## 1korea2022001 ## Source details **Canonical URL:** [1korea2022001](https://www.imf.org/-/media/files/publications/cr/2022/english/1korea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1korea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1korea2022001.pdf.json) --- ### Recent economic developments - Recovery and public health - Over 85 percent of the population now fully vaccinated; over half the population boosted. - Rapid vaccination in 2021, effective containment, and proactive policy support minimized scarring and sustained income growth. - Growth and sectoral performance - Real GDP growth in 2021: 4 percent. - Tech exports and related investment were key drivers; consumption recovery slower with many services segments below pre-COVID levels. - Supply bottlenecks that affected automotive production in mid-2021 appear to be normalizing. - Labor market and inflation - Employment and the unemployment rate at pre-COVID levels; labor force participation not fully recovered for 20–49 year-olds; underemployment and out-of-labor-force potential supply remain above previous norms. - Headline inflation rose to 3.6 percent in January. - Producer prices suggest potential continuation of inflationary pressures; wage increases modest when adjusted for productivity. - External and financial sector - Current account surplus in 2021 widened to around 4.9 percent of GDP. - Reserves increased by US$20 billion by end-2021, including IMF’s 8.2 billion SDR allocation. - Sovereign and corporate yields increased but remain low by historical standards; equity valuations close to record highs with some correction. - Household credit grew very rapidly during the pandemic; household debt levels very high among OECD countries. House price-to-income ratio at a multi-decade high; staff analysis indicates house prices are in overvaluation territory. ### Outlook and projections - Growth - Forecast: 3.0 percent in 2022; 2.8 percent in 2023. - Q1 2022 expected to soften due to omicron wave; supplementary budget partially buffers. - Above-trend growth projected rest of 2022 assuming relaxation of social distancing and normalization of private saving supporting consumption. - Productivity estimated to have increased by over 4 percent in 2021. - Medium-term potential growth projected between 2-2.5 percent. - Inflation - Headline inflation projected to remain above 3 percent most of 2022; moderate to about 2.5 percent by end-2022; 2 percent in 2023. - Core inflation projected to remain in the mid-2 percent range in 2022 before falling to about 2 percent in 2023. - External position - External position expected to remain broadly in line with fundamentals over medium term. - Current account surplus projected to narrow slightly in 2022 as transitory COVID factors recede. ### Risks and vulnerabilities - Downside growth risks - Global: Omicron/global COVID developments; geopolitical uncertainties; global monetary normalization causing abrupt slowdowns in trading partners; protracted supply chain disruptions; disorderly market adjustments. - Domestic: Rising COVID infections; elevated household debt; high real estate prices. - Inflation risks - Tilted to the upside from continued global price pressures, domestic supply disruptions, or higher pent-up demand for domestic services. - Possibility of stagflationary pressures if supply disruptions persist. - Financial risks - Financial conditions accommodative but risk sentiment may be turning; corporate bond rates risen; funds rotating from risk assets. - Duration risk increased due to search-for-yield; ABCP borrowings fallen partly due to tighter liquidity regulations. - A large share of SMEs vulnerable with weak balance sheets and low profitability. ### Key statistics and exact figures - Vaccination: over 85 percent fully vaccinated; over half boosted. - Real GDP growth: 4 percent in 2021. - Headline inflation: 3.6 percent in January. - Current account surplus: around 4.9 percent of GDP in 2021. - Reserves: increased by US$20 billion by end-2021, including IMF’s 8.2 billion SDR allocation. - Growth forecasts: 3.0 percent in 2022; 2.8 percent in 2023. - Productivity: estimated to have increased by over 4 percent in 2021. - Medium-term potential growth: between 2-2.5 percent. - Inflation path: headline inflation above 3 percent for most of 2022; about 2.5 percent by end-2022; 2 percent in 2023. - Tax revenues: 323.4 trillion won by end-November; projected to reach 343 trillion won or 16.6 percent of GDP in 2021; projected medium-term decline to around 15.5 percent of GDP. - Central government fiscal deficit: as of end-November stood at 1.1 percent of GDP; staff estimate end-year deficit around 2 percent of GDP. - Supplementary budget proposed by authorities: 16.9 trillion won. - Central government debt: 2019: 36.3 percent of GDP; 2020: 42.4 percent of GDP; 2021 (estimated): 43.6 percent of GDP. - General government debt: 2019: 42.1 percent of GDP; 2020: 48.9 percent of GDP; 2021 (estimated): about 50 percent of GDP. - Debt projections: central government debt projected about 52 percent of GDP by 2026; general government debt projected to approach 58 percent of GDP by 2026. - Public debt change (selected cumulative figures): 2019: 0.6; 2020: 2.0; 2021: 6.1; 2022: 1.2; 2023: 1.4; 2024: 1.5; 2025: 2.0; 2026: 1.7; projection cumulative to 2026: 9.5 (percent of GDP). - Primary deficit (central government, excl. social security fund) by year (percent of GDP): 2019: 0.0; 2020: 1.1; 2021: 3.8; 2022: 1.9; 2023: 2.4; 2024: 2.0; 2025: 2.0; 2026: 1.8; projection cumulative: 12.1. - CA assessment metrics (2021): 2021 CA: 4.9 percent of GDP; Cycl. Adj. CA: 5.3 percent of GDP; EBA Norm: 3.7 percent of GDP; EBA Gap: 1.5 percent of GDP; Staff Gap: 0.6 percent of GDP. - NIIP (2020): 35.3 percent of GDP; gross assets: 119.6 percent of GDP; gross liabilities: 84.3 percent of GDP. - Reserves as of end-2021: 25 percent of GDP; gross reserves rose by US$20 billion (1.1 percent of GDP) year-to-date. - Portfolio outflows 2021: 1.1 percent of GDP; financial account: net FDI and portfolio outflows comprised the bulk (2.4 and 1.1 percent of GDP, respectively). ### Monetary policy stance and guidance - BoK actions - Policy rate raised three times since August 2021 by a cumulative 75 basis points (bps). - Markets pricing in further hikes by end of year. - Real policy rate remains below most estimates of Korea’s real neutral rate; stance remains accommodative. - Guidance and recommendations - Continue calibrated, data-dependent normalization to stabilize inflation and anchor expectations. - Enhance communications to provide greater guidance on monetary policy. - Consider the next monetary policy framework review to address BoK’s multiple mandates. - If downside risks materialize, monetary policy has moderate conventional space to provide stimulus but may face tradeoffs if supply disruptions exacerbate inflation. ### Fiscal policy guidance and debt strategy - 2021 public spending increased by about 1 percentage point of GDP; tax revenue overperformance reduced deficit versus projections. - Fiscal stance - Broadly neutral fiscal stance in 2022 recommended; fiscal deficit projected to remain around 2 percent of GDP. - If downside risks materialize, fiscal policy has ample space to provide further support; options include front-loading expenditures and enacting supplementary budgets with targeted measures. - Medium-term consolidation - Staff’s DSA projects central government debt to rise from 36 percent of GDP in 2019 to about 51 percent of GDP in 2025 based on current policies. - Recommendation: phased fiscal consolidation combining revenue mobilization and expenditure rationalization to stabilize public debt while accommodating aging and structural transformation needs. - Revenue options: broaden tax base; reassess significant tax deductions; review VAT exemptions; VAT rate currently 10 percent. ### Tax revenue overperformance and outlook - Tax revenues reached 323.4 trillion won by end-November; higher than same period in 2020 and 2019 by 21 and 17 percent, respectively. - 2nd supplementary budget projection: 314.3 trillion won for whole year; actuals surpassed that. - Projected tax revenue: 343 trillion won, or 16.6 percent of GDP (decades-high). - Overperformance drivers: strong recovery and buoyant real estate and stock markets; taxes on income, profits, capital gains, and property taxes accounted for nearly the entire increase between November 2019 and November 2021. - Medium-term: asset market-related tax revenues projected to decline moderately but remain above pre-COVID levels; property tax revenue expected to stay close to 2021 level; capital gains tax revenue expected to fall moderately; tax revenue expected to decline from 16.6 percent of GDP in 2021 to around 15.5 percent of GDP over the medium term. ### Withdrawal of lending support and SME transition - Pandemic lending support focused on maturity extensions for SMEs and small merchants to aid short-term liquidity by lowering NPV of debt; less take-up of principal/interest deferrals. - Concerns - Some SME leverage increased versus pre-COVID trend; corporate insolvency filings remain lower than pre-COVID, possibly delaying exit of unviable firms; pre-COVID around 50 percent of SMEs had interest coverage ratio below 1. - Recommended withdrawal package (Box 2 summary) - Progressive, sequenced narrowing of eligibility to firms viable pre-COVID, especially in lagging sectors. - Remove payment of principal to reveal firms’ repayment behavior and viability. - Make support terms less generous and lower proportion guaranteed under loan guarantee schemes. - Clear, timely communication on phasing out support. - Supervisors to assess banks’ capitalization via stress tests; set aside more capital for substandard and stressed loans; use degraded economic outlook for provisioning. - Expand private sector role in insolvencies; incentivize capital market funds to buy into troubled firms; promote out-of-court solutions under Corporate Restructuring Promotion Act; develop SME triage indicators. - Complementary social measures: strengthen programs for vulnerable households; extend individual vulnerable debtors’ program (authorities extended support till June 2022); strengthen unemployment support and social safety nets. ### Financial stability, macroprudential and housing policy - Financial resilience and prudential stance - Strong prudential framework supported resilience; borrower-based measures and tighter monetary conditions beginning to slow household debt and house price growth. - Bank capital levels remain above regulatory minimums; NPL ratios remain low. - Macroprudential recommendations - Consider further tightening borrower-based measures; implement sectoral counter cyclical capital buffer (sCCyB); introduce stressed DSR ratio; formalize unsecured debt-to-annual income ratio ceiling; incentivize banks to lower share of new unsecured floating rate lending via higher risk weights. - Review regulatory gaps between banks and non-banks to prevent circumvention. - Housing policy and supply-side measures - Drivers of house price increases: decline in mortgage rates, shifts in household formation, structural demographic factors; housing supply growth outpaced by demand. - Supply measures: ease brownfield density restrictions; fast track review for redevelopment; allow pre-sale of new apartments; upgrade transport links to greenbelt developments. - Authorities’ announced projects: ‘30-80 plus’ project to increase housing supply by 300 thousand homes in Seoul and 800 thousand homes nationwide over next decade; government to purchase 35 thousand new development properties in Greater Seoul for rental housing. - Staff view: combined package of supply reforms and higher property taxes would lower nationwide house prices, with greater impact in Seoul. ### FSAP and regulatory reforms (Annex X highlights) - Cybersecurity and fintech inspections: FSC introduced periodic and non-periodic inspections and framework for cyber security inspections on December 22, 2021. - Household debt and Jeonse risks: FSC announced measures in October 2021 to strengthen household debt management; FSS monitoring Jeonse deposit-related risks. - Stress testing and FX liquidity: planned revision of FX liquidity stress testing under Basel III LCR framework; improve stress-testing methods over mid- and long-term. - Institutional framework: Act on Supervision of Financial Groups legislated and took effect in June 2021; measures to strengthen group-wide risk management. - CCyB: FSC/FSS considering requiring banks to set aside additional capital proportional to household assets, ranging from 0% to 2.5% of total risk-weighted assets. - Recovery and resolution: RRPs for financial holding companies and banks came into effect in June 2021; D-SIFIs required to draw up recovery and resolution plans as of June 30, 2021. ### Structural reforms, labor, gender, and pension policy - Structural priorities - Shift focus from support