## _cr16278

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### CONTEXT
- Historical growth and potential:
  - Average growth historically in excess of 7 percent for nearly fifty years.
  - Per capita income rose from 5 percent of the United States in 1960 to around 55 percent by the global financial crisis.
  - Staff estimate potential growth dropped from 7 percent in the early 1990s to below 3 percent now.
- Structural challenges:
  - Demographics: working-age population projected to peak in 2017 and decline thereafter; overall population expected to start declining after 2025; fiscal outlays expected to rise sharply.
  - Export dependence: exports exceed 50 percent of GDP; vulnerability to spillovers from China and global trade slowdown.
  - Sectoral and corporate weaknesses: heavy industrial sectors (shipbuilding, shipping, steel, petrochemicals) face bleak prospects; some firms will need restructuring.
  - Labor-market issues: female labor-force participation below OECD average; heavily segmented labor market with extensive non-regular labor and seniority-based compensation.
  - Productivity gaps: service-sector labor productivity much lower than peers; SME productivity one-third that of large enterprises (down from one-half in the late 1980s).
  - Social protection: total social spending about 10 percent of GDP (less than half the OECD average); NPS covers about one-third of the elderly; pension benefits around one-quarter of the average wage in 2015 (OECD).
  - Household debt: rising and a short-term vulnerability for financial stability and a structural drag on consumption and medium-term growth.
- Distribution and mobility:
  - Gini coefficient near the OECD average.
  - Only 20 percent of households moved to a higher income bracket between 2011 and 2014; a similar share slid into a lower bracket.
  - Relative poverty rates, particularly among the elderly, among the highest in the OECD.
- Fiscal outlook:
  - Public debt at 38 percent of GDP (current).
  - Authorities’ conservative baseline projects debt reaching 60 percent of GDP by 2060 due to population aging; fiscal consolidation could keep debt around 40 percent of GDP in the long run.
- Policy focus: comprehensive structural reforms plus judicious use of fiscal space to boost potential growth, foster inclusion, and support gradual rebalancing.

### RECENT DEVELOPMENTS AND OUTLOOK
- Activity and near-term outlook:
  - Growth sluggish since 2012; output gap negative (around 1½ percent of potential GDP).
  - Staff forecast growth: "2.7 percent" in 2016 and "3.0 percent" in 2017; output gap closing only by "2021".
  - Drivers of anticipated pickup: growing private consumption, a stronger housing market, fiscal and monetary easing.
  - Risks: difficult export prospects, heightened uncertainty weighing on fixed investment, inventory payback.
- External sector, capital flows, and FX:
  - Current account surplus reached record-high "7¾ percent of GDP" in 2015.
  - NIIP positive for first time in 2014; reached "14½ percent of GDP" in 2015; projected to strengthen to "19½ percent of GDP" in 2016 (Annex).
  - Portfolio outflows after the “RMB tantrum,” in anticipation of Fed “lift-off,” and following Brexit.
  - Real effective exchange rate began to weaken after two years of appreciation; staff assesses REER for 2015 to be "4 to 12 percent" weaker than level consistent with fundamentals and desired policies.
  - Reserves stable around 121 percent of IMF composite reserve adequacy metric; reserves increased by "$4 billion" in 2015.
- Inflation and monetary policy:
  - Headline CPI around "1 percent" (below target); Bank of Korea’s target recently reduced to "2 percent" (from "2½–3½ percent" range).
  - Core inflation closer to "2 percent"; policy rate cuts implemented, including a 25 basis point cut on June 9 and cumulative "50 basis points" over the past year.

### FINANCIAL SECTOR, HOUSEHOLD DEBT, AND CORPORATE VULNERABILITIES
- Household credit and NBFIs:
  - Credit growth to households: "11 percent y/y in 2015".
  - Household debt reached "163 percent of net disposable income" (above OECD average "131 percent").
  - About one-third of household credit from NBFIs; as of 2015 NBFIs accounted for about half of household lending.
  - Nonbank household credit growth accelerated as banks tightened lending standards.
  - Macroprudential caps: LTV at "70 percent"; DTI at "60 percent" (applies only to mortgage debt).
  - Staff recommends gradual tightening of DTI toward "30 to 50 percent" and extension to other household debt; monitor and implement comprehensive DSR.
- Banking system and policy banks:
  - Financial soundness indicators relatively strong on a point-in-time basis.
  - Banking sector NPL ratio ticked up to "1.9 percent in March 2016".
  - Bank profitability very low by international standards.
  - Policy-bank exposure: Korea EXIM lending to shipbuilding and shipping "KRW 38 trillion (2¼ percent of GDP)"; KDB "KRW 20 trillion (1¼ percent of GDP)"; combined EXIM and KDB lending to shipbuilding/shipping "KRW 58 trillion (around 3½ percent of GDP)" as of March 2016.
  - Government estimates "KRW 5 to 8 trillion" additional capital required to meet Basel III; government providing "KRW 1 trillion" in-kind Tier 1 capital to Korea EXIM in 2016; Policy Bank Recapitalization Fund up to "KRW 11 trillion" (financed by "KRW 1 trillion" from IBK and up to "KRW 10 trillion" from BOK).
  - Staff recommends expeditious financial and operational restructuring; recapitalization is fiscal responsibility; BOK bridge financing role should be unwound ASAP.
- Corporate vulnerabilities and stress tests:
  - Aggregate corporate leverage moderate: nearly "90 percent" of companies have debt-to-equity ratio < "2".
  - Share of vulnerable firms (ICR < "1.5") rose beyond "35 percent" last year.
  - Stress test: a "1 percent" slowdown in external demand would reduce Korean corporates’ earnings growth by up to "1¼ percent".
  - Debt-at-risk and employment-at-risk projections:
    - Mild/baseline: EBIT contraction "10–15 percent" → debt-at-risk increase by "15 percent"; employment-at-risk increase by "10 percent".
    - Severe: combined EBIT contraction "20–25 percent" → debt-at-risk increase by "30 percent"; employment-at-risk increase by "15 percent".
  - Restructuring cost estimates: about "6 percent of GDP" in baseline; up to "8 percent of GDP" in severe scenario (gross cost, not necessarily fiscal).

