## 1. Korea’s Health and Economic Response to the COVID-19 Outbreak ## Source details **Canonical URL:** [1. Korea’s Health and Economic Response to the COVID-19 Outbreak](https://www.imf.org/-/media/files/publications/cr/2021/english/1korea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1korea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1korea2021001.pdf.json) --- ### Pre‑COVID‑19 context - Per capita incomes exceed $30,000. - Growth slowed to an average of 2.8 percent over the last five years, reaching 2.0 percent in 2019. - Inflation was well below the Bank of Korea’s (BOK) two percent target. - Net international creditor position, adequate reserves, and a flexible exchange rate. - Public debt and borrowing costs were low; recent FSAP found most parts of the financial system prudentially sound and resilient, but noted vulnerabilities from high private debt. - Longstanding inequalities in education and labor markets (women, youth, elderly); rising housing prices in metropolitan Seoul. - Moon administration measures: substantially raised minimum wage, expanded public sector jobs, measures to expand housing supply and contain speculative demand. - Fiscal policy turned expansionary from 2019 onward to strengthen social safety nets. - Presidential elections due in March 2022 (presidents serve a single term). ### Recent economic developments and sectoral dynamics - Pandemic-driven cycle: - Infections first spiked in February leading to a downturn in Q1-2020; supply chain disruptions and reduced external demand intensified the downturn in Q2; new cases near zero by summer supported a rebound in Q3; recovery softened in Q4 with new infection highs. - Real GDP growth for 2020 at -1.0 percent. - Labor market and slack: - Employment declined by one million jobs (-3.7 percent) in March-April 2020; after a brief upturn, employment returned to that trough despite headline activity recovery. - High proportion of those losing jobs exited the labor force; negative output gap of around 2.5-3 percent of GDP in 2020. - K-shaped recovery: - Manufacturing and exports rebounded strongly; tech exports outperformed. - Business investment buoyant for exporting firms; services activity sluggish and consumption below pre-COVID levels. - Job losses concentrated among “non-regular” workers, lower-wage sectors, and disproportionately affected female and young workers. - Inflation: - Headline and core inflation remain below 1 percent despite rises in food and fuel prices. - Headline inflation increased to 1.1 percent y/y in February (from 0.6 percent in January); core inflation modest at 0.3 percent y/y (Jan.: 0.4 percent). - Staff forecasts headline inflation to reach 2 percent in the coming months, before falling to just above one percent by year‑end; projected to remain below target for some time. ### Korea’s health and containment response (key pillars) - Testing: - Aggressively ramped up testing capacity with fast-track approval for test kits and drive-through/walk-through facilities. - Korea performed more than 300 thousand tests by late March 2020. - Tracing: - Data-driven epidemiological investigations using credit card transactions, GPS, and other data; anonymized information disclosed to the public; wide deployment of digital tools (mobile apps) for contact tracing. - Treatment: - Triage to hospitalize high-risk patients while isolating/monitoring mild cases at community treatment centers; secured additional beds and temporary isolation rooms with portable negative pressure devices. - Central government coordination: - Central government led cooperation with private sector to accelerate test kit production, expand diagnostic networks, centralize COVID-related data, develop digital quarantine/isolation management tools, and intervened in markets when necessary (e.g., masks) via centralized purchasing and prioritized distribution. ### Policy response: fiscal, monetary, financial (measures and scale) - Fiscal measures: - Above-the-line fiscal support of 2.9 percent of GDP focused on disease control/prevention and support to affected businesses and workers. - Discretionary support rolled out in phases through four supplementary budgets. - First emergency relief transfer to all households in May was well-timed and helped lift household spending. - Overall fiscal balance for 2020 estimated at -4.1 percent of GDP, with an estimated fiscal impulse of 2.6 percent of GDP. - Monetary and liquidity measures: - BOK reduced policy rate by 75 basis points to 0.5 percent. - Unlimited repos temporarily offered; FX auctions tapping the U.S. Fed swap line used to ease dollar funding strains. - Small government bond purchases to prevent market volatility. - Credit and market support: - Credit facilities amounting to about 5.5 percent of GDP, including fresh loans and guarantees to SMEs via public banks and private institutions. - Industry stabilization fund, KDB-created SPVs to purchase low-rated corporate bonds and SME working capital loans. - Financial facilities and stabilization funds for equity and bond markets financed jointly by policy banks and private financial institutions. - Temporary easing of macro- and micro-financial regulations to preserve lending capacity. - Aggregate policy support figures (authorities’ summary): - Unprecedented policy support amounting to more than KRW 310 trillion (equivalent to USD 280 billion or around 16 percent of GDP), including four supplementary budgets (KRW 66.8 trillion) and financial support packages (more than KRW 175 trillion). - Three rounds of emergency relief payments: universal cash transfer KRW 14.3 trillion; targeted support KRW 17.1 trillion. - Authorities purchased 106 million doses of vaccines (for 56 million people) and are discussing purchase of 20 million additional doses; vaccinations began on February 26 with aim of inoculating 70 percent of the population by November. ### Financial conditions, credit, and systemic risks - Markets and funding: - After initial stress, financial market segments stabilized; domestic dollar funding costs temporarily spiked then eased. - Equity markets rallied to record highs; long-term equity risk premium fallen; Price-Earnings ratio near a record high. - Credit, leverage, and vulnerabilities: - Credit growth accelerated supported by policy measures. - Leverage gaps widened to 6 percent for households and 4 percent for firms. - Household debt over 190 percent of net disposable income in 2019 (among highest in OECD). - Pre-pandemic, around 15 percent (13 percent of GDP) of household debt owed by liquidity-constrained households. - About 50 percent of SME debt (22 percent of GDP) was “at-risk” entering the outbreak; around one quarter of non-financial corporate debt was at risk pre-COVID. - Bank provisioning has risen substantially since the COVID outbreak; NPL ratios remain low. - Regulatory responses and non-bank sector: - Steps to more tightly regulate securities-brokerage sector and increase disclosures; continue strengthening prudential and supervisory approach for policy banks; prudential tightening in asset managers’ leverage and liquidity ratios, mandatory stress testing, and consumer protection measures. ### Key findings and implications - Containment strategy limited need for stringent lockdowns and supported a milder GDP contraction relative to peers. - Targeted, phased fiscal support and emergency transfers boosted household spending at key moments. - Monetary, liquidity, and market-stabilization measures preserved market functioning and eased dollar funding strains. - Recovery is unequal: strong large, tech export‑oriented firm performance vs weak services sector; labor-market scarring risks for non-regular, female, and young workers. - Elevated household debt and pockets of corporate debt-at-risk (particularly SMEs) present medium-term financial stability concerns despite resilient banking system metrics and supportive policy interventions. --- ### External position, outlook, projections, and risks ### External position and current account - Preliminary estimates for 2020 suggest external position broadly in line with medium-term fundamentals. - Current account balance rose to 4.6 percent of GDP in 2020 from 3.6 percent in 2019. - Over the medium term, current account surplus projected to narrow to 4.3 percent of GDP as domestic demand recovers and transitory COVID factors recede. - NIIP in 2020: 27.1 percent of GDP; Gross Assets: 118.9; Debt Assets: 27.3; Gross Liab.: 91.8; Debt Liab.: 29.2 (all % GDP). - Reserves increased somewhat and remain adequate relative to Fund’s reserve adequacy metric; FX intervention in H1-2020 was $6.2 billion (net sales, excluding temporary use of the Fed swap line) and reserves increased by $11.7 billion through 2020‑Q3. ### Outlook and growth projections - Real GDP growth projected at: - 3.4 percent in 2021 - 2.9 percent in 2022 - Assumptions: - Gradual COVID-19 normalization domestically and externally with rollout of an effective vaccine in Korea through end-year. - Drag from fiscal impulse of -0.3 percent of GDP implicit in the 2021 budget. - Diminishing use of off-balance-sheet credit support. - Inflation: - Forecast to rise modestly to 1.2 percent in 2021 on higher commodity prices. - Recovery characteristics: - Exports and related fixed investment expected to remain key near-term growth drivers. - Divergence between exports/manufacturing (stronger) and services/consumption (weaker) likely to persist. - Medium-term output: - Pandemic projected to add to demographic-driven slowdown in potential growth. - Potential output would remain about 2.5–3 percent below the pre-shock path by 2025. - Output gap expected to close only gradually absent substantial additional policy measures. ### Risks to the outlook (selected) - Downside risks: - Renewed infection surges and slower vaccinations; second-round effects on consumption and investment from weakened household and SME balance sheets; negative spillovers if trade tensions recur; snapback in risk premia triggering outflows and asset price correction. - Upside risks: - Faster-than-expected containment; continued resilient semiconductor demand. - Risk assessment matrix highlights: - Unexpected shift in Covid-19 pandemic: Likelihood Medium; Impact High (downside). - Sharp rise in global risk premia: Likelihood Medium; Impact Medium. - Accelerating de-globalization: Likelihood Medium; Impact Medium. - NFC and household balance sheet stress: Likelihood Medium; Impact High. - Progress in normalizing relations with North Korea: Likelihood Low; Impact High (upside). --- ### Policy discussions and recommendations ### Near‑term priorities and macro stance - Key priorities: nurture ongoing recovery and solidify foundations for resilient, inclusive medium-term growth. - Given sizable slack, remaining downside risks, and available policy space, staff recommends a more accommodative stance than authorities’ current plans: - Somewhat easier fiscal and monetary policy than implied in authorities’ plans. - Maintain credit support programs until recovery broadens and then gradually phase them out. - Keep macroprudential policies geared toward maintaining and building resilience. - Focus structural policies on implementing and complementing the Korean New Deal (KND). ### Fiscal policy: stance, KND, and recommendations - 2021 budget implies some fiscal tightening relative to 2020: tightening estimated about 0.3 percent of GDP after cyclical adjustment. - KND: multi‑year fiscal package with expenditures of about 1 percent GDP per year; envisages KRW 114 trillion (equivalent to 5.9 percent of 2019 GDP) in public spending and KRW 45.9 trillion in associated private investment during 2020–2025. - Staff view: - A more expansionary fiscal stance for 2021 desirable; Korea has substantial fiscal space and administrative capacity. - Modestly positive or neutral overall fiscal contribution in 2021 would be appropriate. - Targeted support and anti‑scarring measures: - Speed expansion of