## 1. Previous IMF Policy Recommendations ## Source details **Canonical URL:** [1. Previous IMF Policy Recommendations](https://www.imf.org/-/media/files/publications/cr/2023/english/1korea2023001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1korea2023001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1korea2023001.pdf.json) --- ### Context and recent macro-financial developments - Growth and inflation: - Real GDP growth: 2.6 percent (y/y) in 2022, down from 4.3 percent in 2021. - Sequential growth: 0.6 percent (q/q) in 2023Q3, recovering from a contraction in 2022Q4. - Headline inflation: peaked at 6.3 percent in July 2022; rebounded to 3.7 percent in September (y/y). - Core inflation: from 4.3 percent in November 2022 to 3.3 percent most recently. - Sectoral developments: - Semiconductor sector: global demand surged during the pandemic and weakened considerably starting in late 2022. - Labor market: - Unemployment rate: 2.6 percent (s.a.) in September 2023 (pre-pandemic levels were 3.5–3.8 percent). - Fiscal and public debt: - Central government fiscal deficit: 3 percent of GDP in 2022 (budgeted at 3.3 percent of GDP). - Revenue shortfalls in 2023H1: 40 trillion won (1.8 percent of GDP). - Central government debt: around 48 percent of GDP in 2022. - Monetary policy: - Bank of Korea policy rate: held at 3.5 percent since February 2023 after cumulative hikes of 300 bps. - Household and housing: - Housing prices: declined by about 8 percent since end-2021 but remain above pre-pandemic levels. - Household debt: about 101.7 percent of GDP as of 2023Q2. - External sector and reserves: - Current account surplus: 1.8 percent of GDP in 2022 (from 4.7 percent in 2021). - Foreign exchange intervention (FXI): net sales of $46 billion in 2022; net sales of $8 billion in 2023H1. - Gross international reserves: $414 billion in August 2023 (from $418 billion as of end-2022). - Reserve metrics: equivalent to 25 percent of GDP, 190 percent of short-term debt (residual), 6.2 months of imports, or 14 percent of M2. - Financial market events: - October 2022 ABCP default triggered spread spikes; stabilization measures eased spreads. - MG Community Credit Cooperatives (MGCCCs) total assets about 12 percent of GDP (May 2022); July 2023 stress led to deposit withdrawals and branch mergers; deposit inflows resumed since August after government measures. ### Outlook and risks - Growth projections: - 2023: expected to reach 1.4 percent. - 2024: projected recovery to 2.2 percent (earlier July WEO forecast: 2.4 percent). - Inflation projections: - Headline inflation: decline to 3 percent by end-2023 and approach 2 percent by end-2024. - Core inflation: expected to decline more gradually. - Current account projection: - 2023: projected to decline to 1.3 percent of GDP. - Medium term: expected to recover to 4 percent of GDP. - Key risks (tilted to the downside): semiconductor demand uncertainty, China demand weakness, weaker growth and tighter monetary policy in major economies, commodity price volatility, global banking turmoil resurgence, reduced trust in domestic NBFIs, renewed real-estate downturn, intensification of geo-economic fragmentation. - Adverse scenario (Box 3): in tighter international financial conditions and sharp USD appreciation, Korea’s growth could decline by 0.4 percentage points relative to baseline while inflation would slow faster. ### Monetary policy: "Staying the course" - Maintain restrictive near-term policy until inflation and expectations are firmly anchored; avoid premature easing. - BoK guidance: maintain current stance for a considerable time; further hikes conditional on incoming data. - If faster disinflation and slower growth (staff’s adverse scenario): - Consider gradual lowering of the policy rate. - Allow automatic stabilizers to operate. - Provide additional targeted support to the vulnerable via strengthened social safety nets. - Scale up growth-enhancing public investments, including green public infrastructure. - Foreign exchange intervention (FXI) guidance: - FX intervention should remain limited to preventing disorderly market movements. - Authorities reaffirmed intention to limit FXI to addressing phases of abnormal currency volatility; FXI was significantly reduced in 2023H1 compared to last year. ### Fiscal policy stance and framework - Fiscal stance: - Fiscal policy should remain tight to slow the build-up in public debt and support disinflation. - Authorities plan to secure funding for budgetary spending by withdrawing government deposits and funds, including from the FX stabilization fund, without additional deficit financing through bond issuance. - Central government fiscal deficit trajectory: - Projected to narrow to around 1.8 percent of GDP (from 3 percent in 2022), with a fiscal impulse of -0.8 percent of potential GDP. - 2024 budget proposal implies deficit decline to 1.7 percent of GDP; implied fiscal impulse of -0.4 percent of potential GDP. - Fiscal rules and medium-term anchors: - Authorities proposed a fiscal rule (under discussion) with a 60 percent of GDP government debt ceiling and a managed fiscal deficit ceiling of 3 percent of GDP (tightening to 2 percent if debt exceeds 60 percent); escape clause for severe shocks; proposed rule to take effect in 2025. - Staff suggests preserving counter-cyclical scope, possibly via a transition phase with a somewhat higher deficit ceiling. - Pension fiscal challenge: - Pension spending rose from 1.8 percent to 4.0 percent of GDP between 2009 and 2022. - NPS expected to go into deficit in 2041 and deplete assets by 2055 under current policies. - Recommendations: raise contribution rates significantly and increase the retirement age further; avoid further reductions in replacement rates without offsetting measures. ### Financial stability, macroprudential policy, and NBFIs - Overall assessment: - Financial risks have risen but remain manageable thanks to buffers and swift policy responses. - Macroprudential measures maintained: 50 percent LTV limit for new mortgages; 40 percent DSR ceiling for individuals’ borrowing from banks. - Staff supports increasing the countercyclical capital buffer (CCyB) from zero to 1 percent starting May 2024, consideration of a stress-buffer capital system, and additional provisioning requirements. - NBFIs and project financing (PF): - NBFIs’ assets >60 percent of total financial system assets in 2022. - PF exposures are the riskiest segment: unsecured, highly leveraged, maturity mismatch; PF project loans ~5 percent of GDP, PF-backed securities ~2.2 percent of GDP, bridge loans 0.5–1 percent of GDP, guarantees ~3 percent of GDP (o.w. 1.1 by securities). - Overall PF delinquency: about 1.2 percent at end-2022 (peak was ~8.2 percent in 2013); substandard PF loan ratios for securities firms are in double digits. - Mutual savings banks and mutual credit cooperatives have rising NPLs and lower provision coverage; loan loss provision coverage for some fell below 100 percent as of 2023Q1. - MGCCCs: - Recommendation: enhance supervision, tighten regulatory requirements to align MGCCCs with other non-bank depository institutions; consider strengthening regulatory and supervisory framework as conditions normalize. - Housing guarantee companies and Jeonse risks: - Jeonse deposit default rates reportedly increased considerably in 2023H1 and expected to further rise in 2023H2. - Stress tests: severe housing-price shocks imply fiscal contingent liabilities of about ¼ percent of GDP. - Policy: keep Jeonse-related lending relaxation temporary; tighten eligibility for subsidized Bogeumjari loans; introduce stress DSR framework for floating-rate loans; tighten regulations for 50-year mortgage loans. - Crisis management and support measures: - Financial Market Stabilization Measures since October 2022 included government and public financial institutions’ bond and ABCP purchase programs, BoK liquidity provision, real estate PF guarantees, and temporary prudential reliefs (e.g., phased restoration of KRW LCR and staged LDR normalization). - Policy advice: keep emergency liquidity support temporary, targeted, penal, fully collateralized, and accompanied by supervisory oversight. ### Stress tests, reserves, and external buffers - FX intervention and reserves: - Bank of Korea reported net FX sales of $45.9 billion (2.8 percent of GDP) in 2022, mostly in Q2 and Q3. - FX intervention in H1 2023: net sales of $8 billion (0.5 percent of GDP). - End-August 2023 reserves: $413 billion (from $418 billion as of end-2022). - Reserve adequacy: about 25 percent of GDP, 1.9 times short-term debt, 6.2 months of imports, 14 percent of M2. - Annex IV stress-test findings (Systemwide Liquidity Stress Testing Tool): - Key assumptions: currency depreciation 30 percent; trade balance shock worst-case -4 percent of GDP; test horizon one year; private sector external debt rollover rates considered at 90, 50, 30 percent. - Example outcomes: - Mild shock (10 percent repatriation, 1 percent LC conversion, trade -1 percent of GDP): 22 percent GIR reduction when private external rollover = 30 percent. - Intermediate shock (30 percent repatriation, 2 percent LC conversion, trade -2 percent): 59 percent GIR reduction when private external rollover = 30 percent. - Severe shock (50 percent repatriation, 3 percent LC conversion, trade -4 percent): 94 percent GIR reduction when private external rollover = 30 percent. - Sensitivities: 50 percent foreign repatriation can deplete 65 percent of GIR; a 10 percent resident LC deposit conversion reduces GIR by 60 percent (illustrative). - Policy recommendations from stress tests: - Tighten FX liquidity regulations and monitoring; expand FX LCR and stress tests to NBFIs; limit FX intervention to preventing disorderly market conditions; improve data on OFCs’ FX liquidity. ### Geoeconomic fragmentation and adaptation (Box 2) - Global loss estimates: - Permanent global output losses range from 0.2 percent (limited fragmentation) to 7 percent (severe). - Fragmentation through the FDI channel alone could lead to global output losses up to 2 percent. - Two-bloc high-tech/energy cutoff scenario: global output loss 1.2 percent; Asia-Pacific 1.5 percent. - Korea-specific exposure: - Korea could face permanent output losses of about 2-4 percent of GDP in a two-bloc scenario; larger losses if non-tariff barriers are added. - Adaptation strategy: - Diversify trading partners and sourcing; upgrade trade agreements; build external and financial buffers; foster innovation and structural reforms; keep trade and investment measures narrowly targeted and WTO consistent. ### Adverse scenario (Box 3): global banking fragility - Scenario setup (IMF’s G20 Model) assumptions: - US bank lending decreases by 4 percent in 2024 relative to current baseline; US corporate spreads increase by 250 basis points in 2024. - For Korea: real corporate interest rates assumed to rise by 35 bps. - US dollar appreciates close to 10 percent (shock smaller for Asia). - Impacts on Korea: - Real GDP growth reduced by 0.4 percentage point in 2024 relative to baseline. - Inflation declines as lower demand outweighs import-price effects. - Policy reaction: monetary policy lowers policy rate by about 50 bps in 2024 and 2025 in the model; automatic stabilizers operate; fiscal space available for additional support. - Downside deviations (selected): - 2024 policy rate (%pt deviation): -0.46; core CPI (%pt deviation): -0.19; real corporate interest rate (%pt deviation): 0.31; unemployment rate (%pt deviation): 0.09; risk premium (%pt deviation): 0.79. - 2025 policy rate (%pt deviation): -0.49; core CPI (%pt deviation): -0.21; real corporate interest rate (%pt deviation): 0.07; unemployment rate (%pt deviation): 0.05; risk premium (%pt deviation): 0.50. ### Financial digitization and crypto regulation (Box 4) - Digital trends and risks: - Open banking, fintech, and Big Tech payments expanded; crypto incidents (FTX, Terra-Luna) raised investor protection concerns. - BoK CBDC work: - Project with FSC and FSS, in cooperation with the BIS; testing stage involving the general public expected around Q4 2024. - Regulatory milestones: - March 2021 AML amendment covering VASPs. - March 2022 travel rule for crypto transfers exceeding