### CORPORATE RESTRUCTURING STRATEGY
- Government three-track approach:
  - Track 1: industry-wide restructuring — shipbuilding and shipping (public sector closely involved).
    - Revitalization plans by three major shipbuilders amount to "KRW 10.3 trillion (0.7 percent of GDP)".
  - Track 2: routine cases of individual distressed firms via banks’ regular credit-assessment and workout programs.
    - Corporates under debt restructuring rose to "229" end-2015 (including "54" large corporations).
  - Track 3: preemptive industry restructuring for overcapacity sectors (steel, petrochemicals, construction), aided by Corporate Vitality Enhancement Act (“One-Shot Law”).
- Staff recommendations:
  - Proceed expeditiously with financial and operational restructuring.
  - Combine restructuring with social spending to assist affected workers.
  - Monitor commercial banks’ exposure to vulnerable sectors and require sufficient loan loss reserves.
  - Deepen market infrastructure for restructuring (M&A, private equity, NPL markets).

### LABOR MARKET AND PRODUCTIVITY POLICIES
- Labor priorities:
  - Address labor market duality to reduce youth unemployment and inequality.
  - Measures: foster cooperative labor relations; expand benefits for non-regular workers; reduce rigidities via performance-based assessment and clearer dismissal conditions; broaden training access.
  - Boost female labor-force participation via childcare support, flexible work arrangements, improved work-life balance, job search and training support.
- Services-sector productivity:
  - Regulatory burden in upstream services stringent; diminishing this burden to reach the OECD frontier by "2025" could boost TFP growth by about "¼ percentage point" each year (staff estimate).
  - Government aims to create "250,000" new jobs in services and increase the sector’s share from "60 percent" currently to "65 percent by 2020".
  - Strategy: promote synergies between services and manufacturing; revamp infrastructure oriented toward services; nurture new businesses (healthcare, tourism).

### FISCAL POLICY, SOCIAL SPENDING, AND REVENUE OPTIONS
- Role of fiscal policy:
  - Given low public debt, there is room for fiscal support to incentivize reforms and cushion transition costs.
  - Staff urged additional fiscal stimulus as primary instrument amid weak conjuncture; suggested a package of about "1 percent of GDP" as a supplementary budget (multipliers on the order of 0.3).
- Announced fiscal measures:
  - Authorities announced package (June 28) of more than "KRW 20 trillion (1¼ percent of GDP)" including a "KRW 10 trillion" supplementary budget; includes "KRW 6.5 trillion" SOE spending announced earlier.
  - Staff estimate package will boost GDP by around "0.3 percent", spread over 2016 and 2017.
- Social spending:
  - Staff recommend targeted expansion of social expenditure to reduce elderly poverty (nearly half of elderly poor), reduce precautionary savings, boost consumption-led growth, and contribute to financial stability.
  - Suggested scope for increases in basic income and national pension; additional spending for public education quality and access.
- Revenue measures and fiscal rules:
  - Korea’s revenue burden at "21 percent of GDP" (one of the lowest in the OECD).
  - Illustrative revenue options: increase VAT from "10 percent" to OECD average "18 percent" could yield "3¾ percent of GDP"; reducing unusually large standard deduction under PIT could generate "3¼ percent of GDP"; room to raise CIT rate.
  - Fiscal rules proposal: a structural budget balance rule for countercyclical policy, and a debt ceiling to anchor public debt (public discussion needed; staff noted "40 percent of GDP" long-run debt may be too conservative given benefits of additional social spending).

### DEBT SUSTAINABILITY, EXTERNAL POSITION, AND RISKS
- Public debt projections and financing metrics:
  - Nominal gross public debt (percent of GDP): 2015: "33.9"; 2016: "35.7"; 2017: "36.6"; 2018: "37.0"; 2019: "36.8"; 2020: "35.8".
  - Public gross financing needs (percent of GDP): 2015: "6.7"; 2016: "7.4"; 2017: "7.6".
  - Effective interest rate series (percent): 2015: "3.0"; 2016: "2.8"; 2017: "4.2".
- External balances:
  - Current account (percent of GDP): 2015: "7.7"; staff-assessed CA gap for 2015: "1¾ to 4¼ percent of GDP" (after accounting for Korea-specific factors); EBA gap: "6 percent".
  - Staff box finding: after adjustments, current account surplus appears on the order of "3 percent of GDP" larger than justified by medium-term fundamentals and desirable policies.
  - Net external debt position: net external debt "-23½ percent of GDP" in 2015.
- REER and reserves:
  - REER: won appreciated since 2012; as of April 2016 depreciated by "2 percent" from 2015 average.
  - Staff assesses REER for 2015 to be "4 to 12 percent" weaker than level consistent with fundamentals (range).
  - Reserves sufficient; intervention should be limited to smoothing excessive volatility.
- Key risks:
  - Global: tighter/volatile global financial conditions; surge in the U.S. dollar; hard landing in China.
  - Domestic: weak private consumption; household debt drag; disorderly corporate restructuring; housing market deterioration; North Korea-related risks.
  - Policy responses across risks: fiscal easing, monetary easing, exchange rate flexibility with limited FX intervention, macroprudential tightening, structural reforms, targeted fiscal support.