social security to non-regular workers; temporarily extend unemployment benefit duration; strengthen job search support; increase basic pension for lowest-income quintile. - Accelerate feasible public investment projects (green and digital under KND). - Consolidation path and transparency: - Compared to pre-COVID medium-term plan, average deficits for 2021–2024 are 1.8 percent of GDP higher. - Recommendation: easier stance in 2021 followed by gradual consolidation in 2022–24; raise revenue‑GDP ratio over medium term. - Expand disclosures on use of public funds, including beneficial ownership of legal persons awarded government procurement contracts. ### Monetary policy stance and recommendations - Staff finds real neutral policy rate plausible range 0 to -1.5 percent; one‑year inflation expectations between 1.1 and 1.8 percent. - Real ex-ante policy rate just below midpoint of neutral range; current stance assessed as moderately accommodative. - Near-term recommendations: - Modest further easing of policy rate using remaining space above zero. - Forward guidance narrowing yields by signaling policy would not be tightened until actual inflation near target. - Targeted easing of credit conditions (expand BILSF or corporate bond/CP SPV). - If downside risks materialize: - Unlimited repo support could be reintroduced. - Negative rates appear less suited for Korea. - Expanded BOK purchases or yield curve control could be considered, with clear communication. ### Financial sector and macroprudential recommendations - Credit support: - Maintain credit support measures until recovery broadens; avoid corporate lending cliff as more than KRW 50tr in loan deferrals coming due in H1-2021. - Expand BILSF as needed; monitor and facilitate use of emergency credit facilities (Key Industry Stabilization Fund, Emergency Lending Program for Small Merchants, Working Capital Support Program). - Use partial loan guarantees and consider solvency support (equity/quasi-equity) for viable firms with weakened balance sheets. - Macroprudential stance: - Broadly proportionate to risks but tighten further if household credit continues to rise sharply. - Potential measures if lending growth persists: apply DSR ceiling at individual borrower level; raise stamp duties and capital gains taxes in overvalued areas; reduce weight applied to corporate credit; make borrower-based tools more forward-looking. - Introduce Sectoral Countercyclical Capital Buffer (SCCyB) set at zero initially, to activate if leverage gaps widen. - Non-bank sector: - Strengthen resilience per FSAP recommendations; supervisory guidance for policy banks; tighten asset managers’ leverage and liquidity ratios; mandatory stress testing; revisit short selling ban removal with retail protections and market-maker enhancements. ### Structural policy priorities and the Korean New Deal (KND) - KND objectives: foster new growth drivers post‑COVID, increase inclusiveness, make activity greener. - KND three pillars: - Digital New Deal: ICT infrastructure (including 5G), AI for smart factories, digitalized educational materials, smart healthcare. - Green New Deal: transition toward low-carbon economy, net-zero by 2050; investments in renewable energy, green remodeling, EV charging, hydrogen vehicle subsidies. - Social safety net: phased expansion of employment insurance coverage to non-standard workers; relaxation of basic livelihood security eligibility; future-oriented job training. - Implementation and scale: - Size of government spending on KND: one percent of GDP per year. - New Deal Fund and task force to mobilize private investment and implement legal/institutional reforms. - Authorities anticipate KRW 160 trillion of investment in the KND from central and local governments and private sector until 2025, creating 1.9 million jobs (authorities’ estimate). - Structural reform priorities: - Reduce legal barriers to entry and startup costs; simplify regulations to favor younger firms in digital medicine and biotechnology. - Lower regulatory barriers to competition to facilitate job-rich growth in services. - Deeper regional integration and trade agreements (RCEP participation noted). - Carbon pricing and green measures: - Korea pledges: cut greenhouse gas emissions by 37 percent below “Business as Usual” by 2030; carbon neutral by 2050. - Current emissions trading allowance price about $20/ton; achieving 2030 pledge requires substantial increase in allowance prices. - Staff suggests aligning emissions caps with 2030 target, a robust rising price floor, increase auctioning, and use revenue to compensate vulnerable groups and support R&D/investment. - Authorities consider a more moderate increase in carbon prices and assess macroeconomic impacts across mitigation policies. --- ### Public debt, DSA highlights, and contingent measures ### Public debt trajectory and key DSA figures (selected) - Nominal gross public debt (percent of GDP): 31.2 (2018), 34.3 (2019), 36.4 (2020), 43.2 (2021), 47.3 (2022), 51.5 (2023), 55.4 (2024), 58.8 (2025), 61.8 (2025) [table shows through 2025]. - Public gross financing needs: 2.7 (2018), 5.0 (2019), 8.0 (2020), 7.1 (2021), 7.0 (2022), 6.7 (2023), 6.3 (2024), 5.8 (2025). - Baseline projections (selected): - Real GDP growth: -1.0 (2020), 3.4 (2021), 2.9 (2022), 2.6 (2023), 2.4 (2024), 2.3 (2025). - Primary Balance (percent of GDP): -4.0 (2020), -3.3 (2021), -3.5 (2022), -3.5 (2023), -3.2 (2024), -2.9 (2025). - Effective interest rate: 2.0 percent (2020–2025 in baseline). - Identified debt‑creating flows and dynamics: - Change in gross public sector debt (cumulative): 0.9 (2018), 0.2 (2019), 2.1 (2020), 6.8 (2021), 4.1 (2022), 4.2 (2023), 3.9 (2024), 3.4 (2025), 3.0 (2025), cumulative 25.3. - Primary (noninterest) revenue and grants (percent of GDP): 17.6 (2018), 19.5 (2019), 19.4 (2020), 19.0 (2021), 19.0 (2022), 19.1 (2023), 19.2 (2024), 19.3 (2025), 19.4 (2025). - Primary (noninterest) expenditure (percent of GDP): 17.9 (2018), 18.4 (2019), 20.5 (2020), 23.0 (2021), 22.3 (2022), 22.7 (2023), 22.7 (2024), 22.5 (2025), 22.3 (2025). ### Policy‑relevant DSA updates and measures - Authorities proposed a supplementary budget for KRW 15tr (0.8 percent of GDP) targeted toward COVID relief and mitigation; with the supplementary budget the fiscal impulse in 2021 now estimated to turn positive (0.3 percent of GDP). - Authorities extended SME relief measures and temporary regulatory relaxations to reduce premature tightening of lending conditions; voluntary extension of loan deferrals permitted until September for qualifying SMEs and small merchants. --- *Source: INTERNATIONAL MONETARY FUND — 1. Korea’s Health and Economic Response to the COVID-19 Outbreak (IMF staff report excerpts and annexes).* ### 1. Korea’s Health and Economic Response to the COVID-19 Outbreak ___________________________ 4 ### 1. Korea’s Health and Economic Response to the COVID-19 Outbreak ### Pre-COVID-19 context - Macroeconomic fundamentals were sound with high income but sluggish growth: - Per capita incomes exceed $30,000. - Growth slowed to an average of 2.8 percent over the last five years, reaching 2.0 percent in 2019. - Inflation was well below the Bank of Korea’s (BOK) two percent target. - External and fiscal position: - Net international creditor position, adequate reserves, and a flexible exchange rate. - Public debt and borrowing costs were low. - Financial sector and vulnerabilities: - Recent FSAP found most parts of the financial system prudentially sound and resilient, but noted vulnerabilities from high private debt. - Social challenges and policy environment: - Longstanding inequalities in education and labor markets, especially for women, youth, and the elderly. - Rising housing prices in metropolitan Seoul (home to about half the population). - Moon administration measures: substantially raised minimum wage, expanded public sector jobs, measures to expand housing supply and contain speculative demand. - Fiscal policy turned expansionary from 2019 onward to strengthen social safety nets. - Presidential elections due in March 2022 (presidents serve a single term). ### Recent economic developments - Pandemic-driven cycle: - Infections first spiked in February leading to a downturn in Q1-2020. - Supply chain disruptions and reduced external demand intensified the downturn in Q2. - New cases near zero by the summer supported a rebound in Q3; recovery softened in Q4 with new infection highs. - Real GDP growth for 2020 at -1.0 percent. - Labor market and slack: - Employment declined by one million jobs (-3.7 percent) in March-April 2020; after a brief upturn, employment returned to that trough despite headline activity recovery. - High proportion of those losing jobs exited the labor force; underutilization concerns and potential scarring. - Negative output gap of around 2.5-3 percent of GDP in 2020. - Sectoral divergence (“K-shaped” recovery): - Manufacturing and exports rebounded strongly; tech exports outperform due to pandemic-driven online activity increases. - Business investment buoyant for exporting firms; services activity sluggish and consumption below pre-COVID levels. - Job losses concentrated among “non-regular” workers, lower-wage sectors, and disproportionately affected female and young workers. - Inflation: - Headline and core inflation remain below 1 percent despite rises in food and fuel prices. ### Korea’s health and containment response (Box 1) - Key pillars enabling control without stringent lockdowns: - Testing: - Aggressively ramped up testing capacity with fast-track approval for test kits and drive-through/walk-through facilities. - Korea performed more than 300 thousand tests by late March 2020. - Tracing: - Data-driven epidemiological investigations using credit card transactions, GPS, and other data; anonymized information disclosed to public. - Wide deployment of digital tools (e.g., mobile apps) to facilitate contact tracing. - Treatment: - Triage to hospitalize high-risk patients while isolating and monitoring mild cases at community treatment centers. - Rapidly secured additional beds and temporary isolation rooms with portable negative pressure devices. - Central government coordination: - Central government led cooperation with private sector to accelerate test kit production, expand diagnostic networks, centralize COVID-related data, and develop digital quarantine/isolation management tools. - Government intervened in markets when necessary (e.g., masks) via centralized purchasing and prioritized distribution. ### Policy response: fiscal, monetary, financial - Fiscal measures: - Above-the-line fiscal support of 2.9 percent of GDP focused on disease control/prevention and support to affected businesses and workers. - Discretionary support rolled out in phases through four supplementary budgets. - First emergency relief transfer to all households in May was well-timed and helped lift household spending. - Overall fiscal balance for 2020 estimated at -4.1 percent of GDP, with an estimated fiscal impulse of 2.6 percent of GDP. - Monetary and financial measures: - BOK reduced policy rate by 75 basis points to 0.5 percent. - BOK offered unlimited repos temporarily to ensure systemic liquidity and conducted FX auctions tapping the U.S. Fed swap line to ease dollar funding strains. - Some small government bond purchases to prevent market volatility. - Financial facilities to stabilize markets included equity and bond market stabilization funds financed jointly by policy banks and private financial institutions. - Credit facilities and measures: - Credit facilities amounting to about 5.5 percent of GDP, including fresh loans and guarantees to SMEs through public banks and private financial institutions. - Industry stabilization fund for financing and restructurings of large firms in severely affected sectors. - KDB-created SPV to purchase low-rated corporate bonds and an SPV to purchase SME working capital loans financed by the KDB. - Temporary easing of macro- and