KRW 1 million. - May 2023: National Assembly bill obliging lawmakers and high-ranking officials to report crypto assets. - July 2023: National Assembly passed new crypto legislation focusing on consumer protection and unfair competition; effective July 2024. - Next steps: issuance and market regulations under preparation; continued monitoring and regulatory upgrades recommended. ### Structural reforms and medium-term priorities - Labor market and gender: - Recommendations: increase labor market flexibility (working hours, performance-based pay), tackle duality, expand unemployment insurance to non-regular workers and self-employed, enhance childcare and parental leave incentives, retraining for re-entry. - Gendered growth accounting: reducing the gender gap in hours worked to the OECD average by 2035 could raise per capita GDP by 18.3 percent (KRW 10.5 million in constant 2015 prices) including ~1 percent productivity spillover. - Innovation and industrial policy: - Keep industrial policy narrowly targeted, WTO-consistent; K-Chips Act increased tax credits (large companies 8 percent to 15 percent; SMEs 16 percent to 25 percent). - Risks of broader measures: relocation incentives, trade distortions, retaliatory responses. - Recommendations: diversify partners, foster innovation, strengthen basic research. - Climate mitigation: - Korea committed to 40 percent emissions reduction from 2018 by 2030 and carbon neutrality by 2050. - ETS prices have remained under $20/MTCO2e. - Recommendations: align ETS caps with NDC, introduce robust rising price floor, transition to full auctioning, reinforce carbon pricing with feebates, increase/expand coal tax. - Estimated economic cost: higher carbon prices in line with targets could reduce annual average growth by 0.2 percentage points through 2030, mitigable by using ETS revenues for growth-enhancing investments. ### Staff appraisal and prioritized policy package - Monetary: maintain current restrictive stance for a considerable time; avoid premature cuts; limit FX intervention to preventing disorderly markets. - Fiscal: continue normalization to slow public debt build-up and support disinflation; mobilize additional financial resources to accommodate 2023 revenue shortfall; 2024 budget targets moderate consolidation. - Financial sector: strengthen buffers, regulation, and supervision; narrow regulatory gaps between NBFIs and banks; preserve prudential norms for vulnerable segments; consider sectoral CCyB for household exposures. - Structural: advance pension reform (raise contribution rates, increase retirement age), reform labor market to reduce rigidity and gender gaps, strengthen innovation and service-sector productivity, and reinforce climate policy instruments. *Source: IMF staff report excerpts from "REPUBLIC OF KOREA" (selected chapter content).* ### 1. Previous IMF Policy Recommendations ________________________________________________________ 25 ### 1. Previous IMF Policy Recommendations ### Context - Korea experienced inflation challenges and a sharp growth slowdown after the pandemic, driven by waning global demand for electronics and domestic demand weakening amid fiscal normalization and monetary tightening. - Growth slowed in mid-2022; inflation peaked in mid-2022 and has declined since, while core inflation has been more persistent. - Pockets of financial vulnerability emerged amid the housing market downturn and rising interest rates; systemic financial risks increased but appear to remain manageable. - Authorities’ policies since the last Article IV consultation have been broadly consistent with staff’s previous policy recommendations. ### Recent Developments — Real Economy and Prices - Real GDP growth: 2.6 percent (y/y) in 2022, down from 4.3 percent in 2021. - Sequential growth: 0.6 percent (q/q) in 2023Q3, recovering from a contraction in 2022Q4. - Headline inflation: peaked at 6.3 percent in July 2022; rebounded to 3.7 percent in September (year-on-year). - Core inflation: from 4.3 percent in November 2022 to 3.3 percent most recently. - Semiconductor sector: global demand surged during the pandemic and weakened considerably starting in late 2022. ### Labor Market and Wages - Unemployment rate: 2.6 percent (s.a.) in September 2023, lower than pre-pandemic levels of 3.5–3.8 percent. - Wage growth moderated, particularly in manufacturing, with bonuses shrinking amid weak profitability. ### Fiscal Developments - Central government fiscal deficit: 3 percent of GDP in 2022 (budgeted at 3.3 percent of GDP). - Revenue shortfalls in 2023H1: 40 trillion won (1.8 percent of GDP). - Central government debt: around 48 percent of GDP in 2022; assessed as sustainable with substantial fiscal space. - Fiscal stance: shift from pandemic support toward normalization since 2022H2; spending execution frontloaded in 2023H1. ### Monetary Policy - Bank of Korea policy rate: held at 3.5 percent since February 2023 after cumulative hikes of 300 bps. - BoK guidance: restrictive policy stance for a considerable time; market expectations moved close to the forward guidance. ### Financial Market and Housing Developments - October 2022 ABCP default triggered confidence loss and spread spikes in commercial paper and corporate bonds; spreads eased after stabilization measures. - Housing prices: declined by about 8 percent since end-2021 but remain above pre-pandemic levels. - Housing transactions plunged and unsold inventories surged in 2022; signs of overvaluation diminished after adjustment. - Policy measures eased some housing restrictions, introduced targeted mortgage assistance, and reduced real estate-related taxes to stabilize prices. - Household debt: about 101.7 percent of GDP as of 2023Q2. - Policy focus shifted to containing household debt with new lending-tightening measures for mortgages. ### Financial Stability Actions and NBFIs - Financial Market Stabilization Measures (since October 2022) included: - Government asset purchase programs (Bond Market Stabilization Fund; public financial institutions' corporate bond and commercial paper purchase programs; ABCP purchase programs). - Bank of Korea liquidity provision and liquidity support for securities companies. - Real estate PF guarantees by the Housing and Urban Guarantee Co. - Temporary prudential reliefs: delay in restoring KRW Liquidity-Coverage-Ratio limit (92.5 percent to 100 percent), partial unwind to 95 percent in July 2023; temporary delay of LDR normalization for banks (cap at 105 percent to 100 percent, ended June 2023); delays for savings banks and specialized credit finance businesses until Dec-2023. - Other operational and collateral eligibility measures for open market operations and net settlement. - MG Community Credit Cooperatives (MGCCCs): - Total assets about 12 percent of GDP (May 2022), majority in loans; liabilities mainly deposits. - July 2023 stress: deposit withdrawals and branch mergers amid rising NPLs. - Government actions: deposit protection in merged branches, tax and interest incentives for re-deposits, possibility of direct liquidity support, joint taskforce; private and policy bank liquidity support; deposit inflows resumed since August following announcements. ### External Sector and Reserves - Current account surplus: 1.8 percent of GDP in 2022, down from 4.7 percent of GDP in 2021. - Real effective exchange rate: appreciated by 1.8 percent through July 2023 after depreciating by 5 percent in 2022. - Foreign exchange intervention (FXI): net sales of $46 billion in 2022 (mostly Q2 and Q3); net sales of $8 billion in 2023H1. - Gross international reserves: $414 billion in August 2023 (from $418 billion as of end-2022). - Reserve metrics: equivalent to 25 percent of GDP, 190 percent of short-term debt based on residual maturity (or 250 percent based on initial contractual maturity), 6.2 months of imports, or 14 percent of M2. - Assessment: external position broadly in line with medium-term fundamentals and desirable policies; reserves provide adequate buffers under plausible shocks. ### Outlook and Risks - Growth projections: - 2023: expected to reach 1.4 percent. - 2024: projected recovery to 2.2 percent (earlier July WEO forecast: 2.4 percent). - Inflation projections: - Headline inflation: decline to 3 percent by end-2023 and approach 2 percent by end-2024. - Core inflation: expected to decline more gradually. - Current account projection: - 2023: projected to decline to 1.3 percent of GDP. - Medium term: expected to recover to 4 percent of GDP. - Risks (tilted to the downside): strength of semiconductor rebound, China’s demand, weaker growth and tighter monetary policy in major economies, commodity price volatility, global banking turmoil resurgence, reduced trust in domestic NBFIs, renewed real-estate downturn, intensification of geo-economic fragmentation. - Adverse scenario: in tighter international financial conditions and sharp USD appreciation, growth could decline by 0.4 percentage points relative to baseline projections while inflation would slow faster than projected. - Upside possibilities: faster global inflation decline or stronger semiconductor demand rebound could lift growth above baseline. ### Authorities’ Views - Authorities’ growth and inflation expectations broadly in line with staff’s views: gradual recovery in 2023H2 into 2024, with semiconductor recovery and tourism (including group tourism from China) supportive. - Authorities judged adverse shocks of the magnitude in staff’s adverse scenario as unlikely but noted risks from more moderate shocks (e.g., higher oil prices) that could hurt growth and raise inflation. - Authorities broadly agreed with staff’s external sector assessment and viewed reserves as adequate. ### Policy Discussions — Key Recommendations - Maintain restrictive near-term policies to limit public debt increases while addressing inflation: - Monetary policy: keep the policy rate above neutral and data dependent as core inflation remains elevated. - Fiscal policy: continue to normalize and expand available buffers given large long-term fiscal challenges from rapid population aging; continued fiscal normalization will support monetary policy in containing inflation. - Continue monitoring and addressing financial stability risks from housing market adjustments, elevated household debt, NBFI strains, and potential spillovers from global financial conditions. - Maintain readiness to deploy liquidity and stabilization measures as needed to preserve market functioning and confidence. *Source: IMF staff report excerpts from "REPUBLIC OF KOREA" (selected chapter content).