### SCENARIOS: IMPACTS OF CHINA’S REBALANCING (Annex VI)
- Model: multi-country, multi-sector Ricardian trade model calibrated to 2011 input-output and trade flows across 40 economies and 34 sectors.
- Scenario 1 (preference shift to consumption): China consumes more like U.S. → Korea income contraction "0.25 percent".
- Scenario 2 (move up the value chain): China more competitive in higher-tech manufacturing; small productivity shifts (> "3 percent") generate materially adverse spillovers to Korea; Korea and Taiwan POC: real incomes falling by "0.08" (text) in baseline experiments.
- Scenario 3 (services rebalancing): increased productivity in China’s nontraded sectors → modest positive spillovers to Korea (reported change "0.04" in scenario table).
- Cross-cutting finding: Korea particularly vulnerable to Scenario 2; many adverse effects driven by terms-of-trade rather than trade volumes; services-channel benefits not captured may offset some negative effects.

### STAFF APPRAISAL AND RECOMMENDATIONS
- Overall appraisal:
  - Staff commend the authorities’ focus on structural reforms and corporate restructuring; agree macroeconomic policies should remain supportive given weak conjuncture and downside risks.
  - Fiscal support has room given low public debt; macroprudential tightening and harmonization across banks and nonbanks needed to contain household and nonbank credit risks.
  - Exchange rate should remain flexible; intervention limited to disorderly market conditions; publishing intervention data with lag could be considered.
- Priority policy package:
  - Near term: finalize and implement fiscal package promptly ("KRW 10 trillion" supplementary budget within "KRW 20 trillion" package), maintain supportive monetary stance, and tighten macroprudential measures.
  - Structural: comprehensive reforms addressing demographics, labor-market duality, service-sector productivity, SME support, corporate restructuring, and strengthening social safety nets.
  - Fiscal strategy: mobilize targeted fiscal support to cushion reform costs (examples: subsidies for children and childcare; unemployment insurance and retraining for restructured workers; fiscal incentives for effective R&D).
  - Medium-term: expand social expenditure carefully, matched by eventual revenue increases and possible fiscal rules (structural balance rule and debt ceiling) to ensure sustainability.
- Corporate restructuring guidance:
  - Proceed expeditiously with restructuring; combine with social spending; ensure policy-bank recapitalization led by fiscal authorities; unwind central bank bridge financing promptly.
- Financial stability:
  - Harmonize prudential regulation across banks and nonbanks; consider FX LCR implementation (require commercial banks to hold at least "60 percent" of FX debt in HQLA, rising to "80 percent" by 2019).
  - Gradual tightening of household DTI and extension to other debt instruments; monitor and limit risks from NBFIs.

*Italic line: REPUBLIC OF KOREA — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION (IMF staff report, July 2016, content unit _cr16278).*

### 2016. The staff team included K. Kochhar (head), K. Mathai, D. Ding,

### REPUBLIC OF KOREA

### CONTEXT
- Korea achieved sustained rapid growth historically, delivering average growth in excess of 7 percent for nearly fifty years and raising per capita income from 5 percent of the United States in 1960 to around 55 percent by the global financial crisis.
- Staff estimate that potential growth has dropped from 7 percent in the early 1990s to below 3 percent now.
- Key structural challenges identified:
  - Demographics: working-age population projected to peak in 2017 and decline thereafter; overall population expected to start declining after 2025; fiscal outlays expected to rise sharply.
  - Export dependence: exports exceed 50 percent of GDP; vulnerability to spillovers from China and global trade slowdown.
  - Sectoral weaknesses and corporate vulnerabilities: heavy industrial sectors (shipbuilding, shipping, steel, petrochemicals) face bleak prospects; some firms will need restructuring.
  - Labor-market issues: female labor-force participation below OECD average; highly segmented labor market with extensive non-regular labor and seniority-based compensation that reduces productivity.
  - Lagging productivity: service-sector labor productivity much lower than peer economies and only half that of manufacturing; SME productivity one-third that of large enterprises (down from one-half in the late 1980s).
  - Insufficient social protection: total social spending amounts to just 10 percent of GDP, less than half the OECD average; NPS covers about one-third of the elderly; OECD reports pension benefits were around one-quarter of the average wage in 2015.
  - Rising household debt: a short-term vulnerability for financial stability and a structural drag on consumption and medium-term growth.
- Income distribution and mobility:
  - Gini coefficient near the OECD average; the gap between richest and poorest quintiles slightly higher than average.
  - Only 20 percent of households moved to a higher income bracket between 2011 and 2014; a similar share slid into a lower bracket.
  - Relative poverty rates, particularly among the elderly, are among the highest in the OECD.
- Fiscal position and medium/long-term challenges:
  - Public debt is 38 percent of GDP now.
  - Authorities’ conservative baseline projects debt reaching 60 percent of GDP by 2060 due to population aging; fiscal consolidation could keep debt around 40 percent of GDP in the long run.
- Policy focus from Article IV discussions: comprehensive structural reforms plus judicious use of fiscal space to boost potential growth, foster inclusion, and support gradual rebalancing.