micro-financial regulations to preserve lending capacity. ### Financial conditions, credit, and systemic risks - Market and funding conditions: - After initial stress, financial market segments stabilized; domestic dollar funding costs temporarily spiked and then eased. - Equity markets rallied to record highs; long-term equity risk premium has fallen and Price-Earnings ratio near a record high. - Term and risk premia compressed; yields driven by expectations of future short-term rates. - Credit and leverage: - Credit growth accelerated supported by policy measures. - Leverage gaps widened to 6 percent for households and 4 percent for firms. - Household debt among highest in the OECD at over 190 percent of net disposable income in 2019. - Pre-pandemic, around 15 percent (13 percent of GDP) of household debt owed by liquidity-constrained households and at risk from a snapback in lending rates. - Housing market transactions and prices rose, particularly in greater Seoul, with signs of widening overvaluation. - Bank provisioning has risen substantially since the COVID outbreak; NPL ratios remain low. - About 50 percent of SME debt (22 percent of GDP) was “at-risk” entering the outbreak (those reporting current interest coverage ratios below one). - Around one quarter of non-financial corporate debt was at risk pre-COVID and likely rose since; most debt-at-risk owed by SMEs. - Regulatory responses: - Steps to more tightly regulate the securities-brokerage sector and increase disclosures, particularly for firms not under a financial holding company. ### Key findings and implications - Korea’s containment strategy limited the need for stringent lockdowns and supported a milder GDP contraction relative to peers. - Targeted, phased fiscal support and timely emergency transfers boosted household spending at key moments. - Monetary, liquidity, and market-stabilization measures preserved market functioning and eased dollar funding strains. - The recovery is unequal: strong performance among large, tech export-oriented firms and weak services sector outcomes with labor-market scarring risks for non-regular, female, and young workers. - Elevated household debt and pockets of corporate debt-at-risk (particularly among SMEs) present medium-term financial stability concerns despite resilient banking system metrics and supportive policy interventions. *Source: INTERNATIONAL MONETARY FUND — 1. Korea’s Health and Economic Response to the COVID-19 Outbreak.* ### 11. Preliminary estimates for 2020 suggest that the external position remained broadly in ### 11. Preliminary estimates for 2020 suggest that the external position remained broadly in ### External position and current account - Preliminary estimates for 2020 suggest that the external position remained broadly in line with medium-term fundamentals and desirable policies (Annex III). - Exports and imports declined sharply in the pandemic’s initial stages amidst supply chain disruptions and shutdowns in trading partners. - Exports rebounded since Q3-2020 and the services deficit narrowed due to continued COVID-related travel restrictions. - The current account balance rose to 4.6 percent of GDP in 2020 from 3.6 percent in 2019. - Over the medium term, the current account surplus is projected to narrow somewhat to 4.3 percent of GDP as domestic demand recovers and transitory factors stemming from the COVID shock recede. - After initial equity outflows by nonresidents, overall capital flows in 2020 have been buoyant, supported by bond inflows and a slowdown in outward investment by residents. - The won has appreciated and is stronger than pre-COVID levels in both nominal and real effective terms. - International reserves increased somewhat and remain adequate in comparison with the Fund’s reserve adequacy metric. ### Outlook and growth projections - Real GDP growth is projected at: - 3.4 percent in 2021 - 2.9 percent in 2022 - Assumptions embedded in the projection: - Gradual COVID-19 normalization both domestically and externally with rollout of an effective vaccine in Korea through end-year. - Drag from the fiscal impulse of -0.3 percent of GDP implicit in the 2021 budget. - Diminishing use of off-balance-sheet credit support. - Inflation: - Forecast to rise modestly to 1.2 percent in 2021 on higher commodity prices. - Projected to remain below target for some time. - Recovery characteristics: - Exports and related fixed investment expected to remain key near-term growth drivers. - Divergence likely to persist between exports/manufacturing (stronger) and services/consumption (weaker) in the near term. - Medium-term output and potential: - The pandemic is projected to add to demographic-driven slowdown in potential growth through: weakened corporate balance sheets; subdued employment due to labor force exits; frictions from sectoral shifts amid rigidities. - Potential output would remain about 2.5–3 percent below the pre-shock path by 2025 (text figure). - Output gap expected to close only gradually through the medium term absent substantial additional policy measures. ### Risks to the outlook - Overall uncertainty remains high (Annex IV); risks broadly balanced with COVID-related factors principal in both directions. - Downside risks: - Renewed surges in infections and slower vaccinations domestically or abroad. - Second-round effects on consumption and investment from weakened household and SME balance sheets. - Negative spillovers on the tech sector if trade tensions recur. - Snapback in risk premia triggering outflows and an asset price correction, impacting firms with large short-term gross financing requirements. - Upside risks: - Faster-than-expected containment of the pandemic. - Continued resilient semiconductor demand spurring exports and investment. ### Authorities’ views on outlook and external assessment - Authorities broadly agreed with staff’s outlook for growth and inflation in 2021. - Expected exports to continue leading the recovery; tech exports prospects still strong but dependent on global COVID-19 developments. - Anticipated policy measures to support consumption early in the year and a potential second-half boost from vaccination and re-opening. - Agreed economic slack is sizable and uncertainty in output gap and COVID-19 impact on potential growth is substantial. - Agreed with staff’s inflation views for 2021. - On risks, authorities agreed COVID-19 developments were the biggest risk factor and noted readiness to deploy additional support if risks materialize. - On external assessment, authorities agreed with the bottom-line findings of the preliminary 2020 external sector assessment. - They reiterated that the EBA model does not fully capture some Korea-specific factors (need to save more for demographic change and possible reunification) but considered the external balance position to be in equilibrium. ### Policy discussions — near-term priorities - Key policy priorities: nurture the ongoing recovery and solidify foundations for resilient, inclusive medium-term growth. - Given sizable economic slack, remaining downside risks, and available policy space, benefits of a more accommodative stance to spur private demand outweigh risks. - Recommendations for near term: - Somewhat easier fiscal and monetary policy than implied in authorities’ current plans. - Maintain credit support programs until recovery broadens across sectors and then gradually phase them out. - Keep macroprudential policies geared toward maintaining and building resilience. - Focus structural policies on implementing and complementing the Korean New Deal (KND) to leverage new drivers of growth and strengthen the safety net. ### Fiscal policy: stance and recommendations - The 2021 budget implies some fiscal tightening relative to 2020: - Tightening estimated to be about 0.3 percent of GDP after cyclical adjustment. - Tightening mainly reflects essentially flat nominal overall expenditure growth as expiration of some temporary transfers from 2020 offsets higher spending in R&D, infrastructure, and the environment. - Korean New Deal (KND) contribution: - KND is a multi-year fiscal package with expenditures of about 1 percent GDP per year to increase digital and green investment and strengthen the social safety net. - Spending reallocated within the approved budget to provide immediate transfers of 0.5 percent of GDP (KRW 9.3tr) to affected firms and workers, and budget execution is being frontloaded. - Staff view: - A more expansionary fiscal stance for 2021 would be desirable. - Korea has substantial fiscal space and sufficient administrative capacity to provide targeted fiscal support. - Fiscal policy likely to have a greater impact during accommodative monetary policy and economic slack; could help return discouraged workers to the labor force. - Modestly positive or neutral overall fiscal contribution in 2021 would be appropriate. - Targeted support and measures to prevent scarring: - Focus direct support on sectors lagging in the recovery and expand measures to enhance inclusion and equity. - Possibilities: speed expansion of social security to non-regular workers; temporarily extend unemployment benefit duration; strengthen job search support; increase basic pension for the lowest-income quintile. - Accelerate feasible public investment projects (green and digital under the KND). - Several measures would also boost medium-term potential growth. ### Fiscal consolidation path and transparency - Gradual consolidation recommended subsequently: - Compared to pre-COVID medium-term budget plan, average budget deficits for 2021-2024 are 1.8 percent of GDP higher. - Recommendation: easier stance in 2021 followed by gradual consolidation in 2022–24, achievable as COVID-related spending unwinds and by raising the revenue-GDP ratio over the medium term. - Transparency recommendation: - Expand disclosures on the use of public funds, especially beneficial ownership information of legal persons awarded government procurement contracts. - Facilitate implementation of relevant recommendations of the 2020 FATF/APG assessment to prevent conflicts of interest in public procurement processes. ### Fiscal rules and institutions - Government proposal for a fiscal rule: - Gross debt anchor at 60 percent of GDP and a flexible consolidated deficit target of 3 percent of GDP. - Includes an escape clause for extraordinary circumstances and provision to temporarily ease the deficit target by 1 percent of GDP in case of a slowdown. - Staff assessment: - Gross debt anchor prudent from a debt sustainability perspective. - Deficit target unlikely to stabilize debt near 60 percent of GDP; scope for countercyclical policy will hinge on effectiveness of the “slowdown provision” whose operational details remain to be finalized. - Consideration: an expenditure rule (annual ceilings on budgetary expenditure) could achieve countercyclicality without reliance on a slowdown provision, though it raises implementation challenges. - Recommend designation of an independent institution (e.g., a fiscal council) to monitor, review and enforce the rule. - Major modifications of the rule should be subject to National Assembly approval. - Authorities’ stance on the rule: - Viewed near-term fiscal policy as sufficiently accommodative while ready to provide additional support if warranted. - Reiterated commitment to prudent medium- and long-term fiscal management supported by the proposed rule. - Agreed on usefulness of establishing a council to oversee implementation, provided they retain latitude to formulate and amend the budget. - Preferred a deficit-based operational rule believing it allows countercyclicality via the slowdown provision and better compatibility with future revenue policy changes. ### Main labor market safety net measures in 2020 and staff recommendations (selected) - Job Retention Program (Existing): partial wage subsidies to prevent job losses. - Government eased application requirements and increased generosity of