* ### 18. Staying the course on monetary policy is appropriate. With headline inflation remaining ### Staying the course on monetary policy is appropriate. ### Monetary policy stance and guidance - With headline inflation remaining exposed to short-term fluctuations in energy prices and core inflation declining only modestly, maintaining the policy focus on addressing inflation is important. - Premature monetary easing should be avoided, consistent with the BoK’s restrictive policy stance and forward guidance of maintaining the current stance for a considerable time, with any further hikes conditional on incoming data. - Communications should continue to underscore that monetary policy will first and foremost focus on addressing inflation. - In case of a faster deceleration of inflation and slower economic growth (such as under staff’s adverse scenario (Box 3)): - Gradual lowering of the policy rate can be considered. - Automatic stabilizers should be allowed to operate. - Additional targeted support should be provided to the vulnerable including through strengthened social safety nets. - Growth-enhancing public investments, including in green public infrastructure, could be scaled up. ### Foreign exchange intervention (FXI) - FX intervention should remain limited to preventing disorderly market movements. - Currency market has tentatively stabilized in 2023, but risks of renewed volatility remain, partly linked to a possible further increase in the spread between the Korean and US policy rates. - Exchange rate volatility generally does not pose significant economic challenges for Korea, given limited currency mismatches and manageable passthrough to consumer prices. - FX market depth, while ranking higher than in most emerging markets, still lags advanced economy peers. - In periods of high global financial market uncertainty, temporarily shallow markets could lead to herding behavior, sharp FX movements, and impaired market functioning; FX intervention should be limited to preventing disorderly conditions. - Authorities’ view: The authorities reaffirmed their intention to limit FXI to addressing phases of abnormal currency volatility; FXI was significantly reduced in 2023H1 compared to last year and is conducted only for smoothing currency market operations in response to high volatility and not intended to target any particular exchange rate level. ### Fiscal policy: stance and developments - Fiscal policy should remain tight to slow the build-up in public debt and support disinflation. - The revenue shortfall is widening in 2023H2 and should be accommodated by mobilizing additional financial resources. - Authorities plan to secure funding for budgetary spending by withdrawing government deposits and funds, including from the FX stabilization fund, without additional deficit financing through bond issuance. - Central government fiscal deficit trajectory: - Projected to narrow to around 1.8 percent of GDP, from 3 percent in 2022, with the fiscal stance remaining contractionary (fiscal impulse of -0.8 percent of potential GDP). - 2024 budget proposal implies a further decline of the fiscal deficit to 1.7 percent of GDP, despite subdued growth in tax revenue (especially corporate taxes); the implied fiscal stance is moderately contractionary (fiscal impulse of -0.4 percent of potential GDP). - The 2024 budget proposal features a reduction of spending as a share of GDP, a significant increase in welfare spending, and significant cuts in R&D spending intended to consolidate spending into areas of highest expected returns (risking negative impact on basic research and medium-term productivity growth). - Fiscal policy should be anchored in a well-designed rules-based fiscal framework (Section C). - Authorities’ view: Reaffirmed commitment to fiscal soundness, plans for continued gradual fiscal consolidation in line with the proposed 2024 budget and the 2023–2027 National Fiscal Management Plan, seeking to contain expenditure growth and maintain central government debt within the mid-50 percent range. ### Energy pricing and public utilities - Domestic energy prices should be better aligned with international commodity prices to enhance the financial health of public utilities. - Higher energy costs due to the 2022 global commodity price surge were not sufficiently passed on to consumers, resulting in significant losses for state-owned utilities including KEPCO (electricity) and KOGAS (gas). - KEPCO’s profitability has improved recently due to receding global commodity prices and moderate electricity price adjustments introduced so far in 2023. - Recommendation: Consider a pricing mechanism linking electricity prices with the cost of energy inputs for power generation to restore KEPCO’s financial health and limit future losses. - Fuel tax cuts introduced in 2021 in response to surging fuel prices should not be extended upon expiration in December 2023. - In the meantime, provide targeted support (such as transfers through social safety nets) to the vulnerable to mitigate higher living costs. - Fiscal risks associated with state-owned utility companies are still limited as their financial outlook improves and they maintain stable market access. ### Industrial policy and trade resilience - Against a weakened multilateral trading system and rising trade tensions, Korea’s industrial policies should remain narrowly targeted to specific objectives and aim to minimize trade and investment distortions. - Korea introduced the K-Chips Act, temporarily increasing tax credits for domestic investment in key strategic areas (semiconductors and batteries): large companies from 8 percent to 15 percent, SMEs from 16 percent to 25 percent. - Risks of broader industrial policy measures: - Incentives for firms to relocate production, distorting trade and investment decisions. - Potentially triggering retaliatory responses by trading partners and further fragmenting global supply chains. - Recommendations: - Keep trade and investment measures narrowly targeted and consistent with WTO obligations. - Resist using such tools to provide competitive advantage to domestic industries. - Improve resilience by diversifying trade partners and sourcing. - Foster innovation and structural reforms to enhance market competitiveness and flexibility. - Impact estimate: Simulations point to potential, permanent output losses of 2-4 percent or more in scenarios of severe worsening of geoeconomic fragmentation (Box 2). - Authorities’ view: Reaffirmed commitment to non-distortionary, open trade and the WTO process; intend to seek continued international dialogue to mitigate negative impacts of foreign industrial policy initiatives on Korea. ### Financial sector resilience: overview of risks and buffers - Financial sector-related risks have risen, but systemic risks appear manageable thanks to sizable financial buffers, adequately tight macroprudential requirements, and swift policy responses. - Household and corporate debt remain high, but ample financial assets provide significant cushions. - Macroprudential measures maintained during the housing downcycle include: - 50 percent LTV limit for new mortgages. - 40 percent debt-service-ratio ceiling for individuals’ borrowing from banks. - Korean banks: - Resilient to recent global stress, but liquidity, capital, and provision ratios, while exceeding regulatory requirements, still fall behind some peers. - Systemwide loan delinquency rates remain at very low levels but have inched up recently. - Rapid financial digitization increases likelihood of faster deposit withdrawals under stress. - Policy support: Staff supports plans to increase the countercyclical capital buffer (CCyB, currently at zero) to 1 percent starting from May 2024, active consideration of a stress-buffer capital system, and additional provisioning requirements. - Non-bank financial institutions (NBFIs) and corporate vulnerabilities: - Some NBFIs have experienced significant increases in NPLs, reflecting riskier exposures to real estate and corporate lending. - Project financing (PF) is the riskiest segment due to a fragile funding structure; credit risk remains elevated for lower-quality PF securities. - Corporate debt has increased and interest coverage ratios (ICRs) have weakened; substantial vulnerabilities to rising interest costs appear in property, energy and utilities sectors, though sizable cash buffers provide some cushions. - Household sector and Jeonse risks: - Household debt, among the highest in the OECD, increased again since 2023Q2 after moderate deleveraging in 2022. - Repayment risk mitigated by sizable financial assets, solid income growth, and a low share of vulnerable borrowers. - Increased interest rates and a high share of floating-rate debt could pose challenges to some households. - Delinquency rates of household loans have been rising gradually from a low base. - Fall in housing prices increased credit risks associated with Jeonse deposit payback; Jeonse deposit default rates reportedly increased considerably in 2023H1 and are expected to further rise in 2023H2. - Government temporarily eased lending-related regulations for Jeonse landlords; BoK stress tests indicate systemic risks from households and Jeonse debt remain contained, but gradual deleveraging is desirable. - Housing guarantee companies: - Sizable real estate guarantees have expanded while capital buffers of housing guarantee companies are limited. - Rise of default claims on Jeonse deposits in 2023H1 has eroded profits for some Jeonse-guarantee providers. - Stress testing suggests additional losses and capital pressures under adverse housing price shocks (Annex VIII). - Implied fiscal contingent liabilities related to publicly owned guarantee companies are limited though (about ¼ percent of GDP under severe stress scenarios). - The loss absorption capacity of some stressed companies needs strengthening. ### Policy recommendations for financial stability and crisis management - Keep financial support measures temporary and targeted to mitigate moral hazard concerns; accompany with strengthened regulation, supervision, and risk monitoring. - Project financing: - Phase out remaining emergency measures as market conditions normalize. - Normalization of the required loan-to-deposit rate in July 2023 and the end of BoK’s temporary liquidity injections through repurchase agreements are welcome. - Adjusted pace of increasing the required liquidity coverage ratio back to 100 percent to ensure smooth transition. - MGCCCs: - Welcome measures announced in July to address deposit withdrawals and preempt broader confidence losses. - Address moral hazard through enhanced supervision of problematic MGCCCs and plans to tighten regulatory requirements to align MGCCCs with other non-bank depository institutions. - Consider strengthening the regulatory and supervisory framework for MGCCCs over the medium term as conditions normalize. - Housing measures: - Strike a balance between preventing excessive price falls and allowing orderly adjustment. - Recent measures stabilizing housing markets have contributed to a rise in household debt; recommended actions include tightened regulations for 50-year mortgage loans, introduction of a stress DSR framework with an interest serviceability buffer for floating-rate loans, tightened eligibility for subsidized Bogeumjari loans, and keeping Jeonse-related lending relaxation temporary and targeted. - NBFIs: - Keep emergency liquidity support temporary, targeted, penal, fully collateralized, and accompanied by supervisory oversight. - Encourage depository NBFIs to build additional buffers. - Strengthen liquidity, capital, and loss provisions of NBFIs; revisit regulatory standards and remaining gaps (such as DSR ceilings). - Welcome authorities’ reforms: higher provisions for real estate exposures in mutual savings banks and mutual credit cooperatives, higher liquidity ratio requirements for securities firms, and building a real-time deposit monitoring system for depository NBFIs. - Enhance NBFI crisis management framework, including BoK’s announcement to enable timely access to liquidity support for depository NBFIs under emergency circumstances. - Banking-sector liquidity and loss-absorption: - Review banks’ liquidity and credit risk assessments and encourage strengthening liquidity and loss absorption capacities. - Support activation of the CCyB, consideration of a stress-based capital system, and reviews of provisioning methodologies. - BoK reforms to the standard lending facility (expansion of eligible collateral and adjustment of lending rates) could enhance emergency liquidity support to banks, with safeguards including mark-to-market valuations with haircuts for collateral. - Progress made on enhancing stress testing practices and adopting new resolution and recovery plans for domestic systemic financial institutions. *International Monetary Fund staff summary based on the source content.