### RECENT DEVELOPMENTS AND PROSPECTS
- Activity and outlook:
  - Growth sluggish since 2012; economy affected by the Sewol ferry accident (2014), MERS outbreak (mid-2015), and global trade slowdown.
  - Policy responses included policy rate cuts, a supplementary budget and tax cuts in 2015, frontloading of expenditure, and a fiscal package for 2016.
  - Output gap remains negative (around 1½ percent of potential GDP).
  - Recent high-frequency data mixed; activity picked up in H2 2015 but slowed in Q1 2016 due to expiry (and later extension) of a consumption tax cut, weaker fixed investment, and inventory payback.
- External sector and capital flows:
  - Nominal exports fell sharply during 2015 and early 2016, with largest declines to Asian partners and emerging markets.
  - Imports fell even more sharply than exports, pushing the current account surplus to a record-high 7¾ percent of GDP in 2015.
  - Korea’s NIIP turned positive for the first time in 2014 and reached 14½ percent of GDP in 2015.
  - Portfolio outflows occurred after the “RMB tantrum,” in anticipation of Fed “lift-off,” and following Brexit; the real effective exchange rate began to weaken after two years of appreciation.
  - Authorities appear to have sold foreign-exchange reserves during several months over the past year.
  - Financial conditions generally remained stable despite volatility; Brexit led to initial sharp losses in equities and the won that were largely reversed within a week.
- Box finding on the current account:
  - After adjustments for terms-of-trade, demographics, retained earnings under BPM6, and other factors, the current account surplus appears to be on the order of 3 percent of GDP larger than justified by medium-term fundamentals and desirable policies.
  - The surplus reflects excess saving and insufficient investment; structural and fiscal policies can boost consumption and investment, reduce the current account surplus, and support higher domestic welfare.
- Inflation and monetary policy:
  - Headline CPI inflation dropped to its lowest levels since mid-1999 by early 2015 and hovers around 1 percent, below the Bank of Korea’s target (recently reduced from a range of 2½–3½ percent to 2 percent).
  - Core inflation has been more robust, with some moderation in early 2016 after the dissipation of a 2015 cigarette-excise hike.

### POLICY DISCUSSIONS AND RECOMMENDATIONS
- Near-term macro policy:
  - Recently announced fiscal support and monetary easing were appropriate given weak conjuncture and downside risks.
  - The fiscal package should be finalized and implemented as soon as possible.
  - Macro policy stance should remain supportive going forward.
  - Exchange rate should continue to be allowed to move flexibly; intervention should be limited to addressing disorderly conditions.
- Financial-sector and prudential measures:
  - Prudential regulations should be tightened and harmonized across banks and nonbanks to contain risks from household debt.
- Structural reform priorities to boost potential growth and inclusion:
  - Implement a comprehensive package of structural reforms to address demographics, export dependence, sectoral overcapacity, labor market segmentation, low service-sector productivity, insufficient social protection, and high household debt.
  - Use fiscal space judiciously to support reforms and mitigate transition costs, while maintaining medium-term fiscal sustainability.
- Political economy:
  - Passage of reforms may be complicated by the political environment following the April general election, where the ruling party lost plurality in the National Assembly; the President remains in office until February 2018.

*Source: International Monetary Fund—Republic of Korea staff report (2016).*

### 11.      While the real economy has lagged, the

### _cr16278 - 11.      While the real economy has lagged, the

### Credit cycle and household credit
- Total private credit is "only slightly above trend," reflecting sluggish corporate borrowing.
- Credit growth to the household sector reached "11 percent y/y in 2015" following earlier rate cuts and a loosening of macroprudential measures.
- About one-third of household credit has come from non-bank financial institutions (NBFIs), such as insurance companies, mutual credit cooperatives, savings banks, and securities companies.
- Nonbank household credit growth has accelerated and may continue as banks’ lending standards tighten.
- Credit gap versus output gap chart references: Sources: BIS; CEIC Data Company Ltd.; IMF, World Economic Outlook database; and IMF staff calculations.

### Financial system resilience and banks
- Financial soundness indicators—capital adequacy, liquidity, and asset quality of both banks and NBFIs—are "relatively strong on a point-in-time basis."
- Banking sector NPL ratio ticked up to "1.9 percent in March 2016."
- Bank credit growth has weakened recently and could slow further given elevated corporate credit risk.
- Bank profitability is "very low by international standards," possibly due to banks’ policy responsibilities and the low nominal interest rate environment.
- The government implemented Basel Committee recommendations on additional capital requirements for domestic systemically important banks (D-SIBs) and countercyclical capital buffers (initially set at "zero").

### Household debt and policy responses
- Household debt reached "163 percent of net disposable income"—above the OECD average of "131 percent."
- Key drivers of household debt:
  - (i) population aging;
  - (ii) a sustained rise in chonsei prices;
  - (iii) the recovery in housing prices.
- Authorities’ measures announced:
  - More stringent bank screening of loan applications.
  - Faster restructuring of the mortgage market toward amortizing and fixed-rate loans.
  - Tighter LTV limits on nonbanks’ nonresidential mortgages.
  - Considering asking banks to monitor a comprehensive debt-service ratio (DSR) for borrowers.
- Following these announcements (under gradual implementation), growth of household bank mortgages began to moderate and house prices moderated, while other household loans continued to grow rapidly.

### Corporate sector vulnerabilities
- Aggregate corporate leverage is moderate: nearly "90 percent" of companies have a debt-to-equity ratio of less than "2".
- Financial soundness deteriorated in certain export-oriented industries and construction as sales have slumped.
- Share of vulnerable firms (interest-coverage ratio below "1.5") has been high since the global financial crisis and rose beyond "35 percent" last year.
- Stress tests: a "1 percent" slowdown in external demand would reduce Korean corporates’ earnings growth by up to "1¼ percent", with serious implications for corporate investment and economic growth.