subsidies. - Staff: consider returning to pre-COVID status after the COVID shock. - Employment Insurance (Existing): coverage expanded to artists and people in cultural industries; some eligibility conditions relaxed. - Staff: during COVID shock extend duration (for young and mid-aged workers, and workers with shorter employment history) with reduced benefit. After shock, expand EI coverage to salaried workers with non-standard contracts. - Unemployment Assistance (New for self-employed; Existing for youth): emergency assistance to self-employed, freelancers, youth not covered by Employment Insurance. - Staff: as EI is expanded, unemployment assistance can focus on non-salaried workers and training afterwards. - Subsidized Family Care Leave (New): subsidy for applicants for family care leave to care for children. - Staff: consider making the subsidy recurrent, at least for double-earner families. - Household Emergency Relief Program (New, all households): a one-off transfer up to KRW 1 million per household. - Staff: untargeted transfers to households recommended only as last resort. ### The Korean New Deal (KND) — summary points - Launched July 2020 to mitigate COVID shock, facilitate digital and green transition, and achieve greater inclusiveness. - Three main pillars: - Digital New Deal: ICT infrastructure (including 5G), AI and 5G for smart factories, digitalized educational materials, smart healthcare, better targeting of safety net programs. - Green New Deal: transition toward low-carbon economy, net-zero carbon emissions by 2050, investments in renewable energy, green remodeling, EV charging facilities, fuel subsidies for hydrogen vehicles. - Social safety net: phased expansion of employment insurance coverage to non-standard workers; relaxation of eligibility for basic livelihood security benefits; establishment of “future-oriented” job training system. - KND envisages KRW 114 trillion (equivalent to 5.9 percent of 2019 GDP) in public spending and KRW 45.9 trillion in associated private investment during 2020-2025. - Aims to boost public and private investment; regulatory streamlining in utilities and transportation to facilitate private investment. *Source: IMF staff report text excerpted from the Korea 2021 Article IV Consultation chapter on Outlook, Risks, and Policy Discussions.* ### 26. The policy rate has been brought to ### 26. The policy rate has been brought to ### Monetary policy stance and neutral rate - Staff analytical work finds a plausible range for the real neutral policy rate of 0 to -1.5 percent. - One-year inflation expectations are between 1.1 and 1.8 percent. - The real ex-ante policy rate is just below the midpoint of the estimated neutral range. - Taking estimation uncertainty and the overall credit and financial conditions into account, staff assesses the current monetary stance as moderately accommodative. ### Near-term policy recommendations - Given the still-tentative recovery, sizable economic slack, and inflation well below target, a more firmly accommodative near-term stance would seem desirable to: - Support the recovery in private domestic demand. - Help avoid a cliff in lending as support from credit facilities diminishes. - Reduce the risks of entrenching an environment of below-target expectations and low-for-long interest rates. - Additional near-term accommodation instruments include: - A modest further easing of the policy rate, using the remaining space above zero and putting Korea’s rate in line with advanced economy peers. - Forward guidance narrowing yields by signaling that policy would not be tightened until actual inflation is near the target. - Targeted easing of credit conditions, for example by further expanding the Bank Intermediated Lending Support Facility (BILSF) or corporate bond/commercial paper SPV. ### If downside risks materialize: unconventional tools and liquidity backstops - Unlimited support through repo operations has provided an effective backstop and could be reintroduced if concerns over financial system liquidity arise. - Negative rates appear less suited for Korea because of the structurally low profitability of banks. - Expanded Bank of Korea (BOK) purchases—possibly through a program of yield curve control (YCC)—could increase lending and boost markets through the portfolio channel, given a majority of government securities are held by the domestic financial sector. - Any asset purchase program would need to be accompanied by clear communication about its rationale and objectives. ### Exchange rate policy, FX measures, and liquidity - The exchange rate has continued to move flexibly, with intervention limited to preventing disorderly market conditions. - FX intervention in H1-2020 was $6.2 billion (net sales, excluding temporary use of the Fed swap line) but returned to zero in 2020-Q3. - Reserves increased by $11.7 billion through 2020-Q3, due to interest on reserves and valuation gains from reserve assets not denominated in U.S. dollars. - Authorities eased the leverage cap on banks' FX derivatives positions and temporarily exempted the levy on FX funding to reduce initial strains on dollar funding and liquidity. - Authorities announced plans to strengthen FX liquidity regulations and monitoring for non-banks and improve the FX policy framework by launching an interagency FX macroprudential council. - A facility was created to be activated in times of stress that enables banks and non-bank financial institutions to obtain FX funding through repos of high-quality FX-denominated securities. ### Authorities’ views on monetary and FX policy - The BOK viewed its current accommodative monetary policy stance as appropriate, weighing macroeconomic and financial stability conditions comprehensively. - The BOK considered benefits of additional policy rate cuts outweighed by potential stability risks from further loosening in financial conditions. - The BOK expected excess capacity to diminish more quickly than staff did and expected inflation expectations to rise gradually. - The BOK saw ample scope for support through existing targeted instruments (BILSF and corporate bond/commercial paper SPV) if downside risks materialize. - The BOK emphasized that purchases of KTBs aimed to avoid market volatility upon news of increased supply, not to broadly loosen financial conditions. - The BOK did not anticipate conditions that would call for quantitative easing or other unconventional policy tools. - Authorities stressed commitment to exchange rate flexibility and limiting FX intervention to preventing disorderly market conditions, and viewed recent FX prudential steps as contributing to market stability. - The recently established FX repo facility is intended as a backstop to be activated when needed. ### Financial sector policy: credit support and SME focus - Credit support measures should be maintained until the recovery broadens across sectors, with sharpening of some tools to support SMEs. - More than KRW 50tr in loan deferrals are coming due in the first half of 2021 alone; the objective is to avoid a corporate lending cliff, especially for SMEs. - The BILSF, being bank-intermediated and involving viability screening, can be expanded as needed. - Authorities should keep conditions and focus under review to facilitate utilization of emergency credit facilities with unused balances, such as: - Key Industry Stabilization Fund - Emergency Lending Program for Small Merchants - Working Capital Support Program - Continued risk sharing through instruments such as partial loan guarantees may be needed to help maintain bank lending to firms in hardest hit sectors as loan deferrals expire. - Consideration may be needed for solvency support, including through equity and quasi-equity instruments, for viable firms with severely weakened balance sheets. - Once the recovery broadens, a gradual withdrawal of support will be appropriate; indicators to guide withdrawal include banks’ lending standards, projected/budgeted lending growth, and indicators of corporate financial health (particularly recovery in operating revenues across sectors). ### Macroprudential stance, household credit, and housing supply - The macroprudential stance appears broadly proportionate to risks but should be tightened further if household credit continues to rise sharply. - Mitigating factors: relatively low LTV ratios, low incidence of subprime lending, and rising shares of secured and fixed-rate amortizing lending. - FSAP stress tests suggest household and non-financial corporate balance sheets are relatively resilient. - Recent tightening in prudential limits and bank risk management on unsecured household lending was appropriate. - Staff analysis shows borrower-based prudential policies that constrain leverage are effective in moderating downside risks to future house price growth and containing probabilities of household debt default. - Potential additional measures if household lending growth does not relent: - Apply the DSR ceiling at the individual borrower level. - Raise stamp duties and capital gains taxes for real estate purchases in areas considered overvalued. - Further reduce the weight applied to corporate credit to tilt bank credit composition away from households, given banks approaching prudential loan-to-deposit ceilings. - Make borrower-based macroprudential tools more forward-looking by factoring in a borrower’s net present income stream across the life cycle. - Introduce a Sectoral Countercyclical Capital Buffer (SCCyB) set at zero initially, to augment the macroprudential toolkit and be activated if leverage gaps widen. ### Non-bank sector resilience and market functioning - Continue efforts to strengthen systemic resilience and address risks in the non-bank sector per FSAP recommendations, including: - Strengthening prudential and supervisory approach for policy banks. - Supervisory guidance for banks limiting dividend distributions, based on stress test results, through H1-2021. - Prudential tightening in asset managers’ leverage and liquidity ratios, mandatory stress testing, and the Consumer Protection Act to reduce mis-selling of structured products. - Revisit and adjust regulations as asset managers diversify strategies. - Use the current supportive financial conditions as an opportunity to remove the ban on short selling to improve price discovery and market risk management, while addressing equitable access through stronger sanctions, stepped-up monitoring, and enhanced role of market-makers. ### Authorities’ views on financial sector policy - Authorities will continue to monitor financial stability risks and further tighten prudential policies if necessary. - Authorities view household debt as a significant risk and remain concerned about rapid growth of mortgage loans and housing prices in some areas despite tight macroprudential stance. - Authorities support complementing macroprudential policies with measures to expand housing supply, particularly in the Greater Seoul area, and have introduced incentives for landowners to promote urban supply. - Authorities concur that the overall financial system remains resilient and are committed to maintaining strong bank capital positions and to using remaining room under existing support facilities, expanding some like the BILSF if necessary to avoid premature tightening of credit, especially for SMEs. - Authorities plan to level the playing field between retail and institutional investors prior to the planned lifting of the short-selling ban in May. ### Structural policy priorities - Reposition the economy for post-pandemic shifts while protecting vulnerable groups. - Facilitate reallocation of resources to new firms and industries by addressing longstanding rigidities in product and labor markets. - Strengthen social safety nets to protect vulnerable groups amid rapid change. *Source: IMF staff calculations.