 2019).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1korea2019001.pdf_