to structural reform as pandemic abates; advance Korean New Deal (KND) implementation to support productivity, innovation, and inclusion. - Reform product and labor market rigidities; boost innovation and productivity via regulatory sandboxes and public-private partnerships. - Labor market and gender - Korea has one of the largest gender gaps among OECD countries; pandemic impact on women’s employment almost double that of men (staff estimate). - Medium-term priorities to close gender gap by 2035 could boost real GDP by more than 7 percent (staff analytical estimate). - Policies: expand childcare, promote shared parental leave, provide reemployment services and targeted training, increase work-life balance measures. - Pension reform and reverse mortgages - Pension system needs reform to be actuarially sound; increase coverage and generosity balanced with contribution rate and retirement age adjustments. - Reverse mortgage market: recent measures lower minimum age and expand property eligibility (office-tels); recommended further flexibility in drawdown, raise property value ceiling, allow more non-bank providers. ### Climate policy and mitigation instruments - Emissions and targets - Renewable sources accounted for 5.7 percent of total energy consumption in 2020. - Korea’s updated NDC target: reduce emissions by 40 percent from its 2018 level by 2030; aligned with carbon neutrality by 2050. - Existing instruments and spending - KETS established in 2015 covering 685 large emitters (~three quarters of domestic emissions). - Renewable Portfolio Standard: target 25 percent by 2026. - Heavy excise on fossil fuel use, tightened vehicle emission standards, and US$ 62 billion set aside under Green New Deal for green projects. - Policy recommendations - Align KETS caps with 2030 target; underpin ETS with robust and rising price floor; transition to fully auctioned allowances. - Reinforce carbon pricing with revenue-neutral feebates in emission-intensive sectors. - Increase and expand coal tax; full coal phaseout requires feed-in tariffs and complementary public investments. ### Micro price data, household debt implications, and monetary transmission - Micro price analysis - Using 101 micro price series and methods from Borio et al. (2021) and Hamilton (2003), salient positive relative price shocks more likely to pass-through to core inflation. - Korea micro data show pass-through of salient relative price increases to core inflation has declined; some observed price increases could be transient. - Household debt and monetary policy (Annex VI) - Approximately 50 percent of household debt linked to floating interest rates and structured as bullet payment. - Counterfactual: if interest rates had remained at early 2000 level, given current household debt, domestic demand would be around 10 percent lower. - Implication: tightening monetary policy would have a greater impact on growth; greater role for prudential policies recommended. - Time-varying monetary policy effects (Annex VII) - The effect of a non-systematic 1 percent monetary policy change has moderated, particularly on inflation. - Explanation: tighter macroprudential stance, ELB constraints; implies potentially stronger policy responses needed to tame inflation with risks for growth. ### Risk Assessment Matrix (selected entries) - Outbreaks of lethal COVID variants: Likelihood: High; Impact: Medium (downside). Policy response: extend fiscal support; BoK asset purchases; liquidity support; prudential regulatory actions. - Abrupt slowdown in China: Likelihood: Medium; Impact: Medium (downside). Policy response: support affected workers and businesses; BoK easing and asset purchases if needed. - Rising and volatile food and energy prices: Likelihood: High; Impact: Medium (downside). Policy response: targeted support to vulnerable groups. - Domestic NFC and household balance sheet stress: Likelihood: Medium; Impact: High. Finding: around 50 percent of SME debt is at-risk; household debt among highest in OECD. Policy response: maintain accommodative fiscal/monetary policies and use macroprudential measures to limit banking system risks. _Italic: IMF staff report excerpt from 1korea2022001._ ### 1. Korea’s 2021 Tax Revenue Overperformance _______________________________________________________19 ### 1. Korea’s 2021 Tax Revenue Overperformance ### Recent Economic Developments - Korea has recovered strongly from the COVID-19 shock, with activity surpassing pre-COVID levels in early 2021 and the cumulative recovery ranking among the strongest relative to other advanced economies. - Recovery supports and context: - Over 85 percent of the population now fully vaccinated and over half the population boosted. - Rapidly ramped vaccination in 2021, effective pandemic containment, and proactive economic policy support minimized scarring and sustained income growth. - High global integration and strong external demand supported the recovery; Korea remained generally resilient to global supply chain disruptions. - 2021 performance and sectoral details: - Real GDP growth in 2021 reached 4 percent. - Tech exports and related investment were key drivers of growth; consumption recovery remained slower with many services segments below pre-COVID levels. - Supply bottlenecks that impacted automotive production and sales in mid-2021 appear to be normalizing. - Labor market: employment and the unemployment rate are at pre-COVID levels, but pockets of weakness remain in high-contact services; labor force participation has yet to fully recover for 20–49 year-olds; underemployment and potential labor supply outside the labor force remain above previous norms. - Inflation: Headline inflation rose to 3.6 percent in January; inflation has accelerated since H2-2021 driven by higher commodity prices and a broadening of price pressures, including services inflation—particularly housing rental and eating out. - Producer prices suggest potential continuation of inflationary pressures in the pipeline; wage increases are modest when adjusted for productivity growth. - External sector: The current account surplus in 2021 widened to around 4.9 percent of GDP, supported by robust tech exports, a narrowed services deficit due to increased transportation surplus, and a favorable income balance. - Reserves increased by US$20 billion by the end of 2021, including the IMF’s 8.2 billion SDR allocation. - Financial sector: Sovereign and corporate yields have increased but remain low by historical standards; equity valuations close to record highs with some correction; corporate bond issuances grew double-digit in 2021 though corporate bond rates have risen recently. - Financial soundness: Bank capital levels remain above regulatory minimums; NPL ratios remain low; recent BoK stress tests found resilience to macro scenarios exceeding the recent downturn. Corporate debt increased from pre-COVID trend, but NFC default probabilities remained low; SMEs remain vulnerable. - Households and housing: Household credit grew very rapidly during the pandemic; household debt levels are very high among OECD countries. LTV ratios are relatively low and little subprime lending exists. House price-to-income ratio is at a multi-decade high and staff analysis suggests house prices are in overvaluation territory. ### Outlook and Projections - Growth projections: - Growth is forecast at 3.0 percent in 2022 and 2.8 percent in 2023. - Growth in Q1 2022 expected to soften temporarily due to the omicron wave, partially buffered by the implementation of a supplementary budget. - Above-trend growth projected for the rest of 2022 assuming relaxation of social distancing and normalization of private saving supporting private consumption. - Exports expected to remain buoyant given strong trading-partner demand, especially for high-tech goods; investment growth expected to recover as supply chains normalize. - Productivity estimated to have increased by over 4 percent in 2021. - Medium-term growth projected to slow toward estimated potential of between 2-2.5 percent due to demographics. - Inflation projections: - Headline inflation projected to remain above 3 percent for most of 2022, moderate to about 2.5 percent by year-end 2022, and to 2 percent in 2023 as monetary policy normalization continues and non-core pressures subside. - Core inflation projected to remain in the mid-2 percent range in 2022 before falling to about 2 percent in 2023. - Inflation expectations have increased but medium-term expectations remain well anchored. - External position: - The external position is expected to remain broadly in line with fundamentals over the medium term. - The current account surplus is projected to narrow slightly in 2022 as COVID-related transitory factors recede and domestic demand strengthens. - Trade integration efforts noted (RCEP and CPTPP referenced as positive steps). ### Risks and Vulnerabilities - Downside risks to growth: - Global risks: Omicron/global COVID developments, geopolitical uncertainties, and global monetary normalization could cause abrupt slowdowns in trading partners, protracted supply chain disruptions, or disorderly market adjustments. - Domestic risks: Rising COVID infections, elevated household debt, and high real estate prices could weaken domestic activity. - Upside activity risk: High household savings create upside risk to activity if pent-up demand for services is unlocked, particularly if reopening occurs in H1-2022. - Inflation risks: - Risks to the inflation outlook are tilted to the upside from continued global price pressures, further domestic supply disruptions, or higher pent-up demand for domestic services. - However, supply disruptions or weaker services supply could also create stagflationary pressures (weaker growth alongside higher inflation). - Financial risks: - Financial conditions remain accommodative but risk sentiment may be turning; corporate bond rates have risen and funds have begun rotating from risk assets. - Duration risk has grown due to search-for-yield; ABCP borrowings have fallen partly due to tighter liquidity regulations and reduced balance sheet space for securities firms. - A large share of SMEs remains vulnerable with weak balance sheets and low profitability. ### Key Statistics and Exact Figures - Vaccination: over 85 percent fully vaccinated; over half boosted. - Real GDP growth: 4 percent in 2021. - Headline inflation: 3.6 percent in January (year not specified in excerpt). - Current account surplus: around 4.9 percent of GDP in 2021. - Reserves: increased by US$20 billion by end-2021, including IMF’s 8.2 billion SDR allocation. - Growth forecasts: 3.0 percent in 2022; 2.8 percent in 2023. - Productivity: estimated to have increased by over 4 percent in 2021. - Medium-term potential growth: between 2-2.5 percent. - Inflation path: headline inflation above 3 percent for most of 2022; about 2.5 percent by end-2022; 2 percent in 2023. - Household debt and housing: house price-to-income ratio at multi-decade high; staff analysis indicates house prices are in overvaluation territory. *International Monetary Fund — Republic of Korea, Selected Chapters and Figures (excerpt).