* ### 42. The KND seeks to foster new growth drivers in the post-COVID environment, increase ### The KND seeks to foster new growth drivers in the post-COVID environment, increase ### KND objectives and implementation - Aim: foster new growth drivers in the post-COVID environment, increase inclusiveness, and make economic activity greener (Box 2). - Promote digitalization throughout the economy to help close longstanding productivity gaps in the services sector, especially among small firms. - Size of government spending on the KND: one percent of GDP per year. - To mobilize private investment: authorities created a New Deal Fund to invest private and public funds in priority projects and sectors and established a task force to identify and pursue implementation of legal and institutional reforms to facilitate the KND’s objectives. ### Structural reform priorities to boost potential growth - Reduce legal barriers to entry and startup costs; simplify complex and burdensome regulations to create an environment favorable for younger firms in emerging industries such as digital medicine and biotechnology. - Lower regulatory barriers to competition to facilitate job-rich growth in the services sector, where productivity growth has lagged manufacturing and advanced-economy peers, resulting in a relatively small share of skill-intensive services in total employment and activity. - Deeper regional integration: planned participation in the Regional Comprehensive Economic Partnership and discussions on several additional free trade agreements. ### Insolvency framework and corporate restructuring - FSAP finding: Korea’s insolvency framework generally capable of efficient corporate reorganization and debt restructuring. - Recent measures: broadened access to the simplified insolvency process for SMEs; accorded seniority to post-commencement financing when a firm enters liquidation. - Suggested additional steps: - Promote out-of-court solutions under the Corporate Restructuring Promotion Act (not widely utilized). - Develop indicators for triage of SMEs and standardized options for their resolution. - Adopt pending FSAP recommendations to clearly delineate duties of directors and bar ipso facto clauses in executory contracts. ### Social safety net, labor market duality, and inclusiveness - COVID-19 impact: employment fell more among “non-regular” workers, who are more likely to be young or female, risking exacerbation of inequalities. - Temporary pandemic interventions mitigated effects but highlighted need for permanent reforms. - Steps being taken: broaden coverage of basic livelihood security programs and the employment insurance system; increase job matching assistance through allowances and training as planned in the KND. - Complementary prior measures: increased minimum wages, earned-income tax credits, and basic pensions—these strengthen automatic stabilizers. - Labor market reform trade-off: reducing labor market rigidity by making regular contracts more flexible remains critical; flexibility could be phased (apply only to new hires) or pursued after economic recovery. ### Carbon pricing and the green pillar - Korea’s pledges: cut greenhouse gas emissions by 37 percent below the “Business as Usual” baseline by 2030; aim to become carbon neutral by 2050. - Current emissions trading allowance price: about $20/ton. - To achieve the 2030 pledge: require a substantial increase in allowance prices from current levels of about $20/ton. - Suggested enhancements: - Align emissions caps with the 2030 mitigation target. - Underpin the system with a robust and rising price floor. - Increase auctioning of allowances; use additional revenue to compensate vulnerable groups, support R&D and investment in climate-smart technology, and lower the tax burden on labor and capital income. - Revenue-neutral fee/rebate schemes for vehicles and power generators with above/below average emission rates to reinforce incentives for mitigation and green investment without imposing a tax burden on the average household or firm or fiscal cost to the government. - Note: strengthened carbon pricing would lessen the likelihood of border adjustments applied by the EU to Korean exports. ### Authorities’ views - Authorities view the KND as a boost to growth via digitalization and new services-sector drivers; emphasize complementary product market reforms. - Recognize improvements in corporate governance and competition from recent reforms to the Commercial Act and the Fair Trade Act; endorse regulatory sandboxes to spur innovation and ongoing streamlining of regulations. - Agree on importance of strengthening social safety net and reducing labor market duality; prioritize labor market stability measures over increased flexibility until recovery, citing the need for intense dialogue between government, labor unions, and corporate representatives. - On climate change, authorities acknowledge importance of carbon pricing but expect the required increase to be more moderate than stylized staff calculations imply, given alternative mitigation tools; they are assessing macroeconomic impacts of various mitigation policies. ### Staff appraisal and policy recommendations - Assessment of pandemic response: Korea weathered COVID-19 comparatively well; authorities used policy space to cushion macro-financial effects, limit market volatility, and sustain credit flows. - Outlook: economy recovering unevenly; projected to grow at an above-trend rate in the near term from substantial slack; exports, investment, and manufacturing recovered more quickly than services and employment; uncertainty centers on pace of re-opening and vaccination progress, domestic and external. - Near-term priorities: nurture the recovery and solidify foundations for resilient, greener, and more inclusive growth. - Fiscal policy recommendation: aim for a more expansionary stance in 2021 than implied by the budget—raise targeted transfers to adversely affected workers and firms and accelerate public investment plans in 2021 to aim for a fiscal stance modestly positive or at least neutral in overall contribution; offset by gradual consolidation in subsequent years; implement the proposed rules-based public finances framework with an effective mechanism to enable counter-cyclical policies. - Monetary policy recommendation: some additional accommodation to underpin recovery and bring inflation closer to the BOK’s target via modest further policy rate easing, forward guidance, and facilities targeted at supporting credit to SMEs. - Exchange rate policy: allow flexible movement; limit intervention to preventing disorderly market conditions; welcome prudential measures to strengthen FX liquidity management of non-banks and the BOK’s FX repo facility. - Credit support and restructuring: avoid premature winding down of credit support programs, especially for SMEs; shift focus from liquidity provision to corporate restructuring and solvency support as recovery broadens. - Financial stability: system remained resilient; macroprudential policies appropriately set but be prepared to tighten if household credit rises sharply; cautious approach to bank dividend distributions preserved capital buffers; resume short selling to enhance price discovery while strengthening retail investor protection through regulation. - Concluding assessment: the KND is a welcome strategy to develop new growth drivers and increase inclusiveness; complementary reforms to reduce entry barriers, stimulate innovation, and tackle labor market rigidities can further boost potential growth; strengthening carbon pricing is important to achieve green pillar objectives and Korea’s mitigation goals. - Recommendation: next Article IV consultation to be held on the standard 12-month cycle. *IMF staff report excerpts.* ### Annex I. Follow-Up on Past IMF Recommendations ### Annex I. Follow-Up on Past IMF Recommendations ### Fiscal policies - Recommendation: Fiscal policy should remain expansionary into the medium term to support growth, job creation and external rebalancing. - Actions since 2019 Article IV Consultation: - Fiscal policies have been expansionary, as the overall balance declined by 2.2 percent of GDP in 2019 and another 3.5 percent of GDP in 2020. - Recommendation: Strengthen social safety nets and active labor market programs. - Actions: The basic pension was increased and an unemployment benefit for youth was introduced. The Korean New Deal envisages plans to increase the coverage of employment insurance and basic livelihood security programs, as well as job training programs. - Recommendation: Greater revenue mobilization to prepare for the aging population. - Actions: After the increase in corporate and personal income tax rates in 2018, the top personal income tax rate will further rise from 42% to 45% in 2021. ### Monetary and financial policies - Recommendation: Monetary policy should remain accommodative. - Actions: The policy rate was cut in four steps between July 2019 and May 2020 by 125 basis points in total. - Recommendation: Financial risks should be managed through macroprudential policies, rather than monetary policy. - Actions: Prudential limits on mortgage loans and unsecured household lending have been tightened. ### Structural policies - Recommendation: Enhance flexibility and security (flexicurity) in the labor market to mitigate duality and foster private sector job creation. - Actions: Increased coverage of employment insurance is planned under the Korean New Deal. Regarding flexibility, hours worked limits have been tightened. There have been no major changes to the restrictive employment protections applied to workers on open-ended contracts. - Recommendation: Better align minimum wage increases with labor productivity growth. - Actions: The minimum wage increased by 2.9 percent in 2020 and 1.5 percent in 2021, broadly in line with productivity growth, following a 10.9 percent increase in 2019. - Recommendation: Diversify the manufacturing sector and liberalize the services sector, by easing the regulatory burden on firms, lowering barriers to entry, and reducing protections to existing firms. - Actions: The Korean New Deal aims to foster new drivers of growth through investment in the digital and green economy and streamlining of applicable regulations. The overall regulatory environment, including that applicable to services, broadly continues in place. *Source: Annex I. Follow-Up on Past IMF Recommendations (from the provided content)* --- ### Annex II. Key Economic Policies in Response to COVID-19 ### Budgetary Fiscal Measures - Supplementary budgets in 2020. Four supplementary budgets approved for a net total of 2.9 percent of GDP: - March 17 (0.6 percent of GDP, net): Spending on disease prevention and treatment, loans and guarantees for affected businesses, and support for affected households and local economies. - April 30 (0.4 percent of GDP, net): Emergency relief transfers to households. - July 3 (1.4 percent of GDP, net): Spending on credit support programs, wage support programs for firms, COVID-19 health response, and Korean New Deal projects, among other measures; downward adjustment in revenue projection. - September 22 (0.4 percent of GDP, net): Spending to support SMEs, employment, low-income households, and daycare costs, among other measures. - Emergency transfers from 2021 budget. December 29, 2020 (0.5 percent of GDP, zero net as it was a reallocation within the 2021 budget). Emergency relief transfers to firms and workers. ### Monetary Policy - Policy interest rate: Reduced by 75 basis points to 0.5 percent in two steps (March and May). - Liquidity provision: Repo operations available in unlimited amounts at the policy rate plus 10 basis points (April-July). Eligible participants and securities for repos and open market operations were temporarily expanded. - Bond purchases: BOK acquired KRW 6 trillion in four one-off purchases (March-August 2020) and KRW 5 trillion under a plan announced for September-December 2020. Announced plans to acquire up to KRW 7 trillion in February-June 2021. ### Support