### Outlook and risks
- Staff forecasts: growth to tick up to "2.7 percent" this year and "3.0 percent" in 2017; inflation remaining subdued; output gap closing only by "2021".
- Anticipated pickup drivers: growing private consumption, a stronger housing market, and the impact of fiscal and monetary easing.
- Offsetting factors: difficult export prospects, sluggish exports, heightened uncertainty weighing on fixed investment, and stockbuilding remaining a drag.
- Credit is expected to continue to grow but at a slower pace consistent with tightening macroprudential measures, the narrowing of the credit gap, and envisaged moderation in construction investment after "2017".
- Downside risks:
  - Domestic: weak private consumption; household debt drag; corporate restructuring could raise unemployment, weaken consumption, and adversely affect banks’ balance sheets and lending.
  - External: high exposure to China—hard landing or a larger slowdown than WEO projections would depress exports; faster Chinese move up the value chain could increase competition; rebalancing in China could alternatively raise demand for some Korean goods and services.
  - Global financial conditions: tighter or more volatile conditions—particularly following Brexit—could lead to capital outflows, falling asset prices, and rising funding costs.
- Authorities’ views:
  - Slightly more optimistic forecast than staff; acknowledged weaker-than-desired growth momentum.
  - Agreed household debt can drag on consumption and growth but noted increased household saving partly reflects rising life expectancy.
  - Saw their fiscal measures, increased budget execution, carryover from prior stimulus, and planned new stimulus as supporting growth.
  - Viewed labor market protections for affected workers and arrangements to keep creditor banks well capitalized as important mitigants.
  - Considered Brexit unlikely to have a substantial impact given limited direct Korea–U.K. linkages, but noted medium- and long-term risks during the U.K.’s exit negotiations.
  - Suggested higher oil prices could benefit Korean exports by boosting demand in oil-exporting nations.

### Policy discussions — corporate restructuring
- Authorities’ three-track approach to restructuring: (1) shipbuilding and shipping; (2) routine cases of individual distressed firms; (3) overcapacity sectors of steel, petrochemicals, and construction.
- Government announced broad plans for Track 1 and measures to recapitalize two policy banks that could face losses as firms are restructured.
- Government designated shipbuilding industry as requiring special support (June 30).
- Tracks 2 and 3 may proceed with minimal government involvement; Track 3 aided by the recently passed “one-shot” law streamlining procedures and offering tax incentives for mergers and acquisitions.
- Staff recommendations:
  - Proceed expeditiously with financial and operational restructuring.
  - Combine restructuring with social spending to help affected workers.
  - Recapitalization of policy banks is the fiscal authorities’ responsibility; BOK’s short-term bridge financing role should be unwound—either repaid from fiscal resources or sold through markets—as soon as possible.
  - Financial supervisory authorities should monitor commercial banks’ exposure to vulnerable sectors and require sufficient loan loss reserves.

Box: Authorities’ plan for shoring up policy-bank capital (high-level facts)
- Korea EXIM and KDB lending to shipbuilding and shipping amounted to "KRW 58 trillion (around 3½ percent of GDP)" as of March 2016.
- Government estimates "KRW 5 to 8 trillion" in additional capital required to meet Basel III after some loans are written down.
- Government will provide "KRW 1 trillion" of in-kind, Tier 1 capital (shares in state-owned enterprises) to Korea EXIM in 2016; additional Tier 1 capital planned through the 2017 budget.
- A Policy Bank Recapitalization Fund of up to "KRW 11 trillion" set up under KAMCO management:
  - Financed by "KRW 1 trillion" in loans from the Industrial Bank of Korea (IBK) and up to "KRW 10 trillion" in loans from the BOK.
  - BOK’s exposure enjoys two levels of credit protection (seniority to KAMCO’s junior tranche; insured by KODIT, fully backed by the government).
  - BOK loans short tenor (one year or less, per Bank of Korea Act); BOK can lend again.
  - The fund launched on July 1 and will operate through end-2017 (date may be changed during end-year review); government supports early redemption of BOK loans.

### Policy discussions — labor markets
- September 2015 Tripartite Agreement contained important reforms but later lost support; related labor-law package is stalled in the National Assembly.
- Government guidance to employers promotes the “wage-peak” system, performance-based assessment, and clarified dismissal conditions.
- Key priorities:
  - Address labor market duality to reduce youth unemployment, inequality, and low investment in training by: (i) fostering cooperative labor relations; (ii) expanding benefits for non-regular workers; (iii) reducing rigidities via performance-based assessment and clear dismissal conditions; and broadening access to training for non-regular workers.
  - Boost labor force participation—especially female participation—via well-targeted childcare support, flexible work arrangements, improved work-life balance, enhanced job search and training support, and addressing gender-based job inequalities.

### Policy discussions — productivity and services sector
- Regulatory burden in upstream service sectors (e.g., electricity, gas, and rail) is very stringent; staff estimates that diminishing this burden to reach the OECD frontier by "2025" could boost TFP growth by about "¼ percentage point" each year.
- Productivity gains can be achieved by promoting competition and deregulation in healthcare, education, and professional services.
- Policy should prioritize fostering growth and innovation in SMEs rather than shielding less competitive firms.
- Korea is highly exposed to China’s rebalancing; policy responses include moving up the value chain, developing sectors benefiting from Chinese consumption, and enhancing traded services.
- Government’s three-pronged strategy to strengthen the service sector:
  - (i) promoting synergies between services and manufacturing;
  - (ii) revamping infrastructure oriented toward services;
  - (iii) nurturing new businesses, notably in healthcare and tourism.
- Government aims to: create "250,000" new jobs in the service sector and increase the sector’s share of the economy from "60 percent" currently to "65 percent by 2020".