* ### 13. The authorities broadly agreed with staff’s outlook for growth and inflation in 2022, ### 1korea2022001 - 13. The authorities broadly agreed with staff’s outlook for growth and inflation in 2022, ### Economic outlook and inflation - Authorities broadly agreed with staff’s outlook for growth and inflation in 2022 while assessing the economy to currently be near its productive potential. - Above-potential growth would be led mainly by consumption and exports, with exports helped by buoyant external demand, notably for tech products. - High private savings rates imply an upshot for consumption if social distancing measures are lifted in the first half of the year. - Authorities judge that economic slack has largely been absorbed by the recovery to date, partly due to lower estimates of potential growth because of: - scarring effects of the pandemic on output, and - a larger drag from the gradual decline of the working age population since the late 2010s. - Both authorities and staff emphasized uncertainty surrounding the degree of remaining slack. - Authorities and staff expect inflation to likely remain above target in 2022 and gradually converge in 2023 as supply chains normalize, contributions of food and energy prices stabilize, and policy accommodation is withdrawn. ### External sector assessment - Authorities generally agreed with staff’s External Sector Assessment for 2021. - Recent growth in the current account surplus reflected transitory COVID-related factors and supply chain bottlenecks. - Noted drivers: much stronger-than-usual semiconductor export and shipping performance; strong search-for-yield activity may have boosted the primary income balance. - Recent won-dollar depreciation was viewed by authorities as reflecting temporary factors rather than an underlying misalignment. ### Policy challenge: normalization amid global uncertainties - Key near-term policy challenge: balancing the appropriate pace of policy normalization against heightened global downside risks. - Under the baseline: - Continue calibrated monetary policy normalization to ensure inflation stabilizes at its target and expectations remain well anchored. - Macroprudential policies should continue to guard against systemic financial risks. - Fiscal policy should be broadly neutral while providing targeted support for affected sectors. - If downside risks materialize: - Fiscal policy has ample space to provide further support. - Monetary policy has moderate conventional space to provide stimulus but may face tradeoffs if supply disruptions exacerbate inflation and hinder activity. ### Monetary policy stance and guidance - The BoK has begun normalizing monetary policy; the policy rate has been raised three times since August 2021 by a cumulative 75 basis points (bps). - Markets are pricing in further hikes by end of this year. - Tightening has reduced monetary stimulus, but the stance remains accommodative since the real policy rate remains below most estimates of Korea’s real neutral rate, including that of staff. - There is further room to continue normalizing monetary policy to address inflationary pressures, rebuild policy space and reinforce a tighter macroprudential stance. - Going forward, monetary policy normalization should remain data dependent, weighing the strength of recovery against rising inflationary pressures. - Considerations informing policy include potential headwinds from high household debt and a lower sensitivity of activity to policy rate changes in recent years (Annex VI and VII). - If downside risks materialize, monetary policy can provide further stimulus but could face tradeoffs if supply disruptions create stagflationary conditions. - Recommendation: BoK should enhance communications to provide greater guidance on monetary policy to help anchor expectations and alleviate tradeoffs. - The next monetary policy framework review could address challenges associated with the BoK’s multiple mandates. ### Fiscal policy developments and guidance - Public spending increased by about 1 percentage point of GDP in 2021, with supplementary budgets used to adjust and target support. - The fiscal deficit was smaller than projected due to strong revenue overperformance. - The central government fiscal deficit as of end-November stood at 1.1 percent of GDP; staff estimate the end-year deficit to be around 2 percent of GDP. - A broadly neutral fiscal stance in 2022 would support policy normalization: - The fiscal deficit is projected to remain at around 2 percent of GDP as lower expenditures as a share of GDP relative to 2021 are offset by less buoyancy in revenues. - This implies a broadly neutral fiscal stance, adjusting for temporary housing market-related revenues. - Authorities proposed a 16.9 trillion won supplementary budget aimed at supporting SMEs impacted by the pandemic, particularly in contact-intensive sectors. - If downside risks materialize, fiscal policy should provide prompt stimulus. Options include front-loading budgeted expenditure and enacting a supplementary budget; targeting could be improved by calibrating support to specific measures of hardship such as income loss. - Staff’s Debt Sustainability Analysis (Annex III) projects central government debt to rise from 36 percent of GDP in 2019 to about 51 percent of GDP in 2025, based on current policies. ### Tax revenue performance (Box 1) - Tax revenues reached 323.4 trillion won by end-November, higher than the same period in 2020 and 2019 by 21 and 17 percent, respectively. - Tax revenue projection in the 2nd supplementary budget was 314.3 trillion won for the whole year; actuals have already surpassed that. - Tax revenue is projected to reach 343 trillion won, or 16.6 percent of GDP, a decades-high for Korea. - Overperformance driven by strong economic recovery and buoyant real estate and stock markets; taxes on income, profits, capital gains, and property taxes accounted for nearly the entire increase between November 2019 and November 2021. - Revenues from VAT, custom duties, and other taxes remained nearly flat in percent of GDP relative to pre-COVID levels. - Going forward, asset market-related tax revenues are projected to decline moderately but remain above pre-COVID levels; property tax revenue expected to stay close to the 2021 level while capital gains tax revenue expected to fall moderately. - Tax revenue is therefore expected to decline from 16.6 percent of GDP in 2021 to around 15.5 percent of GDP over the medium term. ### Lending support, SME vulnerabilities, and withdrawal strategy - Lending support policies during the pandemic were critical to limit corporate stress, particularly among SMEs; focus was on maturity extensions for SMEs and small merchants to aid short-term liquidity by lowering the NPV of debt. - Less take-up of credit support based on principal and interest payment deferrals. - Rapid economic recovery has reduced demand for support facilities, though some measures of SME leverage have increased compared to pre-COVID trend. - Corporate insolvency filings remain lower than pre-COVID levels, which may indicate that current measures are holding back exit of unviable firms; pre-COVID around 50 percent of SMEs had an interest coverage ratio below 1. - Withdrawal of lending support should be carefully calibrated to avoid sudden tightening of credit and a spike in insolvencies; transition support should focus on viable firms. - Recommended transition: move from liquidity support to solvency support, restructuring, and facilitating exit as markets normalize (Box 2). Box 2 — Recommended package for withdrawal (summary) - Withdrawal of support policies should be progressive and sequenced; start by narrowing eligibility to firms viable pre-COVID, particularly in lagging sectors. - Remove payment of principal to reveal firms’ repayment behavior and viability. - Make support terms progressively less generous and lower the proportion guaranteed under loan guarantee schemes. - Issue clear and timely communication on conditions for phasing out support to reduce surprise and abrupt adjustments. - Contingency planning: supervisors should assess banks’ capitalization via stress tests before withdrawing support; set aside more capital for substandard and stressed loans and use a more degraded economic outlook for provisioning. - Insolvency and restructuring: expand private sector role in insolvencies, incentivize capital market funds to buy into troubled firms, promote out-of-court solutions under the Corporate Restructuring Promotion Act, develop indicators for triage of SMEs, and adopt FSAP recommendations to clarify duties and contractual clauses in DBRA. - Complementary support policies: strengthen programs for vulnerable households; extend individual vulnerable debtors’ program (authorities extended support till June 2022); strengthen unemployment support and social safety net measures as part of bolstering automatic stabilizers. ### Financial stability, prudential measures, and market structure - Korea’s strong prudential framework supported financial sector resilience during the pandemic, but further tightening of prudential measures may be needed to contain risks from housing and household debt. - Pandemic saw unprecedented growth in household debt and house prices, which are beginning to slow with tighter monetary conditions and borrower-based prudential measures. - Authorities’ vigilance, including regular stress testing, is commended; borrower-based policies may need further tightening and banks’ capital buffers could be strengthened for sector-specific real-estate risks. - Current stable and supportive financial conditions provide a window of opportunity to lift the short-selling ban for all listed securities to improve price discovery and risk management. - To address concerns about equitable access, recommendations include strengthening sanctions for violations, stepping up monitoring, enhancing role of market-makers, and requiring disclosure of short positions above a certain proportion of listed shares. - Single stock futures market provides retail investors with short-selling opportunities. ### Authorities’ views (BoK) - The Bank of Korea is normalizing monetary policy by comprehensively taking into account growth, inflation and financial imbalances; it raised the base rate three times since August by a cumulative 75 basis points. - BoK views these rate hikes as reflecting current and expected solid growth, a prolonged period of inflation above the target, and accumulated financial imbalances. - Given expected persistence of robust growth and inflationary pressure and high risks from financial imbalances, BoK believes monetary accommodation still needs appropriate adjustment. - BoK will continue to assess trade-offs between policy goals as monetary accommodation is reduced. - Considering still accommodative policy and potential pent-up consumption from accumulated spare household savings, BoK believes normalization is less likely to have a negative impact on consumption and growth. - BoK will closely monitor upside and downside risks to domestic growth and inflation and whether the risk of financial imbalances is abating before deciding timing of further adjustments in monetary accommodation. *Source: 1korea2022001 - 13. The authorities broadly agreed with staff’s outlook for growth and inflation in 2022,* ### 26. The authorities stressed their commitment to exchange rate flexibility and limiting FX ### The authorities stressed their commitment to exchange rate flexibility and limiting FX intervention to preventing disorderly market conditions ### Exchange rate policy and FX arrangements - Authorities committed to exchange rate flexibility and limiting FX intervention to preventing disorderly market conditions. - The US dollar FX swap line with the Federal Reserve expired at the end of 2021, and the authorities do not see a need to renew it given stable US dollar funding conditions. - FX prudential measures have contributed to market stability and will continue to help in the monitoring and reviewing of policy settings as appropriate. - In line with the 2020 FSAP recommendation there are plans to revise FX liquidity stress testing under the Basel III LCR framework. - Macroprudential policy may help monetary policy by containing financial risk premia, helping lift the neutral interest rate, and reducing the probability of monetary policy hitting the effective lower bound (ELB) in the future. ### Fiscal stance and contingency planning - The authorities agree with staff on the need for additional support should downside risks materialize. - The fiscal policy stance envisioned in the 2022 budget and supplementary budget is considered expansionary, since budgeted expenditure (including policy lending) are expected to increase at a faster pace than GDP. - The authorities view that fiscal policy will continue to support growth in 2022. ### Approach to rolling back lending support policies - Authorities will take a case-by-case approach to rolling back lending support policies. - Concerns: - Covid-19 support measures may have delayed restructuring of unviable SME firms. - A rapid withdrawal in support measures may trigger a wave of bankruptcies and produce stress on household balance sheets. - Planned actions and mitigants: - Maintain close communication with stakeholders and expand debt counseling and restructuring tools so firms can prepare in advance. - Banks have been issued advisories to add to their capital buffers and provisioning. - Continued reforms of the insolvency system to give more firms the option of a statutory out-of-court bank-led restructuring mechanism. - Increase the debt threshold for filing rehabilitation proceedings and individual rehabilitation proceedings to broaden SME access to the simplified insolvency process. - Promote post-commencement financing. - Capital market reforms in the pipeline to give SMEs more financing options, including through increasing liquidity in the KONEX market. ### Household debt and housing vulnerabilities — key findings - The pandemic magnified pre-COVID trends: rising household debt and rapid house price growth, raising macro-financial risks and social tension. - Real estate prices grew at an unprecedented rate during the pandemic; the house price-to-income ratio is at a multi-decadal high. - Drivers of house price increases: decline in mortgage rates, shifts in household formation, and longer-term structural factors linked to demography. - Strong real-estate demand surpassed new housing supply, particularly in Seoul. - Historically low mortgage rates fueled speculative behavior; major cities now show significant valuation pressures. - House prices have significantly outpaced wages and widened inequality. - House price growth is beginning to slow due to tighter prudential and