for Credit and Financial Markets - Small business/SME lending and guarantee programs: Various programs through policy banks and commercial banks for up to KRW 65.5 trillion (initiated February-May 2020, expanded January 2021). BOK increased ceiling on bank-intermediated SME lending facility by KRW 18 trillion in three steps (March, May, and October). - Bond market stabilization fund: Invest up to KRW 10 trillion in corporate bonds, bank debentures, and commercial paper, with option of expanding to KRW 20 trillion (April). Other measures include liquidity support for securities firms, programs for corporate bond underwriting and refinancing, and support of primary collateralized bond obligation issuance. - Corporate bond-backed lending facility: Temporary BOK facility to provide loans to financial institutions with high-quality bonds as collateral, up to KRW 10 trillion (April). - Special purpose vehicle for fixed-income instruments: Funded by Korea Development Bank and BOK, to purchase corporate bonds, commercial paper, and short-term debts. Instruments with credit ratings from AA to BBB are eligible. Established for KRW 10 trillion, can be expanded to up to KRW 20 trillion (July). - Equity market stabilization fund: Invest up to KRW 10.7 trillion in equities, funded by public and private financial institutions (April). - Key industry stabilization fund: Established fund to provide support of up to KRW 40 trillion through loans, payment guarantees, and other investments under conditions that could include maintaining employment, limiting dividend payouts, and restructuring, among others (May). - Trade financing: Extend maturity of trade credit and raise ceiling for export insurance, among other measures, for a total of up to KRW 36 trillion (April). - Regulatory measures: Temporarily permitted loan-to-deposit ratio above regulatory ceilings for various institutions (April 2020-June 2021). Temporarily lowered total liquidity coverage ratio to 85 percent from 100 percent (April 2020-March 2021). Temporarily prohibited short selling of equity shares (March 2020-May 2021). ### FX Funding - Fed swap line: Swap line with U.S. Federal Reserve for US$60 billion (March). - Leverage cap on FX derivative positions for banks: Raised existing limits by 25 percent (March). - Levy on financial institutions’ non-deposit FX liabilities: Temporarily set at zero (April-June). - FX liquidity coverage ratio: Temporarily lowered to 70 percent from 80 percent (April 2020-March 2021). - BOK repo facility: Created a facility to be activated in times of stress, for financial institutions to repo FX-denominated securities with the BOK. *Source: Annex II. Key Economic Policies in Response to COVID-19 (from the provided content)* --- ### Annex III. External Stability Assessment ### Overall Assessment and Policy Responses - Overall Assessment: On a preliminary basis, and adjusting for transitory factors, recent developments suggest that the external position in 2020 remained broadly in line with the level implied by medium-term fundamentals and desirable policies. The CA surplus widened from the 2019 level on account of a recovery in exports, lower oil prices, and narrowing of the service sector deficit, and is projected to narrow slightly over the medium term as domestic demand recovers and transitory factors related to the COVID-19 shock recede. However, this assessment is subject to uncertainty given the preliminary nature of data for 2020 and the impact of the COVID-19 crisis. The final assessment will be provided in the 2021 External Sector Report. - Potential Policy Responses: To support activity following the COVID-19 outbreak, the authorities have deployed fiscal and monetary stimulus, of which a substantial part is expected to be temporary. Ensuring that the external position remains in line with medium-term fundamentals will require continued accommodative fiscal and monetary policies, as well as structural policies to stimulate investment and facilitate rebalancing of the economy toward services and other new growth drivers. Desirable reforms include reducing barriers to firm entry and investment, deregulating the non-manufacturing sector, and strengthening the social safety net to lessen the need for precautionary saving across sectors. Reforms in some of these areas are contained in the authorities’ Korean New Deal, to be implemented over the next five years. The exchange rate should remain market determined, with intervention limited to preventing disorderly market conditions. ### Foreign Asset and Liability Position and Trajectory - Background: The NIIP has been positive since 2014. Data for 2020 imply that Korea’s NIIP was 27.1 percent of GDP, with gross liabilities at 91.8 percent of GDP, of which around one-third was gross external debt. The NIIP declined by about 3 percent of GDP from the 2019 level, largely reflecting valuation effects resulting from a sharp rally in domestic equity prices in the second half of 2020. The NIIP is projected to rise to about 50 percent of GDP in the medium term, on the back of CA surpluses and search-for-yield activity by financial institutions driven by asset accumulation for old-age consumption. - Assessment: The positive NIIP is a source of external sustainability. Foreign asset holdings are diversified, with around 43 percent held in equity or debt securities. About 60 percent of foreign assets are denominated in U.S. dollars, implying won depreciation could have positive valuation effects. The structure of liabilities limits vulnerabilities, with equity and direct investment accounting for around 60 percent of total liabilities. - 2020 (% GDP): NIIP: 27.1; Gross Assets: 118.9; Debt Assets: 27.3; Gross Liab.: 91.8; Debt Liab.: 29.2 ### Current Account - Background: The CA surplus in 2020 widened to 4.6 percent of GDP from 3.6 percent in 2019, driven by a rebound in exports since 2020:Q3 and a narrowing of the services deficit due to COVID-19 travel restrictions. The CA surplus has been trending down from the peak of 7.2 percent of GDP in 2015, reflecting a fall in savings, particularly for the household sector, and increase in the investment-to-GDP ratio. Over the medium term, the CA surplus is projected to narrow slightly to 4.3 percent of GDP as export demand and the service sector balance normalize. - Assessment: The EBA model estimates the cyclically adjusted CA to be 4.4 percent of GDP. The CA norm is estimated at 3.6 percent of GDP, with a standard error of 0.9 percent of GDP. After accounting for transitory factors arising from the COVID-19 shock (in the tourism and oil sectors), staff estimates the 2020 CA gap midpoint to be 0.0 percent of GDP. The relative policy gap contribution is estimated at 1.9 percent of GDP, however this is driven mainly by large exceptional fiscal stimulus in the rest of the world relative to Korea, and not expected to persist over the medium term. - 2020 (% GDP): CA: 4.6; Cycl. Adj. CA: 4.4; EBA Norm: 3.6; EBA Gap: 0.8; COVID-19 Adj.: -0.8; Other Adj.: 0.0; Staff Gap: 0.0 ### Real Exchange Rate - Background: Following sustained appreciation during 2015–18, the REER depreciated in 2019 by around 4.5 percent, with the REER returning to its 2015 level. The REER depreciated further in the first half of 2020 before recovering somewhat more recently. Overall, the average REER for 2020 has depreciated by about 2 percent relative to the 2019 average. - Assessment: The staff CA gap implies a REER gap of 0 percent (applying an estimated elasticity of 0.36). The EBA REER index model estimates a REER undervaluation of 3.6 percent, while the REER level model estimates a 11.8 percent undervaluation. Staff uses the estimated CA gap for its assessment given the better fit of the EBA CA model. Consistent with the staff CA gap, staff assesses the REER to be in the range of -3 to 3 percent with a midpoint of 0. ### Capital and Financial Accounts: Flows and Policy Measures - Background: Net FDI and portfolio outflows have declined since 2017, when outflows peaked at 4.6 percent of GDP. Portfolio outflows were 3.6 percent of GDP in 2020, reflecting further portfolio diversification and institutional investors’ continued search for yield. Net FDI and portfolio outflows comprised the bulk of the 2020 financial account (1.4 and 2.5 percent of GDP, respectively), whereas other investments (net) recorded inflows (0.6 percent of GDP). Despite non-resident equity outflows in the first half of the year, overall capital flows have remained relatively stable in 2020, supported by portfolio debt inflows and a slowdown in outward FDI. - Assessment: The present configuration of net and gross capital flows appears sustainable over the medium term. In recent years, including in the context of the COVID-19 shock, Korea has demonstrated ample capacity to absorb short-term capital flow volatility. ### FX Intervention and Reserves Level - Background: Korea has a floating exchange rate. FX intervention appears to have been two-sided since early 2015, based on staff estimates and published data. As of end-2020, reserves stood at 27 percent of GDP reflecting legacy accumulation with valuation gains in 2020 from non-USD denominated assets. FX intervention data released by the Bank of Korea shows that it sold a net US$5. 9 billion (0.4 percent of GDP) in the first quarter of 2020 amidst depreciation pressures on the won. Net intervention was close to zero in the second and third quarter. During March-May 2020, the Bank of Korea temporarily drew US$20 billion from the US$60 billion swap line established with the Federal Reserve. - Assessment: Since 2015, intervention appears to have been limited to preventing disorderly market conditions. As of end-2020, FX reserves were around 115 percent of the IMF’s composite reserve adequacy metric which, together with access to the Federal Reserve swap facility, provides enough buffer against a wide range of possible external shocks. *Source: Annex III. External Stability Assessment (from the provided content)* --- ### Annex IV. Risk Assessment Matrix (Selected Risks, Likelihoods, Impacts, and Policy Responses) - Unexpected shift in the Covid-19 pandemic. - Likelihood: Medium - Impact of Risk: High (downside): Recovery would be more uneven and scarring deeper. Need for greater fiscal and monetary support could exhaust policy space. - Policy Response: Provide additional fiscal support to affected firms and workers; further ease monetary policy, including through larger asset purchase program to support liquidity in bond markets and the transmission of monetary policy; provide liquidity support to banks; expand financial facilities in place to maintain credit flows. - Upside scenario: Faster containment. Pandemic is contained faster than expected due to the rapid production and distribution of vaccines, boosting confidence and economic activity. - Likelihood: Medium - Impact: Medium (upside): Strong confidence impact in the near term; activity recovers faster than expected over the medium term and limits scarring. - Policy Response: Begin process of unwinding crisis measures while avoiding a hasty withdrawal of support that risks undermining the recovery. - Sharp rise in global risk premia exposes financial and fiscal vulnerabilities. - Likelihood: Medium - Impact of Risk: Medium: Vicious circle of tighter financial conditions, higher risk aversion, deleveraging, and lower growth. - Policy Response: Extend market stabilization measures already in place; expand BoK asset purchase program to support liquidity in bond markets, compress risk premia, and strengthen the transmission of monetary policy; and provide liquidity support to banks. - Accelerating de-globalization. - Likelihood: Medium - Impact of Risk: Medium: Given that Korea is an open economy, trade restrictions to re-shore and protect supply chains could reduce exports and growth. - Policy Response: Engage in support for the multilateral rules-based trading system and advocate trade liberalization. - Non-financial corporate (NFC) and household balance sheet stress. - Likelihood: Medium - Impact of Risk: High: Recovery would be more uneven and scarring deeper. - Context: Around 50 percent of SME debt is at-risk, with the sector employing around 70 percent of the workforce. Household debt is among the highest in the OECD. - Policy Response: Maintain accommodative fiscal and monetary policies. Use macroprudential policies to limit risks to the banking system. - Progress in normalizing relations with North Korea (upside risk). - Likelihood: Low - Impact of Risk: High: Domestic demand could be higher than anticipated. - Policy Response: Prepare plans on how to support North Korea, in cooperation with the international community. *Source: Annex IV. Risk Assessment Matrix (from the provided content)* *Source: IMF staff report content provided in the input (Annexes I–IV).