*Source: IMF staff country report text provided in the content unit.*

### 25.      Fiscal support should be mobilized to incentivize and cushion any adverse impacts of

### _cr16278 - 25.      Fiscal support should be mobilized to incentivize and cushion any adverse impacts of

### Fiscal support to accompany structural reforms
- Fiscal support should be mobilized to incentivize and cushion any adverse impacts of structural reforms.
- Examples of targeted fiscal measures:
  - Additional, well-targeted subsidies for children and for childcare to stem declining fertility and improve labor force participation.
  - Fiscal incentives to make Korea’s substantial R&D activity more effective and complement efforts to promote a “creative economy.”
  - Fiscal support including unemployment insurance benefits, retraining opportunities, and job-search facilities to assist workers affected by corporate restructuring or labor market reforms—support that would allow more equitable outcomes and increase consensus for structural reforms.

### Box 3 — Developing the “Creative Economy”
- Objective: foster innovation, create new firms and decent jobs, transform the economy by creating a virtuous business ecosystem to facilitate new industries and higher-value added in existing industries; raise total factor productivity, reduce savings, and boost private investment.
- Measures introduced:
  - Centers for Creative Economy and Innovation (CCEIs): 17 CCEIs nationwide providing close support to start-up entrepreneurs; serve as R&D clusters and provide customized support matching each venture’s growth stages up to global expansion; development of the Pangyo Creative Economy Valley as a Korean version of Silicon Valley.
  - Start-ups and venture capital: facilitated access to venture capital and IPOs; enhanced “cooperative competition” between large firms and SMEs; strengthened regulatory environment for protection of IP rights by creating a market for trading IP (i.e., a stock exchange for small firms).
  - New markets and industries: creation of new markets via fusion of science, technology and ICT, notably in biomedical sectors, nanomaterials, and renewable energy; promotion of M&A activity, including by revising laws on private equity.
- Reported outcomes:
  - The number of start-ups exceeded 30,000 for the first time in 2015.
  - New start-up investment reached an unprecedented level.
  - A total of KRW 176.6 billion of investment for 1,050 startups has been secured, with 7,044 cases of test product support carried out as of May 2016.

### Expanding social expenditure and distributional impact
- A carefully targeted expansion of social expenditure, sustained over the medium term, could yield multiple benefits:
  - Directly reduce relative poverty among vulnerable groups such as the elderly, nearly half of whom are poor.
  - By increasing disposable income for these groups and reducing precautionary savings, boost consumption-led growth and reduce reliance on volatile external demand.
  - Contribute to financial stability by reducing retirees’ borrowing to open small businesses.
  - Create room to rationalize support to SMEs, thus boosting labor productivity.
- Staff see scope for increases in the basic income as well as the national pension, among other programs.
- Additional spending to strengthen the public education system would also be desirable.
- Note in text: improving the quality of schools and access to public afterschool tutoring would reduce Korean households’ private spending on education, which, at 38 total spending, is nearly double the OECD average.

### Long-term revenue needs and fiscal rules
- To preserve sustainability, revenue increases will be needed in the long term to pay for expanded social spending; fiscal rules could help ensure these materialize.
- Trade-offs:
  - Increasing revenues too early would reduce household disposable income and undercut the desired boost to consumption and growth.
  - Compensatory measures will be needed eventually given long-run fiscal challenges.
- Potential revenue and tax measures noted:
  - Increasing social contributions as a natural place to focus.
  - Korea’s revenue burden at just 21 percent of GDP—one of the lowest in the OECD.
  - Example reforms discussed in Box 6 of the 2015 Article IV Consultation staff report (listed in source): streamlining tax expenditures; reducing income shifting; moving property taxes toward recurrent taxes on property owned.
  - Illustrative revenue options cited: increasing the VAT rate from the current 10 percent to the OECD average of 18 percent could yield 3¾ percent of GDP in extra revenues; reducing the unusually large standard deduction under the personal income tax could generate 3¼ percent of GDP in revenues; there may be room to raise the CIT rate.
- Fiscal rules proposal (Box 4): introduce a rule-based fiscal framework to address two challenges in Korea’s current framework:
  - Countercyclical policy: supplementary budgets can be introduced only under very specific circumstances, which may hamper short-term countercyclical fiscal policy.
  - Long-term anchor: no formal anchor in place despite scenarios keeping debt around 40 percent of GDP in the long run.
- Possible pair of rules:
  - A structural budget balance rule to provide a framework for countercyclical fiscal policy (noting communication difficulties from output gap uncertainty).
  - A debt ceiling to anchor public debt at a prudent level while allowing flexibility on tax and spending mix; public discussion required to pin down an appropriate debt level (noting 40 percent of GDP over the long run may be too conservative given benefits of additional social spending).

### Authorities’ views on fiscal strategy
- Authorities agreed on importance of structural reforms to boost growth, inclusion, and rebalance the economy.
- Emphasized corporate restructuring would move ahead quickly and that the unemployment fund would provide sufficient coverage for affected workers.
- Agreed fiscal policy would play lead role in policy bank recapitalization; viewed BOK involvement as consistent with its mandate as part of a contingency plan.
- Government’s broader reform agenda includes: (i) labor-market reform; (ii) reforms in state-owned enterprises (SOEs); (iii) measures to improve education; and (iv) financial sector reforms focused on deregulation and technological innovation.
- Authorities agreed on benefits of a stronger social safety net but noted social spending was already on a rising trajectory and were wary of new entitlements.
- Their strategy for rising social spending: first seek increases in pension and healthcare contributions from those enjoying larger benefits; next seek savings through discretionary expenditure reform; only then consider increased taxation (which they did not envisage for the time being).
- Fiscal rules were under discussion and authorities welcomed staff’s further analysis.