monetary policies, but affordability remains a concern. - Housing supply: - Housing supply has expanded but was surpassed by strong demand since the pandemic. - Housing supply has grown by 30 percent in Seoul over the last decade, but the home ownership ratio remains relatively unchanged and lower than peer countries. - Measures introduced to improve supply include easing brownfield density restrictions for redevelopment projects; a fast track one-stop review process for redevelopment projects; allowance of pre-sale of new apartments to facilitate housing access to first-time buyers; efforts to upgrade transportation links to greenbelt developments on the outskirts of Seoul. - Over the medium term, new dwelling supply planning needs to consider Korea’s projected decline in population to avoid potential boom-bust cycles. - Household debt dynamics: - Real-estate demand drove very strong growth in household debt during the pandemic, but vulnerabilities are mitigated by borrower-based macroprudential stance supporting low NPLs and debt servicing ratios. - Lending remains concentrated among high credit score individuals; average LTVs are around 40 percent. - FSAP and Bank of Korea stress tests—applying a more severe shock than the pandemic downturn—showed that risks from household balance sheets are contained. - Emerging risks: - Larger share of new bank loan origination has been unsecured lending linked to floating interest rates, used to top up lending and meet tight LTV requirements. - Strong growth in bullet loans linked to the Jeonse market raises rollover risks. - Some subprime borrowers resorting to non-banks to increase financing, indicating circumvention of borrower-based restrictions. - Around 11.5 percent of all borrowers had their credit ratings upgraded since the pandemic because of buoyant asset markets. - Household assets concentrated in real-estate and intertwined with demographic challenges: - Households tend to self-insure for retirement by accumulating real-estate, equity of which could be withdrawn in the reverse mortgage market. - Unlike other advanced economies, engagement with the credit market does not decline with age in Korea. - Pre-COVID approximately 50 percent of household debt-at-risk was headed by an individual above or close to the official retirement age of 55. ### Policy package to contain vulnerabilities — recommendations - Macroprudential policies: - Borrower-based prudential measures have been effective; recent measures including the individual based DSR ceiling are welcomed. - Additional measures recommended (as per 2020 FSAP): - (i) a sectoral counter cyclical capital buffer (sCCyB) to ensure banking sector resilience; - (ii) introducing a stressed DSR ratio to moderate borrowing risk in the event of a snapback in lending rates; - (iii) formalizing the unsecured debt-to-annual income ratio ceiling that is currently a supervisory recommendation for both banks and non-banks; - (iv) incentivizing banks to lower the share of new unsecured floating rate lending via higher risk weights applied to unsecured loans. - Review remaining gaps in lending-related regulations between banks and non-banks (e.g., DSR ceilings and loan-to-deposit ratio prudential requirements) to avoid circumvention by borrowing from multiple institutions. - Tax policies: - Implemented measures include raising the Comprehensive Real Estate Holding Tax (CRET) for multiple-home owners and a transfer tax on short-term capital gain. - Assess effectiveness of these measures against housing market outcomes. - Higher CRET likely helped expand supply by raising holding costs for multiple-home owners; could be broadened and raised to foster increased supply. - The capital gains tax hike on multiple-home owners, while designed to reduce speculative demand, may have reduced existing-housing supply in the short term by disincentivizing multiple-home owners from selling and should be reassessed as experience is gained. - Housing supply and regulatory distortions: - Private sector incentives distorted by regulatory and tax treatment, including price caps on new pre-construction apartment sales and excess capital gains on redevelopment projects; these should be reviewed to increase private housing supply. - Further efforts to accelerate repurposing commercial land to residential usage in urban areas through greater coordination between governmental agencies and local councils. - The setting up of a public-private task force composed of the Ministry of Land and Infrastructure, local governments, and industry is welcome. - Combined policy effect: - Staff analysis suggests reforms that increase the elasticity of the supply of housing and higher property taxes would result in lower nationwide house prices (with the impact likely to be greater in Seoul). - A combined policy package, together with the normalization of monetary policy conditions, would strengthen the effectiveness of these measures to reduce housing price growth over the medium-term. ### Authorities’ views - Authorities view the rise in household debt and house prices as the single biggest non-COVID related risk facing the economy. - They attribute the rapid growth in house prices since the pandemic to historical low interest rates, ample liquidity and search for yield, excess demand due partly to shifts in household formation, and heightened expectations of housing price appreciation. - To moderate house prices and improve affordability, authorities identify three areas to tackle: - (i) increasing housing supply; - (ii) managing excess liquidity that rotates to the real-estate sector; - (iii) rooting out speculative activities. - Authorities see signs of stabilization following recent tightening in monetary and macroprudential policies and will wait for further developments before deciding whether further macroprudential tightening is required. - Authorities are aware of risks to financial inclusion and intergenerational equity from further tightening borrower-based macroprudential policies. - On supply measures: - Government announced a ‘30-80 plus’ project aiming to increase housing supply by 300 thousand homes in Seoul and 800 thousand homes nationwide over the next decade. - Initial focus on easing building codes to increase supply of office-tel apartments, which can be built more speedily. - Government will directly purchase 35 thousand new development properties in Greater Seoul to be repurposed as rental housing for lower income households. - Reforms focused on increasing private sector engagement by raising the cap on loans to finance housing projects. - Authorities reviewing stronger financial support for small and mid-sized construction companies by alleviating construction prerequisites for project financing loan guarantees. - Authorities do not share staff’s view that the capital gains tax hike may have reduced housing supply, noting the number of housing units for sale began to rise in September 2021 after a temporary decline since June. - On price caps and excess gain caps: - Authorities deem the pre-sale apartment price and excess gain caps as necessary to maintain house price affordability and stabilize house prices for actual buyers. - They contend increasing the ceiling of pre-sale apartment prices would fuel inflation in existing apartments in surrounding areas and that excess gain caps ensure gains of private sector led redevelopment contribute to the public good. ### Transitioning to a post-COVID normal - Policy focus should shift from economic support to structural reform priorities, including under the Korean New Deal (KND). - Renewed structural reform momentum and implementation of the KND will be important to transition to a post-COVID normal. - Policies should: - Support productivity growth and innovation; - Provide transitory support amidst reforms to address product, services, and labor market rigidities; - Ensure Korea’s human capital remains central to the transformation process. - Fiscal policy should be anchored in a medium-term fiscal framework that stabilizes the path of public debt post-pandemic, considering expected fiscal implications of demographics, structural transformation costs, and the need to retain space for countercyclical fiscal policy when necessary. *Republic of Korea: IMF country report content excerpt* ### 39. Given medium-term fiscal pressures from structural transformation needs and ### 1korea2022001 - 39. Given medium-term fiscal pressures from structural transformation needs and ### Fiscal framework and countercyclical policy - A rules-based fiscal framework should be introduced and operationalized as the exit from the pandemic takes hold to anchor public finances and preserve space for countercyclical fiscal policy. - Strengthening public financial management by safeguarding budgetary independence and enhancing fiscal transparency is recommended. - Ongoing policy debate should improve parametric, operational, and institutional aspects of the fiscal framework. - Scope for counter-cyclical fiscal policy should be preserved, including specification and clarification of operational details of the ‘slowdown provision’. - A proposed fiscal rule with ceilings of 3 percent of GDP for fiscal deficit and of 60 percent of GDP for government debt was submitted to the parliament in December 2020; discussion of the rule is ongoing. - The debt and deficit limits could be “soft” limits as discussed in the 2020 Selected Issues Paper “Fiscal Rules in Korea—Some Considerations.” ### Automatic stabilizers - Korea’s automatic stabilizers are currently less effective compared to most OECD economies, due to weaker social protection programs. - Strengthening automatic stabilizers would make fiscal responses more targeted, timely, and temporary, reduce the need for discretionary fiscal interventions, buffer short-term impact of structural reforms, and lower the risk of monetary policy hitting the effective lower bound (ELB) during a severe downturn. - The expansion of unemployment insurance in recent years is welcome; further strengthening of such programs is advised, including building on permanent safety net measures introduced during the pandemic. - Strengthening automatic stabilizers should be considered as part of the broader architecture of the new fiscal framework. ### Medium-term consolidation, public debt, and revenue options - Korea’s public debt has grown substantially since 2019 owing to pandemic-related discretionary spending. - Even as the pandemic wanes, public debt is projected to grow at a faster pace in the medium and long term relative to pre-COVID trends due to higher discretionary spending, including on the KND, and fiscal costs of demographics. - General government debt is projected to rise to 60 percent of GDP by 2027 from less than 50 percent at present. - Stabilizing public debt requires a phased fiscal consolidation strategy anchored on rationalizing spending and mobilizing revenues over the medium term. - Expenditure-side steps: start rationalizing discretionary spending (as the pandemic abates), increase efficiency, and strengthen expenditure management. - Revenue-side options given the low tax burden by OECD standards: - Broadening the tax base: reassess significant tax deductions in personal income tax; review tax expenditures on industry, including SMEs, and streamline if necessary. - Expanding VAT: review and rationalize the scope of VAT exemptions. Depending on comprehensiveness of base-broadening measures, it may still be necessary to raise some tax rates, notably the VAT rate which is relatively low at 10 percent. ### Pension reform and reverse mortgages - Pension reforms are required given the coming rise in the ratio of retirees-to-workers. - Currently, contribution rates are not commensurate with benefits; the relatively low level of pension benefits contributes to Korea’s relatively high old-age poverty rate. - Priority: ensure pension system is on an actuarially sound footing. - Policy mix: increases in pension coverage and generosity should be balanced with appropriate adjustments in contribution rates and the retirement age commensurate with longer life expectancy. - Reforms could include development of pension and contractual savings products by introducing multi-employer pension schemes and building further capacity for oversight of pension funds market (in line with the 2020 FSAP recommendation). - Strengthening pension benefits would reduce over time reliance on real estate assets to self-insure for retirement. - Greater access to the reverse mortgage market could help alleviate old-age poverty: - Recent measures: lowering the minimum age, expanding property eligibility by allowing office-tels as collateral. - Further recommended measures: allow greater flexibility in monthly drawdown options (including greater payments at early stages), raise the property value ceiling, and allow more non-bank financial institutions to offer reverse mortgages to expand the market. ### Product and labor market