* ### Annex V. Public Debt Sustainability Analysis ### Annex V. Public Debt Sustainability Analysis ### Debt indicators and projections (2009–2025; percent of GDP unless otherwise indicated) - Nominal gross public debt: 31.2 (2018), 34.3 (2019), 36.4 (2020), 43.2 (2021), 47.3 (2022), 51.5 (2023), 55.4 (2024), 58.8 (2025), 61.8 (2025) [table shows through 2025] - Public gross financing needs: 2.7 (2018), 5.0 (2019), 8.0 (2020), 7.1 (2021), 7.0 (2022), 6.7 (2023), 6.3 (2024), 5.8 (2025) - Real GDP growth (in percent): 3.2 (2018), 2.9 (2019), 2.0 (2020), -1.0 (2020 historical), 3.4 (2021), 2.9 (2022), 2.6 (2023), 2.4 (2024), 2.3 (2025) - Inflation (GDP deflator, in percent): 2.0 (2018), 0.5 (2019), -0.9 (2020), 1.1 (2021), 0.0 (2022), 0.7 (2023), 1.2 (2024), 1.6 (2025), 1.6 (2025) - Nominal GDP growth (in percent): 5.3 (2018), 3.4 (2019), 1.1 (2020), 0.1 (2021), 3.5 (2022), 3.6 (2023), 3.8 (2024), 4.0 (2025), 4.0 (2025) - Effective interest rate (in percent): 3.2 (2018), 2.3 (2019), 2.1 (2020), 2.0 (2021), 2.0 (2022), 2.0 (2023), 2.0 (2024), 2.0 (2025) - Sovereign spreads shown: EMBIG (bp) and Y CDS (bp) 27 (Y CDS) [table headers present; EMBIG (bp) 3/ - not populated] ### Contribution to changes in public debt (cumulative and annual components) - Change in gross public sector debt (cumulative): 0.9 (2018), 0.2 (2019), 2.1 (2020), 6.8 (2021), 4.1 (2022), 4.2 (2023), 3.9 (2024), 3.4 (2025), 3.0 (2025), cumulative 25.3 - Identified debt-creating flows (cumulative): 0.1 (2018), -0.6 (2019), 2.5 (2020), 6.8 (2021), 4.1 (2022), 4.2 (2023), 3.9 (2024), 3.4 (2025), 3.0 (2025), cumulative 25.4 - Primary deficit (in percent of GDP): 0.3 (2018), -1.1 (2019), 1.1 (2020), 4.0 (2021), 3.3 (2022), 3.5 (2023), 3.5 (2024), 3.2 (2025), 2.9 (2025), cumulative 20.4 - Primary (noninterest) revenue and grants (percent of GDP): 17.6 (2018), 19.5 (2019), 19.4 (2020), 19.0 (2021), 19.0 (2022), 19.1 (2023), 19.2 (2024), 19.3 (2025), 19.4 (2025), cumulative 115.1 - Primary (noninterest) expenditure (percent of GDP): 17.9 (2018), 18.4 (2019), 20.5 (2020), 23.0 (2021), 22.3 (2022), 22.7 (2023), 22.7 (2024), 22.5 (2025), 22.3 (2025), cumulative 135.5 ### Automatic debt dynamics and components - Automatic debt dynamics (percent of GDP): -0.6 (2018), -0.4 (2019), 0.4 (2020), 0.7 (2021), -0.6 (2022), -0.7 (2023), -0.9 (2024), -1.0 (2025), -1.1 (2025), cumulative -3.7 - Interest rate/growth differential (percent of GDP): -0.6 (2018), -0.4 (2019), 0.3 (2020), 0.7 (2021), -0.6 (2022), -0.7 (2023), -0.9 (2024), -1.0 (2025), -1.1 (2025), cumulative -3.7 - Of which: real interest rate: 0.3 (2018), 0.6 (2019), 1.0 (2020), 0.3 (2021), 0.8 (2022), 0.6 (2023), 0.4 (2024), 0.2 (2025), 0.2 (2025), cumulative 2.5 - Of which: real GDP growth: -0.9 (2018), -1.0 (2019), -0.7 (2020), 0.4 (2021), -1.4 (2022), -1.3 (2023), -1.3 (2024), -1.3 (2025), -1.3 (2025), cumulative -6.2 - Exchange rate depreciation contribution: 0.0 (2018), 0.0 (2019), 0.0 (2020) [no further values shown] - Other identified debt-creating flows: 0.4 (2018), 0.9 (2019), 1.0 (2020), 2.2 (2021), 1.4 (2022), 1.4 (2023), 1.3 (2024), 1.3 (2025), 1.1 (2025), cumulative 8.7 - Policy lending and other adjustment terms specified: 0.4 (2018), 0.9 (2019), 1.0 (2020), 2.2 (2021), 1.4 (2022), 1.4 (2023), 1.3 (2024), 1.3 (2025), 1.1 (2025), cumulative 8.7 - Residual, including asset changes: 0.8 (2018), 0.7 (2019), -0.4 (2020), 0.0 (2021), 0.0 (2022), 0.0 (2023), 0.0 (2024), 0.0 (2025) ### Baseline, historical, and alternative scenarios (selected assumptions and profiles) - Baseline Scenario (projections): - Real GDP growth: -1.0 (2020), 3.4 (2021), 2.9 (2022), 2.6 (2023), 2.4 (2024), 2.3 (2025) - Inflation: 1.1 (2020), 0.0 (2021), 0.7 (2022), 1.2 (2023), 1.6 (2024), 1.6 (2025) - Primary Balance (percent of GDP): -4.0 (2020), -3.3 (2021), -3.5 (2022), -3.5 (2023), -3.2 (2024), -2.9 (2025) - Effective interest rate: 2.0 (2020), 2.0 (2021), 2.0 (2022), 2.0 (2023), 2.0 (2024), 2.0 (2025) - Historical Scenario (alternative profile shown): - Real GDP growth: -1.0 (2020), 3.3 (2021), 3.3 (2022), 3.3 (2023), 3.3 (2024), 3.3 (2025) - Inflation: same as baseline (1.1, 0.0, 0.7, 1.2, 1.6, 1.6) - Primary Balance: -4.0 (2020), -0.1 (2021), -0.1 (2022), -0.1 (2023), -0.1 (2024), -0.1 (2025) - Effective interest rate: 2.0 (2020), 2.0 (2021), 2.1 (2022), 2.1 (2023), 2.2 (2024), 2.2 (2025) - Constant Primary Balance Scenario: - Primary Balance held at -4.0 for 2020–2025 - Other variables as in Baseline (Real GDP growth, Inflation, Effective interest rate) ### Composition of public debt and market indicators - Gross nominal public debt and public gross financing needs are charted by year (2018–2025) in percent of GDP (figures shown in source). - Debt by maturity: Medium and long-term versus short-term composition plotted for 2009–2025 (percent of GDP). - Debt by currency: Local currency-denominated versus foreign currency-denominated composition plotted for 2009–2025 (percent of GDP). ### Underlying technical assumptions and formulas - Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year. - Automatic debt dynamics 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; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar). - Real interest rate contribution derived as r - π(1+g); real growth contribution derived as -g. - Exchange rate contribution derived as ae(1+r). - Residual includes asset changes and interest revenues (if any); for projections includes exchange rate changes during the projection period. - Projections assume key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year. ### IMF staff update and policy-relevant developments (Staff statement, March 17, 2021) - Authorities proposed a supplementary budget for KRW 15tr (0.8 percent of GDP) targeted toward COVID relief and mitigation: relief and financing support for small business owners, employment retention and creation measures, and funding for vaccination rollout. - With the supplementary budget, the fiscal impulse in 2021 is now estimated to turn positive (0.3 percent of GDP), consistent with staff recommendations. - Authorities extended measures aimed at maintaining accommodative credit conditions: - For qualifying SMEs and small merchants, financial institutions permitted to voluntarily extend the deferral period on loan principal and interest payments until September. - Temporary reduction in banking system maximum loan-to-deposit ratios and minimum domestic and foreign currency liquidity coverage ratios have been extended. - These measures reduce the risk of a premature tightening in lending conditions, especially for SMEs. - GDP revisions and staff projection: - Small upward revision to Q4-2020 real GDP: 1.2 percent (q/q) in Q4 (from 1.1 percent). - Annual growth in 2020 remained at -1.0 percent. - Staff projects growth of 3.6 percent in 2021 (after stimulus and supplementary budget). *Source: IMF staff.* ### 4. Inflation in February was in line with staff projections. Headline inflation increased ### 4. Inflation in February was in line with staff projections. Headline inflation increased ### Inflation developments - Headline inflation increased to 1.1 percent year-on-year, from 0.6 percent in January, driven by rising food and fuel prices. - Core inflation remained modest at 0.3 percent year-on-year (Jan.: 0.4 percent). ### Staff forecasts and outlook for inflation - Staff forecasts headline inflation to reach 2 percent in the coming months on higher commodity prices and base effects, before falling to just above one percent by the end of the year. - The authorities shared staff’s views on inflation which is projected to remain at a little over 1 percent in 2021. ### Statement by Korean authorities (March 17, 2021) - On behalf of the Korean authorities: Chang Huh, Executive Director for Republic of Korea; Byung Hee Yoo, Senior Advisor to Executive Director; and Jinhyuk Yoo, Advisor to Executive Director. - The authorities thanked Mr. Andreas Bauer and his team for candid and constructive discussion during the 2021 Article IV consultations. - The authorities value staff’s continuous engagement and broadly agree with staff’s assessment on the economic outlook and policy recommendations. - Despite the contraction brought on by the pandemic last year, the Korean economy has remained resilient through strong economic fundamentals and appropriate policy responses. ### COVID-19 response and vaccination (authorities’ description) - Korea managed to contain the spread without strict lockdowns via: extensive testing, rigorous contact tracing, prompt isolation of confirmed cases, transparent disclosure of COVID-related information, nation-wide compliance with containment measures (e.g., wearing masks), utilization of ICT technologies, and innovative measures such as drive-through testing. - The authorities have secured enough COVID-19 vaccine to cover the entire population. - Vaccinations began on February 26 with the aim of inoculating 70 percent of the population by November this year; initial priorities: medical staff and the elderly group. - The authorities pursued a two-track approach balancing containment and economic recovery, deploying fiscal, monetary, and financial measures. ### Fiscal and financial policy responses (quantified) - Unprecedented policy support amounting to more than KRW 310 trillion (equivalent to USD 280 billion or around 16 percent of GDP), including: - Four supplementary budgets (KRW 66.8 trillion). - Financial support packages (more than KRW 175 trillion). - Three rounds of emergency relief payments: - Universal cash transfer to the entire population (KRW 14.3 trillion). - Targeted support to those most affected (KRW 17.1 trillion). - Employment-focused supports: - Employment Retention Subsidy (KRW 2.7 trillion) covering up to 90 percent of allowances for paid leave. - Emergency Employment Stability Subsidy (KRW 2.6 trillion) for freelancers and non-regular workers. - Measures to restore consumption and facilitate investment and export included distribution of discount coupons (equivalent to USD 1.8 billion) for culture and hospitality sectors, streamlining investment tax incentives, and creating online platforms for exporting SMEs. - The authorities have purchased 106 million doses of vaccines (for 56 million people) with four pharmaceutical companies and are discussing the purchase of 20 million additional doses. ### Recent developments and macro outlook (findings and projections) - 2020 outcomes: - Real GDP contracted by 1.0 percent. - CPI inflation: 0.5 percent in 2020; core inflation averaged 0.4 percent. - Employment decreased by about 218,000; unemployment rate 4.0 percent, up 0.2pp compared to 2019. - Current account surplus reached USD 75.3 billion in 2020, up by USD 15.6 billion from the previous year. - Quarterly real GDP growth (positive Q-o-Q): - 3Q: 2.1 percent - 4Q: 1.2 percent - Authorities’ 2021 growth projection: 3.0-3.2 percent reflecting rebound in exports and domestic demand. - Drivers cited for 2021 growth: continued facility investment, strong government spending, rebound in exports, upturn in the semiconductor cycle, investment plans in new industry