* ### 37. Comprehensive efforts are needed to address risks from high levels of private debt. ### Comprehensive efforts are needed to address risks from high levels of private debt. ### Financial vulnerabilities and recommended financial-sector measures - Maintain adequate prudential norms to contain debt in vulnerable segments (notably real estate). - Consider cost-effective debt-restructuring programs for vulnerable borrowers. - Enhance restructuring and insolvency mechanisms (in line with FSAP recommendations). - Time-bound and targeted financial support to households and companies; forbearance programs should be temporary and targeted. - Recent initiatives to facilitate debt restructuring, including via the PF inter-creditor group, are welcome. - Consider a sectoral CCyB for household exposures to contain the increase in household debt. ### Progress on FSAP recommendations and remaining gaps - Steps taken: - Assess potential rollover risks of Jeonse debt. - Strengthen prudential requirements of state-controlled banks. - Enhance stress testing practices. - Increase supervision of insurers. - Improve the resolution framework of financial conglomerates (Annex IX). - Progress in impact assessment of prepaid electronic payment and enhancing crypto-related regulations (Box 4). - Remaining reform areas: - Further widen the definition of financial holding companies. - Strengthen the insolvency and creditor rights regime. ### Authorities’ assessment and actions - Authorities’ assessment of financial vulnerabilities broadly aligned with staff views; preemptive actions to enhance financial resilience underway. - Housing market stabilization has eased near-term sector stress concerns (project financing and Jeonse deposit defaults) but latent vulnerabilities are monitored among some small-sized mutual savings banks, credit cooperatives and securities companies. - Measures adopted to improve NBFIs’ loss-absorption capacity and supervision; recognized regulatory gaps between depository NBFIs and banks (difference in required capital ratio and portfolio DSR regulations). - Plans to improve loss-absorption capacity of public housing guarantee companies and tighten requirements for new issuance of Jeonse-related guarantees. ### Policies to contain household and corporate debt risks - Prudential policy focus shifted from ensuring a soft landing of the housing market to containing household debt increases. - Authorities announced plans to tighten some mortgage support programs while maintaining normalization of earlier restrictive housing regulations and tax measures. - A further sustained rise in household debt could imply a need to keep policy rates higher for longer. - Technical preparations for a sectoral CCyB for household lending largely completed; priority is implementation of planned increase in the general CCyB. - Corporate sector: limited systemic concerns; corporate delinquency rates and debt-to -equity ratios are stable and in line with historical averages, but potential risks in some mostly small firms are under close monitoring. ### Moral hazard mitigation and targeted exit strategies - Authorities acknowledge moral hazard concerns and emphasize keeping financial support measures temporary and targeted. - Withdrawn the bulk of market stabilization measures for PF-related risks and developed exit plans for remaining ones. - Enhanced supervision of project financing sites and initiated a joint PF creditor-group to facilitate PF debt restructuring; property developers requested to devise self-resolution plans before public support. - MGCCCs: priority on resolving issues with vulnerable cooperatives; plan to enhance regulatory and supervisory requirements as situation stabilizes. ### Fiscal framework and medium-term fiscal policy recommendations - Authorities proposed a fiscal rule (under discussion in parliament) featuring: - Government debt ceiling of 60 percent of GDP - Managed fiscal deficit ceiling (fiscal balance excluding social security funds) of 3 percent of GDP, tightening to 2 percent in case debt exceeds 60 percent of GDP - Escape clause for severe adverse shocks; reviewed every five years - If passed, the rule will take effect in 2025 - Staff view: parametric targets broadly prudent but space for counter-cyclical fiscal policy should be preserved; authorities’ projected deficits under the 2023-27 National Fiscal Management Plan are close to 3 percent of GDP, leaving very limited space. - Suggestion: consider a transition phase with a somewhat higher deficit ceiling to preserve counter-cyclical scope. - Oversight of the escape clause and monitoring of the fiscal rule should be strengthened and administered by an independent entity (for example, the National Assembly Budget Office). ### Pension, revenue, and spending reforms - Pension spending rose from 1.8 percent to 4.0 percent of GDP between 2009 and 2022 and is projected to rise significantly further due to rapid aging. - National Pension Service (NPS) expected to go into deficit in 2041 and deplete its assets by 2055, despite legislated reductions of replacement rates and increases in the retirement age. - Recommendation: raise contribution rates significantly and increase the retirement age further to ensure fiscal sustainability; reducing replacement rates further would likely increase old-age poverty and require raising the non-contributory basic pension benefit to mitigate social impact. - Revenue and spending options include: - Reducing income tax deductions - Streamlining tax expenditures on industry and SMEs - Rationalizing VAT exemptions - Raising the VAT rate (10 percent) - Improving spending efficiency and reducing wasteful spending, including subsidies ### Labor market and gender reforms - Advance reforms to tackle high labor market rigidity, including: - More flexible working hours - Switching to a performance-based pay system - Tackling labor market duality - Implement reforms with credible measures under conducive economic conditions; consider deregulation to reduce employment protection for regular workers as growth recovers. - Strengthen social safety nets: expand unemployment insurance to more non-regular workers and the self-employed; enhance access and generosity of social assistance programs. - Narrow large and sustained gender gaps by: - Increasing labor market flexibility and reducing duality - Further incentives for parental leave and enhanced childcare options - Retraining programs to reenter the labor market after family care pauses ### Innovation and productivity - Foster innovation beyond manufacturing by: - Establishing a level playing field between services and manufacturing in tax rates and public utility charges - Lowering legal barriers to entry and startup costs; simplifying licensing and permit requirements; facilitating firm exit - Strengthening support to basic research ### Climate mitigation policy recommendations and costs - Korea committed to reducing emissions by 40 percent from 2018 levels by 2030 and to reaching carbon neutrality by 2050. - Main policy tool: Emission Trading Scheme (ETS); prices have remained under $20/MTCO2e. - Recommended policy actions: - Align ETS emissions caps with the NDC target - Underpin the ETS with a robust and rising price floor - Transition to fully auctioned allowances - Reinforce carbon pricing with feebates in emissions-intensive sectors - Increase and expand the coal tax (currently applied only to coal in power generation); full coal phaseout will require feed-in tariffs and complementary public investments - Economic cost estimate: higher carbon prices in line with climate targets could reduce annual average growth by 0.2 percentage points through 2030; costs can be mitigated if additional ETS revenues are used for growth-enhancing investments and green-sector job/value-added increases partly offset contraction in emission-intensive sectors. ### Staff appraisal: macroeconomic outlook and policy priorities - Outlook: - Gradual strengthening expected due to recovery of global semiconductor demand, a strong domestic labor market, and housing market stabilization. - Inflation has come down significantly from its mid-2022 peak and is expected to decline further toward the BoK’s target. - Pockets of financial sector vulnerability emerged amid the housing market downturn and rising interest rates; systemic financial risks increased but appear manageable. - External position in 2022 broadly in line with medium-term fundamentals and desirable policies. - Policy priorities: - Monetary policy: maintain current restrictive stance for a considerable time; any further hikes conditional on incoming data; avoid premature rate cuts; limit FX intervention to prevent disorderly markets. - Fiscal policy: continue fiscal normalization to slow public debt build-up and support disinflation; 2023 revenue shortfall should be accommodated by mobilizing additional financial resources; 2024 budget targets moderate further consolidation. - Financial sector: strengthen buffers, regulation, and supervision; narrow regulatory gaps between NBFIs and banks; maintain prudential norms for vulnerable segments and consider sectoral countercyclical capital buffer for household lending exposures. - Exit pandemic-era corporate lending support as planned; consider cost-effective debt-restructuring programs for vulnerable borrowers; enhance restructuring and insolvency mechanisms. *Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1korea2023001.pdf* ### 60. A rules-based fiscal framework would help anchor public finances amid rapid ### A rules-based fiscal framework would help anchor public finances amid rapid ### Fiscal framework and counter-cyclical policy - The proposed fiscal rule features broadly prudent parametric targets. - Space for counter-cyclical fiscal policy should be preserved, for example through a transition phase, as the authorities’ projected medium-term deficits are close to the target. ### Pension reform: fiscal sustainability and old-age poverty - Korea’s main pension scheme remains unsustainable in the long term despite legislated reductions of replacement rates and increases in the retirement age. - Policy recommendations: - Raise contribution rates significantly. - Increase the retirement age further. - Avoid additional reductions of already low replacement rates given high old-age poverty; any further reduction would likely require raising the non-contributory basic pension benefit to mitigate social impact. ### Climate policy: strengthening instruments to meet mitigation goals - Achieving Korea’s ambitious climate mitigation goals will require significant strengthening of climate policies. - Recommended measures: - Align the ETS emissions caps with the NDC target. - Underpin the ETS with a robust and rising price floor. - Transition to fully auctioned allowances. - Consider feebates in emissions-intensive sectors. - Increase and expand the coal tax. ### Innovation, service sector productivity, and industrial policy - Reforms should foster innovation and raise service sector productivity by: - Establishing a level playing field between services and manufacturing. - Lowering legal barriers to entry and startup costs. - Simplifying licensing and permit requirements. - Facilitating firm exit. - Use of industrial policies should remain narrowly targeted to specific objectives and consistent with WTO obligations; avoid using such tools to provide competitive advantage to domestic industries. - Strengthen support to basic research to enable innovation. ### Labor market rigidities and gender gaps - Structural reforms needed to tackle labor market rigidities and reduce gender gaps. - Authorities’ intended labor market reforms focus on key bottleneck areas; implement concrete reform proposals under conducive economic and policy conditions. - To narrow wide gender gaps: - Lower the family care burden on women through further incentives for parental leave and enhanced childcare options. - Provide retraining and reeducation programs for women reentering the labor market after a family care pause. - Reduce labor market duality to help address gender gaps. ### Next Article IV consultation - Recommendation: hold the next Article IV consultation on the standard 12-month cycle. ### Box 1 — Previous IMF Policy Recommendations (summary of actions) - Monetary policy: - Recommendation: Calibrate pace of monetary policy normalization to ensure inflation stabilizes at its target and expectations remain well anchored. - Action: The BoK raised the policy rate by 300 bps cumulatively. - Fiscal policy: - Recommendation: Take a broadly neutral fiscal stance for 2022, provide stimulus if downside risks materialize. - Action: Two supplementary budgets totaling 3.5 percent of GDP were introduced. - Housing and financial: - Recommendations included calibrating withdrawal of lending support, tightening macroprudential measures, and further housing supply and demand policies. - Actions: Pandemic-related financial forbearance scheduled to expire by end-March 2024; prudential focus shifted to containing household debt; targeted mortgage assistance and steps to increase supply of public housing and facilitate reconstruction and redevelopment. - Structural: - Recommendations: Broaden safety net, increase flexibility of regular employment contracts, improve work-life balance, facilitate re-entry of women, introduce a rules-based fiscal framework, strengthen automatic stabilizers, pursue fiscal consolidation, reform pension system, boost innovation through regulatory reforms, and strengthen climate policies (KETS reform, sectoral feebates, coal taxes). - Actions: Plans to improve flexibility of working hours, switch to performance-based pay, tackle labor market duality; training programs and consulting for female employee retention; proposed fiscal rule in 2022 pending parliamentary approval; National Fiscal Management Plan envisages continued fiscal consolidation over the medium term mainly through containing expenditure growth; authorities considering pension reform options and preparing new climate mitigation policies; some regulations removed or adjusted to improve ease of doing business. ### Box 2 — Geoeconomic fragmentation: risks and adaptation - Global impacts: - Permanent global output losses estimates range from 0.2 percent of GDP (limited fragmentation) to 7 percent of GDP (severe scenario). - Fragmentation through the FDI channel alone could lead to global output losses of up to 2 percent. - In a scenario of two blocs with high-tech and energy trade cut off, global output losses estimated at 1.2 percent of GDP, Asia-Pacific at 1.5 percent of GDP. - Korea-specific exposure: - Korea is among potentially more strongly affected countries due to high involvement in strategic high-tech sectors with both the US and China. - China is Korea’s largest export destination, followed by the United States. - Korea exports large amounts of semiconductors to China; car exports are disproportionately destined for the United States. - A significant share of Korea’s intermediate goods for manufacturing are sourced from China. - Korean companies maintain sizable manufacturing facilities in the United States and China; Korea’s FDI linkages with China and the United States are large. - Corporate announcements in 2021 cited: Samsung Electronics $200 billion investment plan in the United States over the next 20 years, and SK Hynix $22 billion investment for building memory chip packaging plant. - Scenario estimates: - In a downside scenario where the world is divided into two blocs, sectoral CGE model estimates suggest permanent output losses for regional, trade-intensive countries like Korea could amount to about 2-4 percent of GDP, and more if large non-tariff barriers are added. - Under a severe re-shoring scenario reversing two decades of foreign sourcing, output losses for Korea could be larger in the longer term. - Mitigating effects could occur if inward FDI and exports in some sectors benefit from other countries’ supply chain de-risking efforts. - Adaptation strategy: - Diversify trading partners by expanding trade relationships. - Lower trade barriers by upgrading trade agreements to increase private sector space to diversify supply chains. - Build adequate external and financial buffers to mitigate risks from capital flow reversals. - Foster innovation and structural reforms to enhance market competitiveness and flexibility. - Provide support for the domestic economy in a way that is not distortionary or discriminatory; keep trade and investment measures narrowly targeted and consistent with WTO obligations. ### Box 3 — An Adverse Scenario: global banking fragility and effects on Korea - Scenario setup (IMF’s G20 Model): - Assumes greater-than-expected fragility in parts of the global banking system leading to tighter global financial conditions. - Key assumptions: - Lower global credit supply: US bank lending decreases by 4 percent in 2024 relative to current baseline projections (about one-fifth of the contraction in credit experienced during the global financial crisis relative to the precrisis trend). US corporate spreads increase by 250 basis points in 2024. For euro area countries and Japan, impact similar to the United States; other countries vary. China’s domestic financial conditions assumed to have a small impact. For Korea, real corporate interest rates assumed to rise by 35 bps. Tightening persists into 2025 and beyond. - Flight to safety and dollar appreciation: In emerging markets excluding Asia, sovereign premiums increase considerably and the US dollar appreciates by close to 10 percent. Shock for emerging market economies in Asia is about half as large; China not directly affected. - Impacts on Korea: - Real GDP growth in Korea reduced by 0.4 percentage point in 2024 relative to the baseline projection, less than the world and advanced economy averages. - Korea’s rebound in growth in 2025 is stronger than average. - Inflation declines as disinflationary effect of lower aggregate demand outweighs higher import prices from currency depreciation. - Impact on inflation and real economy in Korea is more moderate than peers due to smaller shock on the real economy. - Policy response and space: - Monetary policy assumed to respond endogenously; policy rate in Korea is lowered by about 50 bps in 2024 and 2025 respectively. - Automatic stabilizers are assumed to operate in advanced economies including Korea. - Given substantial fiscal space in Korea, additional fiscal support can be provided. - Balance sheet policies, temporary and targeted financial sector support, and prudential measures by central banks and regulators could also help though they are not explicitly modeled. - Downside scenario—Other Variables (deviations): - 2024: - Policy interest rate (%pt deviation): -0.46 - Core CPI inflation (%pt deviation): -0.19 - Real corporate interest rate (%pt deviation): 0.31 - Unemployment rate (%pt deviation): 0.09 - Risk premium (%pt deviation): 0.79 - 2025: - Policy interest rate (%pt deviation): -0.49 - Core CPI inflation (%pt deviation): -0.21 - Real corporate interest rate (%pt deviation): 0.07 - Unemployment rate (%pt deviation): 0.05 - Risk premium (%pt deviation): 0.50 *Source: IMF staff summary as presented in the provided content unit.* ### Box 4. Financial Digitization in Korea ### Box 4. Financial Digitization in Korea ### Digital evolution and emerging risks - Rapid digital evolutions have improved the efficiency of financial services but have created new challenges. - Following the introduction of the “open banking system”, Fintech and Big Tech payments have further increased during the pandemic. - The 2020 FSAP highlighted that the rapid rise of Fintech activities could pose potential new risks on market concentration, consumer protection, liquidity, and operational fronts. - Recent incidents (FTX bankruptcy and the collapse of Terra-Luna) raised concerns about investor protection in the crypto market. - The volatility associated with the crypto market, and growing interactions with the traditional financial system could pose potential stability risks in the future. ### Central bank CBDC work and testing timeline - The Bank of Korea (BoK) has advanced its research into CBDCs and launched a project with the FSC and FSS, in cooperation with the BIS. - The project aims to present a prototype of the future monetary system, including wholesale CBDCs and tokenized deposits, and lay a foundation for implementing various innovative use cases of digital currencies. - Both technical experiments in virtual environments and limited real-world experiments will be conducted. - The testing stage involving the general public is expected to commence around the fourth quarter of 2024, following technical preparations. ### Regulatory responses and reforms - Financial regulations have been upgraded to prepare against emerging risks from digitization. - The BoK initiated regular impact assessments of the open banking system and recommended improvements; measures implemented included: - enhancing consumer protection rules; - upgrading IT infrastructure; - fortifying user eligibility criteria. - Progress on crypto-asset regulation to ensure financial stability, maintain financial integrity, and protect investors includes: - March 2021: Amendment to the anti-money laundering law imposing regulations on virtual asset service providers (VASPs), extending obligations like customer due diligence and reporting of suspicious transactions to VASPs. - March 2022: Introduction of a "travel rule" mandating VASPs transferring any crypto assets exceeding KRW 1 million to provide transfer-related information to the recipient VASP. - May 2023: National Assembly passed a bill that obligates lawmakers and high-ranking public officials to report on their crypto assets. - July 2023: National Assembly passed new legislation on crypto assets, focusing on consumer protection and unfair competition, which will become effective in July 2024. ### Remaining agenda and next steps - The next phase of crypto regulations is under preparation and will focus on issuance and market regulations. - Continued monitoring and regulatory upgrades are implied to address market concentration, consumer protection, liquidity, operational, and investor-protection risks as digital financial activities evolve. *Source: Box 4. Financial Digitization in Korea.* ### 2. Labor supply has gradually returned to the pre-COVID rising trend after an initial ### 2. Labor supply has gradually returned to the pre-COVID rising trend after an initial ### Labor supply: recovery and structural composition - The Korean labor force contracted significantly at the onset of the pandemic as rising COVID cases and public health interventions discouraged labor force participation. - Recovery timing: - "It has since recovered, most notably between late-2021 to mid-2022, and conformed to the pre-COVID trend." - Drivers: - "The rising trend of labor force participation is mainly accounted for by increasing female and elderly labor force participation." - Nature of recent labor force growth: - "The strong growth in the labor force in 2021-22 was thus largely cyclical since it primarily reflected post-pandemic normalization, and modest structural gains in the labor force can be expected over the medium term reflecting continued increases in female and elderly labor force participation." ### Labor demand: rebound and cyclical dynamics - "Labor demand has also recovered to pre-COVID levels." - Evidence and timing: - "Strong economic recovery since 2021 fueled a rebound of labor demand from the initial COVID shock." - "The job vacancy rate (the ratio of job vacancies to the labor force) peaked in the first half of 2022, before it edged down again reflecting weakening growth momentum from 2022H2 onwards." - "Nevertheless, the job vacancy rate is now around the average level in 2018-2019." - Interpretation: - "There is a strong correlation between labor demand and overall macroeconomic conditions. The contribution of labor demand growth to post-COVID unemployment was thus predominantly cyclical." ### Labor market matching efficiency: trend, drivers, and implications - Measurement approach: - "A standard Cobb-Douglas labor market matching function, together with data on vacancies and unemployment, is used to estimate unobserved labor market matching efficiency." - Trend: - "Quarterly estimates show a clear improving trend since at least 2018, disturbed only briefly by the pandemic." - Comparative note: - "This stands in sharp contrast with the U.S. labor market, where labor market matching efficiency has displayed a marked deterioration during the pandemic." - Possible drivers of recent improvement: - "The expansion of service sector jobs as COVID restrictions were lifted, together with the increase in labor force participation of females and the elderly, who are disproportionately likely to seek jobs in the service sector, might also have contributed to improved labor market matching efficiency more recently." - Mechanism: "the matching efficiency is likely to be higher in the service sector relative to manufacturing, as required skills of job seekers are more homogeneous, which facilitates the matching process." - Cyclicality caveat: - "In this sense, some of the more recent improvement in the labor market matching efficiency could be cyclical." ### Contribution to unemployment dynamics: decomposition and