reforms - The pandemic shifted demand away from high-contact industries (accommodation and food services; wholesale and retail trade) toward professional services and higher-skilled manufacturing; automation and digitalization have risen. - To capitalize on these shifts, more flexible product and labor markets and a lower regulatory burden are needed. - Advance reform priorities to ease bottlenecks to service sector productivity, spur innovation and investment, facilitate reallocation of resources across sectors, and ensure creation of high-quality, sustainable employment: - Boosting innovation and productivity growth: continue regulatory sandboxes and public-private partnerships; lower legal barriers to entry and startup costs; simplify licensing and permit requirements; adjust regulations inhibiting SME expansion or raising costs; increase flexibility of employment regulations. - Labor markets: emphasize sustainable private sector employment over direct government short-term hires; focus on training and reskilling; set sound incentives for labor force participation; the human capital pillar added to the KND is welcome and involves private sector cooperation in training and job creation; increase higher education flexibility to match graduates with new occupations; balance flexibility and fair conditions for platform workers; increase flexibility of regular employment contracts over time to reduce labor market duality and income inequality. - Increasing female labor participation: expand childcare leave, reduce working hours for expecting women, encourage shared childcare between spouses, and provide employment services tailored to women; continued efforts needed to boost female employment rates, improve work-life balance, and facilitate re-entry after caring periods. ### Gender gaps in the labor market (Box 3) - Korea has one of the largest gender gaps among OECD countries, exacerbated by the pandemic; staff estimate the pandemic’s impact on women’s employment is almost double that of men. - Causes: women’s employment concentrated in high-contact service sectors; higher proportion of females with non-regular labor contracts making them more vulnerable to shocks. - Authorities strengthened multifaceted support: supplementary budgets to incentivize employing and retaining women; support for family care leave and flexible work arrangements; reemployment services and training tailored to women. - Medium-term priorities to close the gender gap by 2035 could boost real GDP by more than 7 percent (staff analytical estimate). - Two dimensions for policy: - Retention: lower family care burdens via increased childcare support, promote shared parental and family care leave, reduce overall work hours. - Re-deployment: proactive re-deployment schemes, career transition assistance, and up-skill training targeted to this group and broader sectors. - A more flexible work environment and better work-life balance would encourage women to return to the job market. ### Authorities’ views on fiscal and labor reforms - Authorities concur with staff on the need to strengthen automatic stabilizers while undertaking medium-term fiscal consolidation anchored on a rules-based fiscal framework. - To ensure public debt sustainability they stress the importance of raising spending efficiency and improving expenditure management; they underscore that revenue measures, such as a VAT rate hike, must be supported by social consensus. - Authorities recognize the need for pension system reforms but stress reforms must be predicated on public consultation and support. - Authorities believe KND implementation and other labor market initiatives will develop dynamic growth drivers and address inequities; KND seen as delivering substantial investment and employment in areas such as artificial intelligence, biotechnology, and green energy. - They emphasize progress under regulatory sandboxes and share concerns about labor market scarring, especially for youth; committed to bolstering training, job creation, and the safety net with focus on lagging groups. - Given the ongoing pandemic, authorities prioritize increased stability for the time being but agree on the need to balance stability and flexibility. ### Climate policies - Korea is among the largest greenhouse gas emitters on a per capita basis; fossil fuels are primarily used in power generation, industry, construction, transportation, and buildings. - Renewable sources accounted for 5.7 percent of total energy consumption in 2020. - Korea’s updated NDC target: reduce emissions by 40 percent from its 2018 level by 2030; aligned with the goal of achieving carbon neutrality by 2050. - Key instruments and measures: - Korea established its Emission Trading Scheme (KETS) in 2015: a cap-and-trade system applying to 685 large emitters and covering about three quarters of domestic emissions. - Renewable Portfolio Standard: regulatory mandate requiring power generators to increase use of renewable sources to 25 percent by 2026. - Tightened vehicle emission standards for passenger vehicles and light trucks. - Heavy excise on use of fossil fuels, especially coal. - As part of the Green New Deal (GND), Korea set aside US$ 62 billion to invest in green projects. - Policy options to strengthen mitigation: - Align emissions caps in KETS with the 2030 mitigation target; underpin ETS with a robust and rising price floor and transition to fully auctioned allowances. - Reinforce carbon pricing with a revenue-neutral sliding scale of feebates in emission-intensive sectors to strengthen decarbonization incentives without imposing fiscal costs or heavier tax burdens. - Increase and expand the coal tax (currently applied only to coal in power generation); full coal phaseout will require additional policies such as feed-in tariffs and complementary public investments. ### Staff appraisal and near-term policy stance - Korea has recovered impressively from COVID-19; activity has surpassed pre-COVID levels despite multiple waves. - Policy challenges: - Near-term: balance appropriate pace of policy normalization against heightened global risks while containing risks from housing and household debt. - As pandemic abates: shift focus to structural reform priorities to reinvigorate potential growth and foster greater inclusion. - Monetary policy: continuing normalization remains appropriate; if downside risks materialize, conventional monetary policy has moderate space for stimulus but could face tradeoffs if supply disruptions create stagflationary conditions; enhance communications to anchor expectations. - Fiscal policy: a broadly neutral fiscal stance in 2022 would support policy normalization; if downside risks materialize, prompt fiscal stimulus should be deployed given Korea’s ample fiscal space, with support targeted to affected segments and especially relevant if stagflationary pressures arise. *IMF staff report excerpt from 1korea2022001* ### 56. The withdrawal of lending support policies should be carefully calibrated to reduce ### The withdrawal of lending support policies should be carefully calibrated to reduce risks of sudden tightening of credit conditions, particularly for SMEs ### Withdrawal of lending support and SME risk - Authorities’ careful approach to winding down lending policies has been appropriate. - Recommendation: Continue lending support until the recovery has broadened but finetune support to further focus policies on viable firms to avoid an abrupt tightening in credit conditions, particularly for SMEs and small merchants. ### Financial system resilience and macroprudential policy - Finding: The financial system has remained resilient, backed by a strong prudential framework. - Concern: Very rapid growth in household debt and house prices is beginning to slow thanks to borrower-based prudential measures and tighter monetary conditions. - Recommendation: Macroprudential policies, particularly borrower-based measures, may need to be tightened further to contain the buildup of risks from housing and household debt. ### Housing affordability — supply and demand measures - Recommendation: Addressing affordability requires further housing supply and demand policies in addition to macroprudential policy. - Policy options: Faster repurposing of land and taxation of real estate to increase the supply of dwellings, particularly for lower income households. ### Structural reforms and the Korean New Deal (KND) - Finding: As the pandemic abates, key structural reforms are critical to complement the KND’s efforts to shift to a more digital, high-tech, and green economy. - Positive steps: The KND’s new human capital pillar is welcome to help address rising demand for skilled labor; welcome steps have been made to increase female labor force participation. - Remaining needs: Further efforts to close remaining gender gaps; broaden the safety net; increase flexibility of regular contracts; address longstanding bottlenecks including services sector productivity. - Recommendation: Advance on pending structural reform priorities to broaden the safety net and increase labor market flexibility. ### Fiscal framework, consolidation, and financing KND priorities - Fiscal pressure drivers: Demographics and structural reform needs. - Recommendation: Adopt a rules-based fiscal framework to anchor public finances, preserve countercyclical fiscal space, and strengthen automatic stabilizers. - Specifics: Authorities’ proposed fiscal rule is welcome and should further specify key parametric, operational, and institutional aspects; the framework should safeguard budgetary independence and enhance fiscal transparency. - Counter-cyclical policy: Preserve scope for counter-cyclical fiscal policy by defining operational details and consider how to strengthen automatic stabilizers. - Safety net: Expansion of unemployment insurance is welcome; further strengthening of the safety net could build on progress made during the pandemic. - Medium-term consolidation: Financing KND spending priorities and coping with projected costs of aging will require a medium-term consolidation strategy within the fiscal framework. - Projection and strategy: Public debt is projected to continue increasing over the medium term due to KND, pensions and aging-related spending pressures. Stabilizing public debt will require a phased fiscal consolidation strategy anchored on rationalizing spending and mobilizing revenues, including broadening the tax base and raising some rates given Korea’s low tax burden. ### Pension reform - Need: Pension reform is needed to strengthen the system given Korea’s rapid demographic shifts. - Issues: Low contribution rates have contributed to an actuarial imbalance; low pension benefits have contributed to high old-age poverty. - Recommendation: Priority should be given to place the pension system on an actuarially sound footing. Balance greater pension coverage and generosity with appropriate adjustments in contribution rates and in retirement age commensurate with longer life expectancy. - Note: Early steps to address these challenges would ease transition costs. ### Climate policy and NDC - Finding: Korea’s new NDC target to reduce emissions by 2030 is welcomed and better aligned with achieving carbon neutrality by 2050. - Recommendation: To reach these goals, current climate policies need to be reinforced, including further strengthening Korea’s Emissions Trading Scheme (ETS) and broadening the scope of carbon pricing. ### Recommendation on IMF consultation cycle - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### External sector assessment — key metrics and assessments - Overall: On a preliminary basis and adjusting for transitory factors, the external position in 2021 is assessed to be broadly in line with fundamentals and desirable policies; assessment subject to uncertainty related to COVID-19 and lack of full-year 2021 data. - Current account: - 2021 CA: 4.9 percent of GDP - Cycl. Adj. CA: 5.3 percent of GDP - EBA Norm: 3.7 percent of GDP - EBA Gap: 1.5 percent of GDP - COVID-19 Adj.: -0.88 - Other Adj.: 0.0 - Staff Gap: 0.6 percent of GDP - Projection: CA surplus projected to narrow to 4.3 percent of GDP over the medium term as semiconductor prices stabilize and the service sector balance normalizes. - Foreign asset and liability position: - 2020 NIIP: 35.3 percent of GDP (data imply NIIP was 35.3 percent of GDP in 2020) - Gross Assets: 119.6 percent of GDP - Debt Assets: 59.7 percent of GDP - Gross Liab.: 84.3 percent of GDP - Debt Liab.: 34.8 percent of GDP - Observation: NIIP increased by about 10 percent of GDP from the 2020 level, largely reflecting residents’ overseas portfolio investment. NIIP projected to rise to about 53 percent of GDP in the medium term on the back of CA surpluses and search-for-yield activity. - Assessment: Positive NIIP is a source of external sustainability; foreign asset holdings diversified with about 39 percent held in equity or debt securities; about 60 percent of foreign