areas (electric vehicles and bio-health), and moderate rebound in private consumption. - The authorities noted disagreement with the Fund on medium-term potential growth, viewing the Fund’s estimate as somewhat large due to IMF’s overestimation of total factor productivity. - The authorities concur with staff that uncertainty remains elevated; principal downside risks: recurrent surges in infections and delayed vaccinations; other downside risks: disruptions in global value chains, continued US-China trade tensions, sudden reversal of risk sentiment in financial markets. ### Fiscal policy near-term stance and measures - Authorities concurred fiscal policy should continue to play a critical role and remain expansionary. - Fiscal execution in 2020: highest ever recorded at 97.8 percent. - 2021 budgetary expenditure will be increased by 8.9 percent compared to the 2020 original budget. - The 2021 budget aims to: - Maintain COVID-related support. - Strengthen momentum for economic recovery. - Support national priorities: digital transformation and a greener and more inclusive economy. - Government plans to frontload spending—committing 63 percent of the budget in the first half of the year—focusing on job creation and SOC projects. - Government submitted a proposal of supplementary budget amounting to KRW 15 trillion early this month to: - Provide emergency relief subsidy to those most affected (small merchants, vulnerable workers including freelancers and platform workers without employment insurance coverage). - Support employment retention and job creation. - Increase spending for COVID-19 vaccine rollout. - The unprecedented expansionary government spending has widened the budget deficit to 4.4 percent. *IMF document: 4. Inflation in February was in line with staff projections. Headline inflation increased* ### 1.5 percent of GDP in the original budget plan in 2020. Although Korea’s government ### 1korea2021001 - 1.5 percent of GDP in the original budget plan in 2020. Although Korea’s government ### Fiscal policy and fiscal rule - Government debt to GDP remains low at around 40 percent as of 2020 compared with other OECD countries. - The government submitted to the National Assembly a proposal of fiscal rule that: - ensures flexibility to manage the government’s debt and fiscal deficit instead of targeting a specific level for either one; - contains a transition period of three years before the national fiscal rules take effect in 2025; - includes a complementary provision that ensures countercyclicality by easing the fiscal balance rule by 1 pp in case of a downturn, in addition to an escape clause in case of a crisis. - The government views the staff recommendation to introduce an expenditure rule as not appropriate at this stage because structural change on the revenue side is expected given increasing welfare expenditure; an expenditure rule can later be considered as an additional operative rule for fiscal sustainability once the government-proposed fiscal rule is well in place and operationalized. - The specific conditions of the escape clause and relaxation provision for fiscal balance rule will be discussed during legislation of the fiscal rule. - Due attention will be paid to the staff recommendation on the designation of an independent institution such as a fiscal council. ### Monetary policy and exchange rate policy - The Bank of Korea (BOK) pursued accommodative monetary policy through a wide range of policy tools to minimize the negative impact on the economy from the pandemic. - In 2020, the BOK: - lowered its policy rate by 75 basis points to 0.5 percent; - temporarily offered unlimited repos; - raised the ceiling on the Bank Intermediated Lending Support to SMEs by KRW 18 trillion to KRW 43 trillion; - introduced Corporate Bond-Backed Lending Facility as a safety net for banks and non-bank financial institutions (NBFIs). - Footnote: BOK’s Corporate Bond-Backed Lending Facility expired on February 3, 2021 as Korea’s financial markets have stabilized and liquidity conditions have been favorable. - The authorities consider the current policy rate supportive and accommodative considering the all-time low interest rate, high money and credit growth, and loose financial conditions. - The BOK is cautious against pre-emptively providing additional monetary accommodation unless economic conditions deteriorate significantly; it noted an additional policy rate cut could have a limited effect on the real sector and may increase the risk of financial imbalances. - The BOK would consider various policy tools as necessary but does not regard yield curve control or negative interest rates as viable options for now. - Authorities implemented FX policy tools flexibly while maintaining a flexible foreign exchange rate regime: - reaffirmed that foreign exchange rate is determined in the market and FX intervention is conducted only in exceptional market conditions; - since December 2019, shortened the publication cycle of net purchase of US dollars for FX market stabilization from semi-annually to quarterly to enhance transparency; - during March 2020 FX market turbulence, relaxed FX macroprudential measures such as a levy on non-deposit foreign currency liabilities and a leverage cap on FX derivatives to ease funding burdens; - in January this year, announced a policy initiative to tighten monitoring on FX management of financial institutions, including measures to strengthen monitoring on FX liquidity of NBFIs, build FX liquidity backstop mechanisms for NBFIs, and recalibrate FX macroprudential regulations. - While authorities concurred with the primary role of macroprudential measures for financial stability, they called attention to the heightened risk of financial imbalances arising from funds concentrated in asset markets and increasing household debt. ### Financial sector policy - Korea’s banking sector entered the pandemic in a strong position and remains sound overall; financial soundness indicators are stronger than the previous year and asset quality indicators are very strong. - The financial sector supported SME borrowers by providing extension of maturity and deferral of loan payments totaling more than KRW 130 trillion. - Measures set to expire at end-March 2021 were extended six more months to September 2021 after consensus among authorities and financial institutions; an orderly exit plan will be discussed before then. - Authorities launched a wide range of financial support facilities to provide emergency credit for SMEs and small merchants and stabilize bond and stock markets. - Most financial support packages have functioned well; some, such as Key Industry Stabilization Fund, have shown low utilization as they are back-up measures and the economy weathered the COVID-driven downturn relatively well. - Temporary relaxations of regulations on financial institutions’ capital adequacy, liquidity, and asset quality—mostly until end-June 2021—were extended by six months due to ongoing virus spread. - In December 2020, authorities extended the SPV for corporate bond and commercial paper by six months to July 2021 and increased the portion of the SPV’s purchase for lower-credit bonds to 75 percent from the previous 70 percent. - Authorities agree with staff that overall household debt risks are limited and manageable given several mitigating factors, but share concern on increasing household loans (unsecured loans and mortgages) driven by asset market rallies: - increased scrutiny on bank risk management regarding unsecured loans; - reviewing a new and stricter DSR rule based on individual borrowers and lifetime income rather than current income; - see merit in introducing Sectoral Countercyclical Capital Buffer (SCCyB) and consider measures requiring banks to set aside additional capital in proportion to their household assets. - Housing market measures: - aim to stabilize housing markets by eradicating speculative demand and protecting end users; - committed to increasing housing supply through measures including relaxing regulation on floor area ratio and extra incentives for landowner-residents; - authorities differ with staff on the effect of pre-construction sales procedures and pre-sale price cap system, asserting these have helped stabilize markets and not prevented private developers from supplying houses. - Financial support facilities listed in the source include Emergency Lending Program for Small Merchants, Working Capital Support Program, Stock Market Stabilization Fund, Bond Market Stabilization Fund, Key Industry Stabilization Fund, and Special Purpose Vehicle to support Corporate Bond and CP Markets. ### Structural policies and medium-term transformation - The Korean New Deal (KND), announced July 2020, rests on three pillars: Green New Deal, Digital New Deal, and strengthening of safety nets. - Green New Deal objectives: - green transition of infrastructure and transportation; - increased supply of low-carbon renewable energy; - innovation-friendly ecosystem for green industries; - underpins Korea’s commitment to carbon neutrality by 2050. - Digital New Deal objectives: - digital transformation of traditional industries by strengthening systems for data, network and Artificial Intelligence. - Industrial policy direction set to green and digital: upgrading production processes in shipbuilding and steel; promoting new industries including future cars, bio-health and system semiconductors. - Authorities anticipate KRW 160 trillion of investment in the KND from central and local governments as well as private sector until 2025, which will create 1.9 million jobs. - Innovation and regulatory reform: - regulatory sandbox (pre-permissive and post-regulatory) approved 410 cases over two years, contributing to more than KRW 1.4 trillion of investment and around 2,800 of jobs created; - multi-ministerial Task Forces and relaxed regulatory measures related to start-ups; Government support extended to the service sector; Regulation Free Zones created in 2019. - Labor market and social safety nets: - commitment to strengthen social safety nets via unemployment benefits and active labor market policies (public employment services and vocational training); - extended coverage of Employment Insurance to artists in 2020 and plan to extend it to non-regular dependent workers in 2021; - working on roadmap to extend mandatory membership to the self-employed; - expanded eligibility of National Basic Livelihood Security by abolishing family-support obligation criteria. - Carbon neutrality by 2050: - plan to accelerate transition across energy, transportation, industry, and city-planning; promote low-carbon industries; - rebuild institutional foundation (taxes, levy, R&D subsidies, emission trading system) to strengthen carbon pricing and support low-carbon transition, introduce a dedicated fund, and increase green financing; - emission trading system (ETS) to be recalibrated in accordance with an upgraded target of carbon emission determined through comprehensive consultation with stakeholders; - authorities view a carbon price floor as premature as it may hinder market determination and reduce companies’ participation in the ETS; - government commits to take care of those left behind in the transition process. ### Corporate resolution and insolvency - The corporate resolution system in Korea is well-organized and authorities affirmed it would work well in the aftermath of the pandemic. - Korean companies have improved corporate balance sheets and reduced reliance on short-term financing, so large-scale corporate bankruptcies are not expected. - Little change in the overall trend of corporate restructuring cases; courts have sufficient capacity to cope with a potential increase of cases. - Corporate resolution system is under review to enhance effectiveness and efficiency. *Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1korea2021001.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1korea2021001.pdf_