outlook - Key finding: - "Improved labor market matching efficiency has contributed the most to low unemployment since COVID." - Decomposition results (qualitative and quantitative): - "The steady improvement in labor market matching efficiency has contributed significantly to lower unemployment, particularly since 2021, averaging about 1 percentage point each year." - "The declines in job vacancies in the early phases of the pandemic increased unemployment in 2020 and 2021, while the normalization of vacancies had the opposite—albeit less pronounced—effect since 2022." - "Declining labor force participation early in the pandemic exerted a dampening effect on unemployment, while the recovery softened the decline in unemployment since 2022." - "The gradual slowdown in working-age population growth due to population aging has also moderately contributed to lower unemployment." - Medium-term projection: - "Over the medium term, the unemployment rate is likely to remain lower than pre-COVID levels if the improvement in labor market matching efficiency proves to be largely structural and is sustained." ### Annex II — Sovereign Risk and Debt Sustainability: macro-fiscal context and projections - Recent macro-fiscal backdrop: - "Growth has slowed since mid-2022 but inflation has remained above target." - "The fiscal deficit of the central government stood at 3 percent of GDP in 2022, below the budgeted deficit of 3.3 percent of GDP." - "Headline inflation has declined significantly from its peak at 6.3 percent last July and, despite a recent uptick, is expected to continue moderating toward the target of 2 percent." - "The Bank of Korea has held policy rate steady at 3.5 percent (above neutral) since February 2023 following cumulative hikes of 300bps since 2021." - "The 10-year Treasury bond yield edged up recently to 3.9 percent in June following a steady decline from the peak of 4.2 percent in October 2022." - Baseline macro assumptions: - "Real GDP growth is expected to decline from 2.6 percent in 2022 to 1.4 percent in 2023, before rebounding to 2.2 percent in 2024 and converging to the estimated potential growth rate of around 2.1 percent over the medium term." - "Inflation is expected to hover around 3 percent through 2023 and approach the target of 2 percent by end-2024." - Fiscal and debt projections: - "The central government’s primary deficit in 2023 is projected to narrow to 1.2 percent of GDP from 1.9 percent of GDP in 2022." - "The primary deficit is expected to narrow further to near zero in the medium term." - "Central government debt is projected to increase gradually from 48 percent of GDP in 2022 to 53 percent of GDP by 2028, and to 54 percent of GDP by 2032." - Risks and policy needs: - "Long-term risks are significant as aging-related expenditures on health and social security are projected to rise substantially driven by rapid population aging, resulting in increasing debt levels and gross financing needs under the baseline." - "Strong measures including pension reform, revenue mobilization, and reforms to increase spending efficiency are needed to address the long-term fiscal challenges." ### Selected DSA and external sector figures (as reported) - Public debt and fiscal flows (selected series from Baseline Scenario figure): - Public debt (percent of GDP): 2022: 47.8; 2023: 49.3; 2024: 50.6; 2025: 51.6; 2026: 52.3; 2027: 52.8; 2028: 53.2; 2029: 53.6; 2030: 53.9; 2031: 54.2; 2032: 54.4. - Change in public debt: 2.7; 1.5; 1.2; 1.0; 0.7; 0.5; 0.5; 0.4; 0.3; 0.2; 0.2 (series corresponding to 2022–2032). - Primary deficit (percent of GDP): 1.9 (2022); 1.2 (2023); 0.8 (2024); 0.1 (2025); -0.1 (2026); -0.3 (2027); -0.3 (2028); -0.3 (2029); -0.3 (2030); -0.3 (2031); -0.4 (2032). - Gross financing needs: 3.5; 3.0; 2.6; 2.2; 2.2; 2.2; 2.4; 2.6; 2.7; 2.9; 3.0 (series corresponding to 2022–2032). - External sector and NIIP (2022 and projections): - "The NIIP has been positive since 2014 and stood at 46 percent of GDP in 2022." - 2022 (% GDP) NIIP: 46.0; Gross Assets: 129.6; Debt Assets: 61.0; Gross Liab.: 83.5; Debt Liab.: 39.7. - NIIP projection: "The NIIP is projected to rise further, to about 55 percent of GDP, in the medium term on the back of CA surpluses." - Current account (2022 and staff estimates): - 2022 (% GDP) CA: 1.8; Cycl. Adj. CA: 4.2; EBA Norm: 4.8; EBA Gap: –0.6; COVID-19 Adj.: –0.4; Staff Gap: –1.0. - Real exchange rate (REER): - "In 2022, a marked depreciation through October was partly reversed by the end of the year, with an average depreciation of 5.4 percent from 2021." - "As of July 2023, the REER was 1.8 percent above the 2022 average." - IMF staff REER assessments: staff CA gap implies a REER overvaluation of 2.9 percent; EBA REER index model estimates a 1.9 percent undervaluation; EBA level model estimates a 3.4 percent overvaluation. Staff assesses REER gap in the range of 0.2 to 5.6 percent, with a midpoint of (text truncated in source). *Source: IMF staff report excerpt (Korea): Labor market trends, DSA baseline, and External Sector Assessment.* ### 2.9 percent. ### Capital and Financial Accounts: Flows and Policy Measures ### Capital and financial flows—key findings - Net capital outflows increased to 4.0 percent of GDP in 2022 from 3.5 percent of GDP in 2021, after trending down from a peak of 6.2 percent of GDP in 2016. - Composition of 2022 financial account: - Net FDI outflows: 2.9 percent of GDP. - Net portfolio outflows: 1.5 percent of GDP. - Other investment: net inflows of 0.9 percent of GDP. - Drivers: - Net FDI outflows driven by rising outbound direct investment. - Net portfolio outflows driven mainly by foreigners’ continued equity sales and sharply decreased debt security purchases amid tightened global financial conditions. - Developments in H1 2023: - Net capital outflows significantly declined due to decreased outbound direct investment and resumption of nonresident debt purchases. - Assessment: - Present configuration of net and gross capital flows appears sustainable over the medium term. - Outflows largely reflect the current account surplus (CA surplus) and rising net international investment position (NIIP). - Inbound portfolio investment remained positive and turned to rebound. - Korea has demonstrated ample capacity to absorb short-term capital flow volatility, including during Russia’s invasion of Ukraine and the Federal Reserve’s interest rate hike cycle. ### Policy implications and measures - Continued monitoring of outbound direct and portfolio investment given their role in net outflows. - Maintain capacity to absorb short-term capital flow volatility through macro- and financial-sector measures. --- ### FX Intervention and Reserves Level ### FX intervention—actions and magnitudes - Korea operates a floating exchange rate. - FX intervention has been two-sided since 2015 (IMF staff estimates and published data). - Bank of Korea reported net FX sales of $45.9 billion (2.8 percent of GDP) in 2022, mostly in Q2 and Q3 during heightened exchange rate volatility. - FX intervention in H1 2023: net sales of $8 billion (0.5 percent of GDP). - Reserves: - End-August 2023: $413 billion (slightly decreased from $418 billion as of end-2022). ### Reserve adequacy assessment - As of end-2022, FX reserves were: - about 25 percent of GDP, - 1.9 times short-term debt, - 6.2 months of imports, - 14 percent of M2. - Systemwide stress tests show reserves provide sufficient FX liquidity buffers under a wide range of plausible shocks. - Assessment of intervention: limited to preventing disorderly market conditions; strict limitation of FX intervention recommended to prevent excessive reliance on reserves. --- ### Annex IV — Reserve Adequacy Stress Tests ### Balance sheet and IIP context - Net international investment position (IIP) as of 2022: net foreign assets of 47 percent of GDP. - FX assets were four times higher than FX liabilities. - Only 40 percent of liabilities are in foreign currencies. - FX liabilities primarily held by Other Depository Corporations (ODCs, mostly banks) and Government. - FX assets largely held by Non-Financial Corporations (NFCs), Central Bank (CB), and Other Financial Corporations (OFCs), including the National Pension Service. - Total liquid FX assets are about 2.5 times as large as liquid FX liabilities, with BoK international reserves accounting for more than half of total liquid FX assets. ### Stress-test methodology and key assumptions - Tool: Systemwide Liquidity Stress Testing Tool (balance sheet approach). - External shock types calibrated on historical data: - Sudden stops of external debt (debt rollover rates assumed at 90 percent, 50 percent, and 30 percent). - Capital flight: - Foreign investors’ repatriation of portfolio investments (stress tests assume up to 50 percent outflow). - Residents’ conversion of local currency (LC) deposits to FX (maximum of 3 percent of total). - Trade balance shock: worst-case set at -4 percent of GDP (historically largest trade deficit was 4 percent of GDP in 1996). - Other assumptions: - Rate of currency depreciation: 30 percent. - FX deposit and debt securities interest rate: 5 percent. - No new external FX financing is considered. - Banks’ FX reserve requirements at the central bank assumed to be 5 percent of FX deposits (actual range 1 to 7 percent). - Banks maintain a minimum FX Liquidity Coverage Ratio (FX LCR) of 80 percent in times of FX liquidity needs. - Test horizon: one year. ### Stress-test results—quantitative outcomes - Example aggregated outcomes: - In a scenario with 30 percent foreign portfolio repatriation and 2 percent resident LC deposit conversion, Gross International Reserves (GIR) decrease by 52~62 percent. - In more extreme scenarios with 50 percent foreign repatriation and 3 percent resident LC deposit conversion, GIR would be exhausted by up to 94 percent. - Illustrative scenario results reported in the stress-test table: - Mild shock (10 percent repatriation, 1 percent LC conversion, trade balance -1 percent of GDP) — shows 22 percent GIR reduction when private sector external debt rollover declines to 30 percent. - Intermediate shock (30 percent repatriation, 2 percent LC conversion, trade balance -2 percent of GDP) — shows 59 percent GIR reduction when private sector external debt rollover declines to 30 percent. - Severe shock (50 percent repatriation, 3 percent LC conversion, trade balance -4 percent of GDP) — shows 94 percent GIR reduction when private sector external debt rollover declines to 30 percent. - Sensitivity findings: - Reduced external debt rollover affects banks’ liquid FX assets but has limited direct effect on GIR, as NFCs and banks have liquid FX assets to absorb much of the impact. - Foreign investors’ repatriation of portfolio investment depletes banks’ FX liquid assets quickly; a 50 percent outflow can deplete 65 percent of GIR. - LC deposit conversion to FX also depletes banks’ liquid FX assets rapidly; a 10 percent conversion of resident LC deposits reduces GIR by 60 percent. ### Policy and regulatory recommendations from the stress-test analysis - Maintain and enhance FX liquidity regulations for banks and non-bank financial institutions (NBFIs), including: - Tight FX liquidity regulations and regular monitoring via stress tests. - Expand application of FX LCR ratio and stress tests to NBFIs (already strengthened in 2021). - Introduce and monitor indicators of FX needs and funding capability, FX asset-liability gap and maturity mismatch. - Strictly limit FX intervention to preventing disorderly market conditions to reduce potential claims on GIR. - Recognize possible data limitations: - Analysis does not fully incorporate OFCs’ FX liquidity due to lack of balance sheet data; OFCs’ FX liquidity buffers may be limited relative to their FX assets. --- ### Risk Assessment and Recommended Policy Responses (selected entries) - Global risks - Intensification of regional conflict(s): Likelihood High; Impact Medium. - Policy response: Provide targeted fiscal support to vulnerable workers and businesses; in disorderly markets, apply temporary and targeted asset purchase and liquidity support with safeguards to mitigate moral hazard. - Abrupt global slowdown or recession: Likelihood Medium; Impact High. - Policy response: Provide targeted fiscal support, scale up growth-enhancing public investment, and, in disorderly markets, apply temporary and targeted stabilization measures including asset purchase and liquidity support with safeguards. - Commodity price volatility: Likelihood High; Impact Medium. - Policy response: Allow public utility companies to pass through international energy prices while providing targeted support to vulnerable groups; maintain a disinflationary monetary stance. - Systemic financial instability: Likelihood Medium; Impact High. - Policy response: Temporary and targeted asset purchase and liquidity support with safeguards; prompt resolutions of problematic NBFIs. - Domestic risks - Worse-than-expected real estate market downturn: Likelihood Medium; Impact High. - Policy response: Relax macroprudential measures and apply temporary and targeted asset purchase and liquidity support; use regulatory actions to facilitate absorption of changes in asset quality and encourage private debt resolution; loosen monetary policy and provide targeted fiscal support as needed, while avoiding excessive household debt build-up. - Structural / sectoral risks - Longer and deeper semiconductor downcycle: Likelihood Medium; Impact Medium. - Policy response: Allow automatic stabilizers to operate; if larger shock, reduce pace of fiscal normalization and consider more accommodative monetary policy. - Deepening geo-economic fragmentation: Likelihood High; Impact High. - Policy response: Diversify trade markets and supply chains; advance structural reforms to boost productivity growth. *Source: IMF staff analysis and stress-test results in the Republic of Korea staff report and annexes.