assets denominated in US dollars. - Real exchange rate (REER): - Historical: REER depreciated in 2019 by about 4.3 percent; average REER for 2020 depreciated by about 2 percent relative to 2019; average REER for 2021 has remained stable compared to 2020. - IMF staff CA gap implies a REER undervaluation of 2.7 percent (applying an estimated elasticity of 0.22). - EBA REER index model: REER undervaluation of 1.6 percent. - REER level model: REER undervaluation of 10.4 percent. - IMF staff assesses the REER gap to be undervalued in the range of -1.4 to 6.8 percent, with a midpoint of 2.7 percent. - Capital and financial accounts: - 2021 portfolio outflows: 1.1 percent of GDP - 2021 financial account: Net FDI and portfolio outflows comprised the bulk (2.4 and 1.1 percent of GDP, respectively); other investments (net) recorded inflows (0.1 percent of GDP). - Assessment: Present configuration of net and gross capital flows appears sustainable over the medium term. - FX intervention and reserves: - As of end-2021, reserves stood at 25 percent of GDP. - FX intervention Q1–Q3 2021: net sales of US$7.2 billion (0.4 percent of GDP) through Q3 of 2021, concentrated in Q3, to limit excess exchange rate volatility. - Gross reserves rose by US$20 billion (1.1 percent of GDP) year-to-date with increase in investment returns. - As of end-2021, preliminary data indicate FX reserves were about 103 percent of the IMF’s composite reserve adequacy metric. - Swap line: $60 billion swap line with US Federal Reserve expired at end 2021. - Assessment: Intervention has been limited to preventing disorderly market conditions; reserves and swap provided adequate buffer against a wide range of possible external shocks. ### Risk Assessment Matrix — key risks, likelihoods, impacts, and policy responses - Outbreaks of lethal and highly contagious COVID-19 variants - Likelihood: High (Failure to contain COVID-19 in trade partners leads to prolonged lockdowns and greater uncertainty.) - Impact: Medium (downside): A slowdown in key export markets would impact Korea’s recovery and damage business confidence. Korea’s high-tech exports represent a mitigant. - Policy response: Extend support measures: (i) fiscal support to affected workers and businesses in affected sectors; (ii) BoK asset purchase program to support liquidity in bond markets and the transmission of monetary policy; (iii) provide liquidity support to financial markets; use prudential regulatory actions to address asset quality deterioration and encourage private debt resolution. - Abrupt growth slowdown in China - Likelihood: Medium - Impact: Medium (downside): Slower growth and damage to business confidence would adversely impact investment and the recovery in private consumption. - Policy response: Provide support to affected workers and businesses, supported by the BoK easing monetary policy and potentially asset purchases to help keep financial conditions accommodative and support lending. - De-anchoring of inflation expectations in the U.S. and/or advanced European economies - Likelihood: Medium - Impact: Medium (downside): Slower growth and damage to business confidence; adverse impact on investment and private consumption recovery. - Policy response: Extend support measures: (i) BoK asset purchase program to support liquidity in bond markets, compress risk premia and strengthen transmission of monetary policy; (ii) provide liquidity support to banks. - Rising and volatile food and energy prices - Likelihood: High - Impact: Medium (downside): As a larger importer of commodities, Korea would face damaged confidence, slowed recovery, and increased inflationary pressures. - Policy response: Provide targeted support to vulnerable groups to ensure inclusive recovery. - Extended global supply chain disruptions - Likelihood: High - Impact: Medium (downside): Slower growth coupled with higher inflationary pressures would adversely impact investment and the recovery in private consumption. Korea’s high-tech exports mitigate some risk. - Policy response: Provide targeted fiscal support to vulnerable groups. - Global information infrastructure failure - Likelihood: Medium - Impact: Low (downside): Could damage business confidence and slow recovery. - Policy response: Provide policy stimulus and liquidity support if needed. - Domestic risks — NFC and household balance sheet stress - Finding: 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. - Likelihood: Medium - Impact: High: House prices softening and balance sheet stress could push many SMEs into insolvency, increasing loan delinquencies and financial stress, creating a further drag on growth. - Policy response: Maintain accommodative fiscal and monetary policies. Use macroprudential policies to limit risks to the banking system. - Upside domestic risk — progress in normalizing relations with North Korea - Likelihood: Low - Impact: High: Faster than anticipated progress could have a positive impact on investment and consumer sentiment, increasing domestic demand. - Policy response: Prepare plans on how to support North Korea, in cooperation with the international community. *Source: IMF staff report on the Republic of Korea (selected excerpts).* ### Annex III. Public Sector Debt Sustainability Analysis ### Annex III. Public Sector Debt Sustainability Analysis ### Overview and main conclusion - Korea’s public debt is sustainable "with high probability" due to its relatively low level and favorable composition. - Debt increased substantially since the onset of the pandemic and is projected to remain on an upward path over the medium term under unchanged policies. - To stabilize debt and accommodate fiscal spending from demographic transition and structural transformation needs, "a phased fiscal consolidation strategy is needed over the medium term." ### Debt levels and composition (recent history) - Central government debt: - 2019: 36.3 percent of GDP - 2020: 42.4 percent of GDP - 2021 (estimated): 43.6 percent of GDP - General government debt: - 2019: 42.1 percent of GDP - 2020: 48.9 percent of GDP - 2021 (estimated): about 50 percent of GDP - Debt composition (2020): - Short-term debt: 7 percent of total central government debt - FX-denominated debt: 1 percent of total central government debt ### Baseline projections and fiscal dynamics - National Fiscal Management Plan assumptions and implications: - Higher levels of expenditure as percent of GDP relative to pre-COVID times through 2025. - Revenue as percent of GDP projected to "decline modestly from the peak in 2021" as the housing market stabilizes. - Central government fiscal deficit expected to stay at around 2 percent of GDP (notably higher than pre-COVID average). - Debt projections: - Central government debt projected to reach about 52 percent of GDP by 2026. - General government debt projected to approach 58 percent of GDP by 2026. - Sensitivity to shocks: - Shocks to real GDP growth, real interest rate, and the primary balance could push debt higher over the projection horizon relative to the baseline. - Central government debt is likely to stay below 60 percent of GDP under all individual shock scenarios and under a combined macro-fiscal shock. ### Quantitative decomposition and dynamics (selected figures) - Change in gross public sector debt (cumulative figures shown in table): - 2019: 0.6 (percent of GDP) - 2020: 2.0 - 2021: 6.1 - 2022: 1.2 - 2023: 1.4 - 2024: 1.5 - 2025: 2.0 - 2026: 1.7 - Projection cumulative to 2026: 9.5 - Identified debt-creating flows (primary deficit etc.): - Primary deficit (central government, excluding social security fund) by year (percent of GDP): - 2019: 0.0 - 2020: 1.1 - 2021: 3.8 - 2022: 1.9 - 2023: 2.4 - 2024: 2.0 - 2025: 2.0 - 2026: 1.8 - Projection cumulative: 12.1 - Primary (noninterest) revenue (percent of GDP): 17.9 (2019), 19.3 (2020), 19.4 (2021), 22.1 (2022), 20.9 (2023), 20.5 (2024), 20.5 (2025), 20.4 (2026), cumulative 124.9 - Primary (noninterest) expenditure (percent of GDP): 17.9 (2019), 20.4 (2020), 23.2 (2021), 24.0 (2022), 23.3 (2023), 22.5 (2024), 22.5 (2025), 22.4 (2026), cumulative 137.0 - Automatic debt dynamics contribution (percent of GDP): - Listed values include: -0.6, 0.3, 0.4, -2.1, -1.8, -1.3, -0.9, -1.1, -1.0, cumulative -8.1 - Real interest rate contribution (selected): 0.4, 1.0, 0.1, -0.5, -0.5, -0.1, 0.2, 0.0, 0.1, cumulative -0.7 - Real GDP growth contribution (selected): -1.0, -0.8, 0.3, -1.6, -1.2, -1.2, -1.1, -1.1, -1.1, cumulative -7.4 - Other identified debt-creating flows (policy lending): - Values by year (percent of GDP): 0.4, 1.0, 1.4, 1.3, 0.8, 0.8, 0.8, 0.8, cumulative 5.5 - Residual, including asset changes: - Values by year (percent of GDP): 0.9, -0.4, 0.5, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 ### Stress tests, scenarios, and realism assessment - Under alternative scenarios (figures and scenario descriptions): - Baseline underlying assumptions (selected): - Real GDP growth: 4.0 (2021), 3.0 (2022), 2.8 (2023), 2.5 (2024), 2.4 (2025), 2.3 (2026) - Inflation (GDP deflator): 2.8 (2021), 3.2 (2022), 2.0 (2023), 1.5 (2024), 1.8 (2025), 1.8 (2026) - Primary balance: -1.9 (2021), -2.4 (2022), -2.0 (2023), -2.0 (2024), -2.0 (2025), -1.9 (2026) - Effective interest rate: 1.7 (2021), 1.9 (2022), 2.0 (2023), 2.1 (2024), 1.9 (2025), 2.0 (2026) - Constant Primary Balance Scenario: - Primary balance held at -1.9 (2021–2026) - Historical Scenario (alternative growth paths): - Real GDP growth: 4.0 (2021), 2.6 (2022–2026) - Primary balance: -1.9 (2021), -0.6 (2022–2026) - Stress test types performed: - Primary Balance Shock - Real GDP Growth Shock - Real Interest Rate Shock - Real Exchange Rate Shock - Combined Macro-Fiscal Shock - Stress test outcome summary: - Central government debt remains below 60 percent of GDP across individual shocks and the combined shock (text statement). - Visuals show alternative paths for gross nominal public debt and public gross financing needs under shocks. ### Risk assessment and vulnerability indicators - Debt profile and market indicators (selected): - Public gross financing needs (percent of GDP): values shown across 2019–2026 in figures (exact annual series provided in underlying tables and charts). - Bond spread (EMBIG or 5Y CDS): referenced in tables and figures (dates and averages noted in original source). - Percentiles and forecast track record: - IMF staff assesses realism of baseline assumptions using historical forecast errors (figures show distributions; specific numeric percentile ranks and some entries labeled "n.a." in the source). - Korea’s 3-year adjustment in cyclically-adjusted primary balance (CAPB) and 3-year average level of CAPB shown with percentile ranks (e.g., 44% and 82% respectively as presented in figures). ### Policy recommendation - Implement a phased fiscal consolidation strategy over the medium term that combines: - Revenue mobilization, and - Expenditure rationalization, to stabilize public debt while accommodating spending needs from population aging and structural transformation. _Italic: Source: IMF staff, Annex III. Public Sector Debt Sustainability Analysis (as of February 03, 2022)._ ### 3. Micro price data can inform on ### 3. Micro price data can inform on ### Methodology - Uses 101 micro price series. - Follows Borio et al. (2021) by extracting relative price ‘salient’ changes from the idiosyncratic component in a factor model. - Transforms the idiosyncratic component using the non-linear transformation in Hamilton (2003). - Uses the transformed series as a regressor on core inflation. ### Findings on relative price shocks and core inflation - Salient and positive relative price shocks are more likely to pass-through to core inflation because: - Being large, they are more noticeable. - Being positive, they tend to constrain consumers more than decreases. - Similar considerations may apply to producer decisions that underlie consumer basket prices. - Korea micro data shows that the pass-through of salient relative price increases to core inflation has declined. - The analysis suggests some recently observed price increases could be transient because the pass-through of relative price shocks into inflation would be small in the current environment of enduringly low and stable inflation. ### Caveats - Inflation dynamics during the pandemic have been unusual. - Recent inflation dynamics occurred in the context of post-Covid normalization and unprecedented global fiscal and monetary stimulus. ### Annex VI. Household Debt implications for Monetary Policy in Korea - Korea has an elevated level of household debt, with approximately 50 percent of household debt linked to floating interest rates and structured as bullet payment. - Bullet loans are riskier because they have shorter maturities and greater susceptibility to rollover risk. - High debt levels can create challenges for monetary policy: - The fall in interest rates has stabilized debt servicing despite significantly higher debt. - A snapback in rates may dampen domestic