### Providing short-term support and addressing vulnerabilities
- Fiscal policy (short term):
  - Staff urged additional fiscal stimulus as the primary instrument to bolster aggregate demand given weak conjuncture and downside risks.
  - Authorities’ plans: ensure full execution of the budget and provide off-budget stimulus of KRW 6.5 trillion (close to ½ percent of GDP); staff judged this helpful but not sufficient.
  - Staff suggested a package of about 1 percent of GDP—ideally as a supplementary budget—similar to the 2015 stimulus, to boost growth toward the authorities’ target of 3 percent without threatening debt sustainability. Multipliers are on the order of 0.3.
- Announced fiscal package (June 28):
  - Package of more than KRW 20 trillion (1¼ percent of GDP) to support the economy and employment.
  - Will include a KRW 10 trillion supplementary budget, as well as spending through other channels such as SOEs.
  - The KRW 6.5 trillion in SOE spending announced earlier in the year is part of the package.
  - Package features: larger unemployment benefits; public infrastructure spending and other measures for regions affected by corporate restructuring; increased tax deduction for housing rent; tax incentives for replacement of old diesel cars and purchase of highly energy-efficient home appliances; part of a broader strategy to develop 11 new growth engines.
  - Staff estimate the fiscal package will boost GDP by around 0.3 percent, spread over 2016 and 2017.
  - Government expects measures largely paid for by revenue overperformance (and thus not requiring additional borrowing), but they represent discretionary stimulus.
- Monetary policy:
  - Staff recommended monetary easing; following the BOK’s recent rate cut, a continued supportive stance appears appropriate.
  - Effects and caveats: monetary policy may not provide strong stimulus alone; could create negative wealth effects for deposit holders; could raise chonsei prices and reduce renters’ disposable income; will not address structural factors behind weak investment and exports.
  - Staff saw a case for coordinated fiscal and monetary easing to send a strong signal and boost confidence.
  - Risks to household debt should be addressed via tightening macroprudential policy.
  - Policy rate history and action: after keeping the policy interest rate at 1.5 percent for almost a year, the BOK cut the rate by 25 basis points on June 9.
- Macroprudential and external sector policies:
  - Household debt:
    - Authorities responded with several measures, but the DTI cap of 60 percent remains high in international comparison and should gradually be tightened toward 30 to 50 percent.
    - DTI cap should be extended to other types of household debt (including so-called “group loans”); planned monitoring of a debt-service ratio is welcome.
  - Nonbank credit:
    - Nonbank lending to households grew at a slower rate in 2015 but accelerated in the reporting year; deserves close monitoring because nonbanks cater to less creditworthy customers and face elevated risks.
    - Staff recommended continued harmonization of prudential regulations across banks and nonbanks, including insurance companies, savings banks, and mutual credit cooperatives.
  - Institutional framework:
    - As recommended in the 2013 FSAP, separating macroprudential policymaking from crisis management would increase transparency and accountability and ensure greater independence.
  - Capital flow measures and FX policy:
    - Planned easing of measures aimed at curbing capital inflows is appropriate given reduced pressure of capital inflows as interest differentials narrowed.
    - Exchange rate should be allowed to move flexibly, with intervention limited to disorderly market conditions; publish data on intervention with an appropriate lag could be considered.
    - Planned macroprudential measures such as the FX liquidity coverage ratio can support a flexible exchange rate.

### Authorities’ views on short-term policies
- Authorities agreed macro policies should be supportive.
- Believed earlier announced fiscal measures (expenditure frontloading and SOE spending) would provide more support than staff acknowledged, but were open to further stimulus and later announced the larger package.
- For monetary policy, authorities emphasized timing considerations around possible Fed tightening, risks of capital outflows, and growing household debt; nonetheless, given the weak conjuncture, the BOK eased on June 9.

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

### 37.      There was also broad agreement on staff’s other short-term policy recommendations.

### _cr16278 - 37.      There was also broad agreement on staff’s other short-term policy recommendations.

### Short-term policy agreement
- Authorities agreed on the need to monitor the growth of household debt closely and expected it to moderate in the future as a result of recent measures.
- Authorities agreed on the need to harmonize requirements across banks and nonbanks to contain nonbank credit growth.
- Authorities did not see the need to change the current institutional framework for macroprudential policy and crisis management.
- On external sector policy, the authorities noted that exchange rate flexibility would continue.
- Authorities continued to have concerns that publication of intervention data could lead to speculative moves in the markets; publication remains under consideration in the context of negotiating trade agreements.
- Planned regulatory measure (authorities’ plan): introduce a foreign-currency liquidity coverage ratio (FX LCR) in 2017.
  - Intention: require commercial banks to hold at least 60 percent of their foreign-exchange debt in high-quality liquid assets to withstand a 30-day net cash outflow in case of systemic risk.
  - The required ratio increases gradually to 80 percent by 2019.
  - Foreign bank branches are exempted.
  - Basel III suggests an FX LCR can be a useful monitoring tool and also requires implementation of a general LCR, which Korea implemented in 2015.