* ### Annex VI. The NBFI–Real Estate–Corporate Nexus ### Annex VI. The NBFI–Real Estate–Corporate Nexus ### Systemic importance of NBFIs - NBFIs have proliferated after the global financial crisis, with asset holdings reaching over 60 percent of total assets in the financial system in 2022. - The increase is broad-based across different types of institutions, and most notably led by nonbank depository corporations, insurers, investment and securities firms, and other specialized financial institutions. ### Expansion of real estate exposure and drivers - NBFIs have significantly expanded their real estate exposure, led by corporate finance. - Corporate loans by NBFIs to developers and construction firms have grown much faster than those provided by banks, though banks remain the dominant source of financing in the real estate industry. - In project financing (PF), NBFIs have taken over banks as the major funding source in the recent decade, driven by NBFIs’ efforts to search for yield. ### Project financing (PF) vulnerabilities - Project financing is described as not secured, highly leveraged, and involves asset securitization with significant maturity mismatch risks. - NBFI PF exposures include: - direct investments in bridge and project loans and asset-backed securities, - indirect exposures through providing credit guarantees (notably by securities firms). - Underlying PF vulnerabilities have been exacerbated by financial tightening in Korea and elsewhere and by concomitant softening in the housing market. - The overall delinquency rate for PF loans: about 1.2 percent in end-2022 (compared to a peak at about 8.2 percent in 2013), but it could rise with further housing market corrections. ### Types of real estate PF exposures (as described) - Bridge loans - For buying land, securing permit - Unsecured loans, rates >10%, ST maturity < 1Y - NBFIs finance only - 0.5-1 percent of GDP - Project loans - For construction and apartment sale - Unsecured loans, rates <10%, maturity 3-5 years - Both NBFIs and banks finance - ~ 5 percent of GDP - PF-backed securities - For risk diversification, liquidity management - PF loans backed ABS, ABCP and ABSTB, maturity <1Y - Both NBFIs and banks finance - ~ 2.2 percent of GDP - Debt guarantees - For credit enhancement of securitization - Securities companies, construction firms, and local gov. guarantees to PF-loans and securities - ~ 3 percent of GDP (o.w. 1.1 by securities) ### Credit quality and market spread observations - Liquidity conditions have normalized overall, but credit risk remains high in some low-quality segments. - Vulnerability is particularly high for bridge loans (short-term, high interest rates, significant rollover risk). - Market spreads: non-investment grade securities spreads have not yet returned to levels before the October 2022 default on a developer’s guaranteed debt. - Among NBFIs, the substandard PF loan ratio of securities firms has continued to rise and now stands at a double-digit level, much higher than other institutions. ### More vulnerable NBFI subsectors - Mutual savings banks, securities companies, and credit specialized institutions are identified as more vulnerable: - Mutual savings banks and credit specialized financial institutions hold a significant amount of project loans relative to their own capital. - Securities firms provide sizable guarantees to PF loan-backed securities. - These institutions hold a large share of commercial real estate projects (returns declined amid significant drops in transactions) and non-investment grade project loans (high credit risks). ### Capital buffers, asset quality, and profitability - Capital buffers are much higher than regulatory requirements across different types of NBFIs. - Overall NPL rates are still low, albeit rising rapidly among mutual savings banks and mutual credit cooperatives. - Savings banks and mutual credit cooperatives appear to have less capital buffers and higher NPLs. - Profitability remains generally solid, albeit declining more recently, especially among mutual credit cooperatives and savings banks. - Loan loss provision coverage ratios (loan loss provisions to substandard-or-below loans) of mutual credit cooperatives and mutual savings banks have dropped significantly, to below 100 percent as of 2023Q1. - Policy action noted: Mutual credit cooperatives are preparing to raise buffers under regulation by raising the loan loss provision ratio for real estate and construction from 100 to 130 percent. ### Systemic risk assessment and stress test results - According to BoK stress tests in June 2023, in a stress scenario of rising real estate PF loan defaults associated with a further 10 percent housing price decline (relative to the baseline level of March 2023) over two years: - the capital ratio of the financial system would decline slightly but remain above regulatory levels in all sectors. - With recent housing market stabilization and enhanced management of asset soundness by supervisory authorities and financial institutions, systemic risks related to real estate PF loan defaults appear to remain contained. _International Monetary Fund staff summary based on Annex VI of the Republic of Korea report._ ### 6. A rise of PF default rates would further deplete capital of guarantee companies. In an ### 6. A rise of PF default rates would further deplete capital of guarantee companies. In an ### Impact of Project Financing (PF) default rates on guarantee companies - Extreme tail-risk scenario: PF default rates rise to the historical peak level (about 1.2 percent in 2012). - Implied capital loss under that scenario: 2.1 trillion won, 13.5 percent of aggregate capital. - An intermediate scenario (“Half of historical peak defaults”) shows an implied uncovered loss of 0.61 trillion won (0.6?8 in the source figure formatting). ### Mortgage default rates and stress-test findings - Empirical/regression analysis indicates mortgage default rates remain low even under severe shocks; estimated impact on mortgage default rates under adverse price shocks is relatively small. - Even under the most extreme scenario, the implied increase in the mortgage default rate is limited, reflecting low and stable historical default rates; estimated capital losses are modest. - Stress tests indicate capital would be eroded under adverse price shocks, but implied fiscal contingent liabilities related to public guarantee companies are modest. - Estimated fiscal cost of recapitalization in the most adverse scenario: about ¼ percent of GDP. - The scenario is based on extreme assumptions with low probability, partly because the Jeonse market has been stabilizing and authorities have taken measures to enhance PF project financial management. ### Authorities’ measures and recommended safeguards - Recent and planned policy actions: - Tightening of regulations on the Jeonse price cap for issuing new guarantees is expected to significantly reduce default rates of Jeonse guarantees from 2025 onwards. - Government’s planned capital injection for a public guarantee company is expected to boost its loss-absorption capacity. - The statutory operating multiple (ratio of outstanding guarantees to capital) should be maintained to ensure adequate capital buffers. ### Regression results on drivers of mortgage default rates (selected coefficients and statistics) - Housing price: -0.0189*** (SE 0.00244), -0.0193*** (SE 0.00336), -0.0193*** (SE 0.00339), 0.000723 (SE 0.00152) across specifications. - Mortgage rate: 0.0542** (SE 0.0260), 0.0567** (SE 0.0266), 0.0135 (SE 0.00964) in available specifications. - GDP growth: -0.00619 (SE 0.0115), 0.00581 (SE 0.00406) in available specifications. - Constant terms: 2.022*** (SE 0.211), 1.869*** (SE 0.355), 1.882*** (SE 0.358), -0.124 (SE 0.156). - Observations: 655, 757, 742 (across specifications shown). - R-squared: 0.488, 0.543, 0.545, 0.962. - Standard errors in parentheses. Significance: *** p<0.01, ** p<0.05, * p<0.1. ### Guarantee companies’ mortgage loan loss under housing-price shocks (assuming recovery rate of mortgage loans at 80%) - Price changes from Mar-2023 — Uncovered loss in trn won, Uncovered loss in pct of equity capital: - Baseline (-1 percent decline): 0.01, 0.20 - 10 percent decline: 0.08, 1.99 - 15 percent decline: 0.12, 2.98 - 20 percent decline: 0.16, 3.98 ### Policy recommendations and supervisory actions (selected items & actions taken) - More robust identification of systemic risk conditions: - Conduct impact assessment of the ‘open banking system’ and e-money on security/operational risks and market structure. Actions: FSC/FSS measures to improve open banking (October 21, 2020); proposed amendment of the Electronic Financial Transactions Act (November 27, 2020); periodic and non-periodic fintech inspections and cyber security inspection framework (December 22, 2021). - Assess potential rollover risk implied by the Jeonse leasehold system and connectedness to securities companies. Actions: FSC measures to strengthen household debt management (October 2021); FSS monitoring of Jeonse deposit-related risk areas. - Enhance stress testing practices for NPL sales, FX and domestic household liquidity, SME loans, securities intermediaries, and sovereign contingent liabilities. Actions: FSS plans to revise FX liquidity stress testing under Basel III LCR framework; improved top-down stress testing methodology with K-IFRS compatible lifetime expected credit loss models; planned further improvements with additional data collection. - Strengthening preemptive management of systemic vulnerabilities: - Strengthen institutional macroprudential oversight (MEFM or equivalent). Actions: Macroeconomic and Finance Meeting operated with macro-prudence primary objective; establishment of Emergency Meeting on Macroeconomic and Financial Stability. - Widen definition of financial holding company and enhance legal powers for group-wide liquidity risks and contingency plans. Actions: Act on Supervision of Financial Groups took effect in June 2021 with provisions on internal control, risk management, and solvency management. - Implement a Sectoral CCyB framework for secured and unsecured household exposures. Actions: FSC/FSS considering additional capital requirement of 0% to 2.5% of total risk-weighted assets; FSC raised the countercyclical capital buffer (CCyB) requirement from zero to one percent of total risk-weighted assets beginning on May 2024. - Intensifying supervision and promoting a level playing field: - Review role of state-controlled banks to ensure conformity with prudential requirements. Actions: Korea Development Bank and Industrial Bank of Korea adopted Basel III credit risk in December 2020 and finalized implementation in January 2023. - Increase risk-based supervisory intensity of insurers and implement K-ICS. Actions: Final version of K-ICS announced and implemented in 2023; FSS changed required capital measurement to stress approach and increased risk confidence levels from 99% to 99.5%; FSS plans to support stable establishment of K-ICS in 2023. - Reinforcing crisis management, safety nets, resolution arrangements: - Include cross-border activities and overseas operations in resolution plans; clarify resolvability and relationship between ELA and resolution funding. Actions: Recovery and Resolution Plans (RRP) for financial holding companies and banks came into effect in June 2021; two cycles completed; third cycle to commence in second half of 2023. - Strengthen insolvency and creditor rights regime through well-resourced courts and functioning insolvency practitioners. Actions: Revision of Act on Establishment and Jurisdiction of Courts of Various Levels (December 2022) to establish Suwon and Busan Bankruptcy Courts; revision of Debtor Rehabilitation and Bankruptcy Act (December 2022) to permit overlapping jurisdictions and allow certain filings in Busan Bankruptcy Court. *Source: Excerpt from IMF staff report chapter (text and tables provided in the supplied content).