demand. - Counterfactual estimate: If the interest rate had stayed at the early 2000 level, given current levels of household debt, domestic demand would be around 10 percent lower. The Bank of Korea has lowered interest rates to offset this shortfall. - Implication: A tightening in monetary policy would have a greater impact on growth due to current elevated household debt levels. - Policy implication: Heightened need for prudential policies rather than monetary policy to contain household debt risks. ### Annex VII. Time-Varying Effects of Monetary Policy in Korea - Modeled interaction between the Bank of Korea’s policy rate and macro-financial variables using a system of money demand, monetary policy, and exchange rate equations. - Model features: - Time-varying parameters allowing for state-dependency and non-linearities. - Allows the size of shocks hitting the Korean economy to vary. - Assumes monetary policy is neutral in the long-run. - Finding: The time-varying effects of a—non-systematic—1 percent monetary policy change have moderated, particularly on inflation. - Possible explanations: - A tighter macroprudential stance limiting pass-through of monetary policy. - Asymmetric effects when central banks are constrained by the effective lower bound (ELB). - Implication: The smaller effect of monetary policy implies a stronger response may be needed to tame inflation, with resulting risks for growth, and a potentially greater role for fiscal and macroprudential policies. - Source note: Haver and IMF staff calculations. ### Annex VIII. Korea Housing Demand - Falling interest rates and rise in expected returns in real estate prices have stimulated strong demand for real estate and speculative activity. - User-cost framework outlined; in an illustrative, risk-neutral example (assuming M_r_t = 0): - 3.4+1+0.7−4.5 = 0.6 percent required rate of return to break even on a property. - With an average price of a house in inner Seoul at US$ 932k, a 0.6 percent marginal cost implies US$ 5,590 in rent per year, or US$ 466 per month. - Average rents are over US$ 1,000 per month, implying agents accrue US$ 534 in economic profit (π_t). - As of 2021, the implied rent on a dwelling was equal to around 20-25 percent more than the cost of the mortgage (R·K). - Implies cost of owning a dwelling has fallen while the flow of output produced by housing has remained stable. - Policy levers to contain housing demand: increases in risk premia, property taxes, mortgage rates, or tighter macroprudential borrower-based policies. ### Annex IX. Fund’s Past Advice on Labor Market, Gender Inequality, and Climate - Labor market recommendations (years cited: 2017, 2019, 2020): - Adopt “flexicurity” in the labor market: more flexibility for regular workers; inclusive safety net for the unemployed; active labor market policies. - Build foundation for “flexicurity”: dialogue with all stakeholders including non-unionized workers, SMEs and the self-employed; flexible working hours; move away from strictly seniority-based wage system. - Cautious in expanding public sector employment and increasing the minimum wage; phase out compensatory subsidies to SMEs; link public sector job creation to services not provided by private sector; set up a Job Stabilization Fund. - Boost youth employment: strengthen work-study dual system and internships; collaboration with businesses to ensure quality placements. - Unemployment benefit: phase-in expansion of insurance coverage to workers in non-standard employment; relax eligibility criteria for basic livelihood security benefits (2020). - Gender recommendations (2017, 2019): - Enhance participation of women: strengthen childcare quality and affordability; promote shared parental leave; make tax treatment of second earners more neutral; introduce corporate benchmarks for women’s employment and leadership; improve work-life balance and mitigate labor market duality. - Climate recommendations (2020): - Increase allowance prices in Korea’s ETC from current levels of about $20/ton. - Align emissions caps with the 2030 mitigation target and underpin system with a robust and rising price floor. - Compensate vulnerable groups for higher energy prices, support R&D and investment in climate-smart technology, and lower the tax burden on labor and capital income. - Increase shares of renewable power generation and electric vehicles; improve energy efficiency of infrastructure; support innovation in green industry; reinforce incentives for mitigation and green investment; revenue-neutral fee/rebate schemes for vehicles and power generators with lower emission rates. *Prepared by Sohrab Rafiq. Source: Haver and IMF staff calculations.* ### 2020. The FSC introduced periodic and non-periodic inspections of fintech companies and ### Korea: FSAP Key Recommendations (Annex X) ### Cybersecurity, fintech inspections, and open banking - The FSC introduced periodic and non-periodic inspections of fintech companies and established a system/framework for inspecting cyber security system of financial institutions on December 22, 2021. - The FSS has monitored cyber security risks related to open banking system. - Banks and electronic financial service providers offering open banking services (54 in total) in the end of 2020 were subject to inspections (conducted from February to April 2021) on their operation of open banking services. ### Household debt, Jeonse leasehold system, and connectedness to securities companies - Recommendation: Assess the potential rollover risk implied by the Jeonse leasehold system and its connectedness to securities companies. - Agencies: FSC/FSS and BoK. Status: PD. - Actions taken / monitoring: - The FSC announced measures to strengthen household debt management in October 2021, which includes improving DSR rules on individual borrowers in order to establish lending practice based on borrowers’ debt-servicing capabilities. - The FSS has been identifying areas/regions where Jeonse deposit-related risks* could occur and carrying out constant monitoring on the areas/regions. - Considering the possibility that gains from increased Jeonse deposits (resulted from rising Jeonse prices) could be injected to the stock market, the financial authorities are monitoring retail investor’s investment trend in the stock market. ### Stress testing, FX liquidity, NPLs, SME loans, and securities intermediaries - Recommendation: Enhance stress testing practices to better estimate vulnerabilities relating to nonperforming loan (NPL) sales, FX and domestic household liquidity, SME loans, securities intermediaries activities, and sovereign contingent liabilities. - Agencies: BoK and FSC/FSS. Status: PD. - Actions taken / planned: - Considering the scheduled unwinding of temporary deregulatory measures (lowering FX LCR from 80% to 70%), the FSS plans to revise FX liquidity stress testing under Basel III LCR framework. - It is planned to improve stress testing methods in the mid-and long-term by collecting related data. ### Institutional framework and financial conglomerates - Recommendation: Strengthen the institutional framework for financial stability by assigning the MEFM (or a body empowered for the equivalent purpose) macroprudential oversight as its sole primary objective. - Agencies: MOEF, FSC and BoK. Status: NA. - Recommendation: Widen the definition of financial holding company and enhance legal powers to cover all financial conglomerates including requirements for group-wide liquidity risks and contingency plans. - Agencies: MOEF and FSC/FSS. Status: PD. - Actions taken: - The FSC made efforts to legislate the Act on Supervision of Financial Groups. The notice of legislation was posted from June to July 2020. The bill was proposed to the National Assembly on August 31, 2020 and passed the National Assembly in December 2020. The enforcement decree of the Act was legislated and the Act took effect in June 2021. - The Act contains provisions related to (i) tightened internal control and risk management and (ii) solvency management (contagion risks and concentration risks, etc.), including the supervision of capital adequacy. Under the Act, it is required to submit and implement a management improvement plan in case of group-wide risks. - The FSS is working on coming up with liquidity regulations that are consistent with international recommendations (LCR and NSFR) * for bank holding companies and introducing the framework. The revised supervisory regulations and enforcement decrees were established in August 2021 and submitted to the FSC in September 2021. ### Countercyclical capital buffer (CCyB) and household exposures - Recommendation: Implement a Sectoral CCyB framework for secured and unsecured household exposures of the banking sector. - Agencies: FSC/FSS and BoK. Status: NA. - Considerations and potential measures: - The FSC/FSS is considering measures to require banks to set aside additional capital in proportion to their household assets ranging from 0% to 2.5% of the total risk-weighted assets. - If adopted, the timing of enforcement will be determined flexibly after examining macroeconomic conditions amidst the COVID-19 pandemic. ### Supervision of state-controlled banks, insurers, and the role of FSC/FSS - Recommendation: Review the role of state-controlled banks and ensure that their commercial lending and investment activities conform, at a minimum, with prudential requirements for nationwide banks. - Agency: FSC/FSS. Status: LD. - Action: To curb excessive commercial lending and investment activities of state-controlled banks, the Korea Development Bank and Industrial Bank of Korea will adopt Basel III framework by the end of 2020. - Recommendation: Increase risk-based supervisory intensity of insurers, ensure a prudent and proportionate implementation of Korea Insurance Capital Standard (K-ICS) and design of the capital charge for longevity risks. - Agency: FSC/FSS. Status: LD. - Actions taken: - Additional capital charges are added to Korea Insurance Capital Standard (K-ICS) to deal with risks such as aging population and longevity. - The FSC/FSS announced the revised version of K-ICS (K-ICS 4.0) in April 2021 in preparation for the implementation of K-ICS in 2023. - The FSS conducted quantitative impact assessments on K-ICS in 2021. - The FSS came up with the final version of K-ICS in December 2021, adding longevity risks to the calculation of the amount of risk of life and long-term insurance policies. - The FSS plans to conduct quantitative impact assessments on the final version of K-ICS in the first half of 2022. - Recommendation: Focus the role of FSC towards strategy, addressing nonbank data gaps, market development policies, and crisis preparedness while assigning greater operational and enforcement authority to the FSS. - Agencies: MOEF and FSC/FSS. Status: D. - Description: - The FSC is responsible for formulating financial policies, supervising financial institutions, and financial markets, protecting consumers, and advancing Korea’s financial industry. - The FSS examines and supervises financial institutions under the oversight and guidance of the FSC as per the Act on the Establishment, etc. of Financial Services Commission. - The FSC and FSS will closely cooperate with each other to address financial issues in a timely and harmonious way while playing their own role stipulated in the Act. ### Pension and contractual savings oversight - Recommendation: Support the development of pension and contractual savings products by introducing multi-employer pension schemes and building further capacity for oversight of pension funds market. - Agencies: FSC/FSS / MOE. Status: L / NA. ### Crisis management, resolution arrangements, and recovery plans - Recommendation: Include cross-border activities and overseas operations of financial conglomerates in resolution plans, clarify issues relating to resolvability, and relationship between ELA and resolution funding. - Agency: FSC/FSS. Status: LD. - Actions taken: - The Recovery and Resolution Plans (RRP) for financial holding companies and banks came into effect in June 2021. The first evaluation and deliberation of recovery plans are underway. KDIC is working on drawing up resolution plans. - Issues regarding cross-border activities/operations are included in FSC’s deliberation standards on RRP and resolution plans developed by the KDIC. - Pursuant to the amendment of the Act on the Structural Improvement of the Financial Industry (December 2020), D-SIFIs* are required to draw up their own recovery and resolution plans. (The requirements came into effect on June 30, 2021) - *There are 10 D-SIFIs, including five big bank holding companies (Shinhan, KB, Woori, Hana, NH) - The FSS develops evaluation reports on the recovery plans prepared by D-SIFIs, and the FSC approves the recovery plans based on the evaluation reports. - Recommendation: Strengthen the insolvency and creditor’s rights regime through well-resourced courts and a functioning insolvency practitioners’ profession. - Agency: MoJ. Status: NA. ### Data, statistics, and surveillance - General: Data provision is adequate for surveillance. - Key data and standards: - Korea compiles quarterly Financial Soundness Indicators (FSIs) and metadata with data currently available through 2021Q2. - Going forward, the Korean authorities should shift to more timely provision of FSI data to the Fund with a time lag in line with the average in advanced G20 economies of no more than 4 months. - Korea subscribed to the Special Data Dissemination Standard (SDDS) on September 20, 1996. - Table of Common Indicators (as of February 17, 2022): Latest observations and frequencies are reported for Exchange Rates (2/16/2022), International Reserve Assets (Jan. 2022), Reserve/Base Money (Dec. 2021), Broad Money (Dec. 2021), Central Bank Balance Sheet (Dec. 2021), Consolidated Balance Sheet of the Banking System (Dec. 2021), Interest Rates (2/16/2022), CPI (Jan. 2022), General Government fiscal data (2020), Central Government fiscal data (Nov. 2021), Stocks of Central Government and Central Government-Guaranteed Debt (Nov. 2021), External Current Account Balance (Dec. 2021), Exports and Imports (Dec. 2021), GDP/GNP (Q4 2021), Gross External Debt (Q3 2021), International Investment Position (Q3 2021). ### IMF Staff update: political and policy context (March 18, 2022) - Suk-yeol Yoon from the People Power Party (PPP) won the presidential election on March 10, garnering 48.6 percent of the vote with a narrow margin of 0.7 percent over the incumbent Democratic Party candidate. Voter turnout was 77 percent. The PPP does not have a majority in parliament; elections are scheduled in 2024. The new administration will take office on May 10. - The new government is likely to follow through on its electoral pledge to reduce tax and regulatory burdens. Immediate policy priorities expected: - Supporting vulnerable sectors, including additional measures to compensate small businesses and the self-employed for losses during the pandemic. - Stabilizing the housing market, and advancing labor and financial market reforms. - Proposed measures include scaling back regulations on the housing market and recent property tax increases, promotion of emerging financial activities including digital finance, labor market reforms focused on increasing flexibility to support private sector led job creation, and continuation of efforts aimed at supporting carbon neutrality, including through an expansion of nuclear energy (reversing the previous policy stance to phase it out). - The incoming administration has pledged to implement the fiscal rule laid out in 2020 which included a cap on the public debt ratio of 60 percent of GDP. *Italic: Source — IMF document: Korea FSAP Annex X and related sections (staff report excerpts). ### 3. The macro-financial impact from the conflict in Ukraine has been contained thus ### 3. The macro-financial impact from the conflict in Ukraine has been contained thus far ### Macro-financial conditions and market sentiment - Financial conditions remain broadly accommodative despite a worsening of risk sentiment, reflected by a shift away from equities and toward safer assets. - The Korean won has modestly depreciated against the U.S. dollar and the Chinese renminbi, but dollar funding conditions remain accommodative. - Markets are pricing in higher short-term inflation, but bond yields suggest that inflationary pressures are viewed as being transitory. ### Main spillovers from the conflict in Ukraine - Direct trade exposure: - About only 2 percent of Korea’s total exports are destined to Russia and Ukraine. - Supply-chain and input vulnerabilities: - Korea relies on Russia and Ukraine for about half of its imports of some rare gases used in the manufacturing of semiconductors. - Sustained supply chain disruptions would weigh on key exports and could be compounded by difficulties procuring other raw materials and inputs if there are broader disruptions of global distribution channels. - Terms-of-trade and price effects: - Rising energy prices will adversely affect Korea’s terms of trade. - Higher semiconductor prices from global pent-up demand and production capacity limits would help buffer the adverse terms-of-trade shock. - Demand channel: - A weakening of partner country demand will have a large effect on Korean exports across a broader range of products. - Inflationary implications: - A sustained increase in global oil and food prices would add to inflation pressures in the coming months and delay the convergence of inflation to target. ### Recent inflation developments - Headline inflation in February increased to 3.7 percent, a 0.1 percent rise from January, driven by rising housing and fuel costs. - Core inflation increased to 2.9 percent, indicating some broadening of price pressures. - Market indicators suggest the spike in inflation is still viewed as transitory. ### COVID-19 wave, vaccinations, and health-system response - Korea has been hit by a new wave of COVID-19 (Omicron), expected to peak in March. - As of March 15: - Nearly 86.5 percent of the population was fully vaccinated. - 62.6 percent had received vaccine boosters. - Authorities shifted COVID-19 response focus to maintaining necessary medical care for severe or critical cases and have flexibly adjusted social distancing measures. - The authorities passed a supplementary budget of KRW 16.9 trillion on February 21 to scale up support to small businesses and vulnerable groups; 90 percent of this supplementary spending will be executed by end-March. ### Growth outlook and external sector - Growth: - Korean economy expected to continue to recover with a growth forecast of about 3 percent this year, in line with staff’s projection, building on a 4 percent growth last year. - Growth forecast for 2022: Bank of Korea (BOK) 3.0 percent, Ministry of Economy and Finance (MOEF) 3.1 percent. - Drivers: - Solid growth in exports and investment, recovery in private consumption, continued momentum in IT and new industry areas such as electric vehicles and bio-health. - Current account: - Current account surplus increased to 4.9 percent of GDP, driven by a temporary increase in transportation surplus and an improved primary income balance despite a substantially narrowing goods surplus. ### Labor market - Employment exceeded the pre-pandemic level in December 2021, with a recovering trajectory since January 2021. - The ratio of workers in regular jobs reached a historic high of 74.2 percent in January 2022. - Youth unemployment has fallen below the pre-pandemic level. - Growth of regular jobs (YoY, thousand): (Sep.21) 515 (Oct) 615 (Nov) 611 (Dec) 652 (Jan) 686. - Growth of discouraged workers (YoY, thousand): (Sep.21) -30 (Oct) -42 (Nov) -106 (Dec) -218. ### Inflation outlook (authorities’ view) - CPI inflation has remained high in the mid- to upper-3 percent range due to rising petroleum product prices and accelerating prices of personal services and industrial products. - Core inflation (excluding food and energy changes) has risen to the upper-2 percent level. - Inflation expectations have run at the mid- to upper-2 percent level. - Forecasts: - CPI inflation is forecast to remain substantially above 3 percent for a considerable time and run at the lower-3 percent level for the year overall. - Core inflation is forecast to remain at the mid-2 percent level this year. - CPI inflation forecast for 2022 – IMF 3.1 percent, BOK 3.1 percent; Core inflation for 2022 – IMF 2.5 percent, BOK 2.6 percent. ### Fiscal policy stance and measures - Expansionary fiscal policy to support recovery with targeted support to businesses and individuals. - In 2021: - Public spending increased by 9.5 percent (KRW 43.1 trillion) from the previous year with an execution rate of 97.6 percent. - Tax revenue in 2021 increased by 20.5 percent (KRW 58.5 trillion) and 9.5 percent (KRW 29.8 trillion) compared to the previous year and the 2021 budget, respectively. - 2022 budget: - Growth rate of expenditure 8.9 percent, nominal GDP growth rate 4.6 percent. - KRW 16.9 trillion supplementary budget passed on February 21 in response to Omicron. - Payment deferrals (insurance premiums, electricity and gas bills) deferred for three months until June. - The government plans medium-term fiscal management in compliance with a proposed fiscal rule pending in the National Assembly; the medium-term fiscal management plan for 2021-25 reflects efforts to manage total revenue and expenditure on the premise of complying with the fiscal rule. - Execution commitment: - The government is committed to fully disburse the supplementary spending as soon as possible, of which 90 percent will be executed by end-March. ### Monetary policy and financial-sector measures - Bank of Korea actions: - Base Rate raised three times by a total of 75 basis points from a record low of 0.5 percent, returning to the pre-pandemic level. - BOK considers current monetary policy still accommodative as real rates remain significantly negative and financial conditions are overall favorable. - BOK sees room for further adjustment to monetary accommodation given sound growth and inflation above its target level (2 percent) for a considerable time. - Emergency support normalization: - Emergency liquidity support facilities that achieved goals have been terminated or scaled back; measures that remain effective and urgent are retained. - Financial institutions extended loan maturity and debt services deferral set to expire at end-March for an additional six months through end-September. - Principal and interest payment deferral takes up a small share of total support; banks have sufficient loan loss reserves. - Authorities to work with banks on tailored support plans based on micro-analysis. - Insolvency: - Continued improvements to the insolvency system focusing on simplified rehabilitation and individual rehabilitation proceedings to broaden access for small businesses. ### Household debt and housing market policies - Household debt: - Increased due to accommodative macroeconomic policy measures, housing market boom, and increased demand for collateralized lending. - Authorities announced plans to curb household debt; BOK’s policy rate hikes complement these efforts. - Regulatory measures: - Individual-based Debt Service Ratio (DSR) ceiling introduced. - Borrowers with bank loans of more than KRW 200 million subject to a 40 percent DSR ceiling since January 2022. - Banks with large household debt will be required to set aside household loan capital buffer up to 2.5 percent. - Average LTV ratio of all financial institutions is 42.3 percent as of June 2021. - A large share of household debt is carried by high-credit debtors; borrowers own enough assets to service their debt. - Housing market: - Housing prices have recently been on a downward trend due to policy measures, tighter household debt regulations, and BOK rate hikes. - Government measures to expand housing supply: building more public housing, streamlining approval processes, increasing density of brownfield redevelopments, improving transportation links. - Presale price cap system has helped stabilize the housing market and has not prevented private developers from supplying houses. ### Structural policies, Korean New Deal, and climate commitments - Korean New Deal (KND): - KND masterplan introduced in 2020 and upgraded to version 2.0 to accelerate green and digital transformation and address inequality. - Central government spent KRW 27.1 trillion for the KND over the past two years; KRW 33.1 trillion allocated in the 2022 budget. - New Deal Fund established with a subscription of KRW 5.4 trillion beyond the annual target of KRW 4 trillion and is currently under investment. - Government identified and improved 191 tasks and completed enactment of 28 laws, including the Carbon Neutrality Framework Act and the Data Framework Act. - Projects include offshore wind farms, smart green industrial complexes, data centres, and super giant AI. - Human New Deal added in KND 2.0 to increase investment in human resources and support youth and vulnerable groups. - Climate and carbon neutrality: - Carbon Neutrality Act passed in August 2021; targets carbon neutrality by 2050. - Nationally Determined Contribution (NDC) target increased to 40 percent of 2018 level by 2030; sectoral targets adjusted accordingly. - KRW 11.4 trillion allocated in the 2022 budget (48 percent increase from KRW 7.7 trillion in 2021) and Climate Response Fund of KRW 2.4 trillion created. - Public green finance to be expanded to KRW 7.5 trillion. - Carbon neutrality R&D budget increased to KRW 1.8 trillion in 2022 from KRW 1.3 trillion in 2021. - Government plans to use carbon pricing (ETS) as a key tool while exploring non-price measures, R&D support, tax incentives, and fostering low-carbon industries (secondary cell, bio-health, hydrogen). *Source: 1korea2022001.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1korea2022001.pdf_