* ### 13. Apart from raising the contribution rate and the retirement age, there are other ### 13. Apart from raising the contribution rate and the retirement age, there are other ### Pension system design, equity, and fiscal sustainability - Recalibrate the roles of the NPS and the Basic Pension: - NPS is relatively redistributive while the Basic Pension redistributes less than typical social pensions. - Reduce NPS benefit levels by lowering the weight of the average income of national pension subscribers over the past three years (A-salary) and replace these benefits with increased Basic Pension benefit levels. - Make Basic Pension means-tested against total old-age income (instead of just the A-value). - The recalibration is described as a simplification and a change of revenue sources that can be largely beneficial and fiscally neutral. - In combination with mandatory contributions after the age of 60, this could improve benefit adequacy. - Integrate special pension regimes into the NPS: - Running separate schemes for different sectors raises equity concerns, hinders labor market mobility, and is administratively inefficient. - Medium-term gradual convergence of rules between the NPS and special occupational schemes could facilitate eventual consolidation into a single scheme. - A careful assessment of liabilities and future contribution revenue is necessary before full integration. - To improve GEPS governance: use assets before using budget transfers to cover deficits; consider recalibrating the GEPS mandate to focus on pension administration before eventual integration into the NPS. - Figure and scenario notes (as presented): - "A. Contribution Rates B. Retirement Age" (figure source: OECD (2021)). - "An additional retirement age increase of 2 years by 2070 would be equivalent to linking the retirement age to life expectancy gains at age 65 from 2035 onwards." - Chart labels show cohorts/ages: 59 61 63 65 67 69 71 73 75 (displayed as FutureCurrentOECD: futureOECD: current). - Table excerpt (variable measurements as presented): - Retirement age Year: 67.9600224 - Contribution rate (employee + employer) Percentage point: 12.8013.804.69.24.6 - Gross replacement rate Percent (as a share of wage): 2200-10-3.300 ### Macro and fiscal impact of aging and pension policies (50 Years Ahead) - Figures presented (IMF staff calculations) show deviations from steady state in: - GDP Per Capita (Percent, dev. from ss) - Public Debt (Percent of GDP, dev. from ss) - Fiscal Revenue: Contribution (Percent of GDP, dev. from ss) - Public Pension Expenditure (Percent of GDP, dev. from ss) - Policy scenarios referenced in the table include: - Steady-state level - Higher retirement age - Higher contribution rate - Lower replacement rate - Mix of policies (example 1, example 2, example 3) ### Labor market rigidity and reform priorities - Key features of Korea’s labor market: - Employment protection stronger than OECD average, with more restrictive regulations on individual dismissals. - High duality: non-regular workers account for a significant share of total employment (among the highest in the OECD), with lower wages, fewer benefits, and less job security. - Public spending on social protection among the lowest in OECD, notably on pensions, labor markets, and support for vulnerable groups. - Wage system is seniority-based; flexibility of wage determination is relatively lower than in other advanced economies. - Korea is among the most overworked countries in the OECD, with long working hours and inflexible working hour arrangements. - Authorities’ reform agenda: - Announced three-pillar reform plan: more flexible working hours, switch to performance-based pay, and tackling labor market duality. - March 2023 working hour reform (reduce restrictive regulations on weekly working hours while limiting overtime over longer time intervals) faced pushback from younger workers; authorities are revising the proposal incorporating public opinion. - Detailed plans still being formulated for productivity-based pay and duality reforms. - Empirical evidence on reform impacts (local projection techniques, OECD countries 1970-2020): - Easing employment protection legislation (EPL) on regular workers: - Positive effects in good times but could be contractionary in slack periods. - A major EPL reform during economic expansions increases both output and employment by about 5 percent on average over the medium term. - For countries with high duality (high share of temporary workers) including Korea, the effects on output and employment increase to about 6 percent. - Active Labor Market Policies (ALMPs) and labor tax wedge reforms: - More positive impacts during low growth periods; often involve fiscal stimulus. - A 10 percent increase in ALMP spending improves output level by 1.1 percent on average over the medium term. - A one percentage point reduction in the labor tax wedge could raise output by 0.6 percent on average. - Labor market reforms produce higher gains when implemented with complementary macroeconomic policies: supportive fiscal and monetary policies help mitigate short-term adverse effects of EPL reforms and facilitate efficient labor reallocations. - Implementation guidance: - Focus on working hours reforms is appropriate under current disinflationary policy stance because reforms not associated with strong contractionary or inflationary impact can be prioritized. - As growth recovers, consider deregulations to reduce employment protection for regular workers combined with a stronger social safety net and targeted support for vulnerable groups during the transition. - Design and communication: refine working-time reform to balance needs of workers and enterprises, ensure stakeholder dialogue, and carefully communicate changes. ### Gender gaps and policies to foster female labor participation - Key statistics and facts: - Gender gap in labor force participation: 18 percentage points. - Gender wage gap: 31 percent. - Non-regular job incidence: 30 percent of paid male workers hold non-regular positions; 47 percent of paid female workers are non-regular workers. - Only 12 percent of managerial positions are held by women. - Drivers: - Social norms and structural labor market rigidities: heavier burden of housework on women; larger role in childcare and education. - Seniority-based pay and long working hours make work-life balance after childbirth challenging, causing many women to leave the labor force in prime age and return in their 40s and 50s. - Women returning after career breaks disproportionately find non-regular jobs, worsening job quality and career prospects. - Policy measures taken and recommended: - Government policies: expanding child-care support and parental leave, reducing working hours, providing career transition assistance for career-disrupted women. - Address structural labor market problems: more flexible work arrangements combined with enhanced social benefits and protection for non-regular workers to reduce disparities. - Quantitative model results (search and matching model with gendered agents and dual labor market): - Reducing firing/severance payments of regular contract workers by 10, 20, and 30 percent were simulated. - Reducing severance payments by 30 percent (alone) results: - Unemployment rate falls by 0.5 percentage points. - Labor force participation increases by 0.9 percentage points for women and 0.3 percentage point for men. - Productivity growth increases up to 0.2 percent for men and 0.5 percent for women. - Income inequality (Gini coefficient) falls by 3.4 percentage points. - Women’s participation: nonregular contracts rises by 0.9 percentage points and regular contracts by 0.5 percentage points. - When combined with policies that foster female labor force participation: - Female productivity increases about 0.6 percent. - Female share of nonregular contracts falls up to 0.3 percentage point. - Female share of regular contracts increases by up to 1.0 percentage point. *Source: IMF staff analysis as presented in the provided content.* ### 5. Significant gains in productivity and growth can be achieved by reducing the gender ### 5. Significant gains in productivity and growth can be achieved by reducing the gender gap in the labor market to the OECD average ### Main finding from gendered growth accounting - A gendered growth accounting exercise based on a standard growth model suggests that Korea could achieve an increase of 18.3 percent in per capita GDP (KRW 10.5 million in constant 2015 prices) by implementing policies that reduce the gender gap in terms of hours worked to the OECD average in 2035. - The projection includes: - the direct increase in output from adding labor, and - technology spillovers, which could increase labor productivity by approximately 1 percent. ### Labor market patterns and constraints (qualitative findings from figures) - Korea has the largest gender wage gap among advanced OECD countries. - Women’s labor force participation drops significantly in their mid-30s compared to peer countries. - Women are disproportionately in less secure and less well-paid positions, such as services and simple worker occupations. - Women who discontinue careers tend to return to less secure and less well-paid positions. ### Model results on labor market reforms (summary of scenarios) - Increasing flexibility (in working hours and related labor regulations) has the following modeled effects: - decreases unemployment and raises labor force participation, especially for women; - raises productivity for both genders, especially for females; - reduces inequality and raises female contract participation for both regular and nonregular contracts. - When gender-targeted policies are added to increased flexibility: - the overall effects on unemployment and participation are similar to flexibility alone; - female productivity rises more than under flexibility-only reforms; - the participation of women in regular jobs rises substantially (shifting participation away from nonregular contracts to regular employment). ### Policy recommendations to support female labor force participation - Measures supporting career development. - Providing affordable and quality childcare services. - Increasing flexible working arrangements. - Removing gender discrimination practices at work. - Additional policy measures referenced elsewhere in the chapter include: - generous childcare support; - retraining programs for re-entry into the labor market after childcare leave; - retention programs to prevent career breaks; - education programs for women’s employment in high-wage sectors. *Source: Staff report chapter on labor and gender from the Republic of Korea — Staff Report for the 2023 Article IV Consultation.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1korea2023001.pdf_