### Implications for rebalancing
- Policies described will tend to reduce savings, boost investment, and support growth.
- Examples and mechanisms:
  - Strengthened safety nets will reduce the need for private precautionary saving and boost consumption.
  - Corporate restructuring will, over time, promote increased investment.
  - Measures to boost the birthrate and increase labor-force participation will raise growth.
  - Labor-market reforms will boost productivity.
- Expected external-sector outcome:
  - These steps imply a reduction of Korea’s large current account surplus—but not an elimination, or reversal, of that surplus.
  - Korea’s stock of net foreign assets will continue to grow, albeit more slowly.
  - The exchange rate will need to stay flexible to accommodate this transformation.
- Rebalancing effects:
  - Make the economy more resilient and help sustain Korea’s growth in a world of slowing trade.
  - Help make the global economy less vulnerable, benefiting an open economy like Korea.

### Authorities’ views
- Authorities saw the increase in the current account surplus as a temporary phenomenon and agreed that rebalancing would be beneficial.
- Agreed contributors to the large current account surplus:
  - Terms-of-trade gains.
  - Weak domestic demand.
  - Korea-specific factors, such as the country’s particular demographic profile and the fiscal challenge of possible future reunification with North Korea.
- Authorities agreed that narrowing of the surplus from its current level would be desirable.
- Authorities agreed on the importance of exchange rate flexibility but emphasized that the current account surplus is unrelated to a weak exchange rate.

### Staff appraisal and policy recommendations
- Macro context and challenges:
  - Korea has made remarkable economic progress over the past sixty years, but potential growth has slowed and inequality and poverty are areas of concern.
  - Major structural headwinds: rapid population aging; a heavy reliance on exports; corporate vulnerabilities; labor market distortions; and lagging productivity, particularly in the service sector and among SMEs.
  - Staff strongly support the priority placed by Korean authorities on structural reforms.
- Corporate sector and social safety net:
  - Staff commend authorities for focus on corporate restructuring.
  - Urgent implementation urged for financial and operational restructuring of distressed firms, while ensuring an adequate social safety net to assist affected workers.
  - Authorities praised for proactively arranging to safeguard policy banks’ capital positions; fiscal policy should play the lead role in this process.
- Fiscal policy stance:
  - Given Korea’s low public debt, there is space to use fiscal policy in a complementary fashion.
  - Fiscal support can incentivize structural reforms and cushion possible adverse effects.
  - A carefully targeted expansion of social expenditure, sustained over the medium term, could reduce poverty and inequality, bolster consumption-led growth, and contribute to financial stability.
  - Increased spending would need to be matched by eventual revenue increases given long-term fiscal pressures from population aging.
  - Authorities could formalize commitment to such measures, and to fiscal sustainability overall, by introducing fiscal rules.
- Macro and macroprudential policy stance:
  - Given the weak conjuncture and downside risks, macroeconomic policies should remain supportive.
  - Authorities have been proactive: recently announcing a new fiscal stimulus and cutting the policy rate—both described as appropriate.
  - Fiscal package should be finalized and implemented as soon as possible; going forward, macro policy stance should remain supportive.
  - Macroprudential standards should be tightened, and harmonized across banks and nonbanks, to contain risks.
  - Exchange rate should continue to be allowed to move flexibly, with intervention limited to addressing disorderly market conditions.
  - Note: Most advanced economies also publish intervention data, with an appropriate lag.
- Rebalancing outlook reiterated:
  - Many policies will tend to reduce savings, boost investment, and support growth.
  - Korea’s large current account surplus will moderate slowly over time.
  - The economy will be able to rebalance away from weak and volatile external demand.
  - The exchange rate will need to be flexible to accommodate the transformation and to help the economy weather external shocks.

*Source: _cr16278 - 37.      There was also broad agreement on staff’s other short-term policy recommendations.*

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

### _cr16278 - 45.      Staff recommend that the next Article IV consultation be held on the standard 12-month cycle.

### Structural Issues
- Korea’s economy relies more heavily on exports than other advanced economies do.
- The speed of aging is one of the highest in the world.
- The share of temporary workers in Korea is double the OECD average.
- Female labor force participation is below the OECD average, and more so for women aged35-44.
- Labor productivity in the service sector is only about half of what it is in manufacturing.
- Corporate performance is weak, especially in some sectors.
- Non-Regular Employment by Type in 2013 (In percent of total employment): chart categories shown but preserve source: Organization for Economic Cooperation and Development (OECD).
- Labor Participation of Female in 2014: Korea and OECD (Percent): age bands 15-24, 25-34, 35-44, 45-54, 55-64, 65+ compared (Korea vs OECD).
- Productivity in the Service Sector Relative to Manufacturing (Manufacturing=100): data span 2007–2015 with Developed Asia / Emerging Asia / country markers including Korea.
- Corporate Sector Interest Coverage Ratio 1/ (25th percentile): interest coverage defined as ratio of EBIT to interest payments — Korea compared with other countries.

### The Real Economy
- Growth has been weak, especially after shocks in 2014 and 2015.
- Nominal imports and exports contracted sharply, although volumes held up somewhat better.
- The manufacturing PMI has rebounded somewhat.
- Retail sales have improved, while consumer sentiment remains weak.
- Inflation has been well below the BOK’s target; annual wage growth has been weak.
- Selected series and indices (preserved as in source):
  - Retail Sales Index base: 2014M1=100.
  - CSI: Expectations of Domestic Economic Situations (neutral=50).
  - Wage (In percent, yoy) and Employment rate (In percent, RHS).
  - Inflation series: Headline and Core (monthly series Jan-2011 to May-2016).
  - Industrial Production Index (Base: 2014M1=100) and Purchasing Managers Index (Manufacturing Output SA, 50+=Expansion).
  - Contributions to GDP Growth (2013Q1–2016Q1): Consumption, Investment, Stockbuilding and Other, External Demand.
- Table 1: Korea: Selected Economic Indicators, 2012–17 (selected figures preserved):
  - Real GDP (percent change): 2012: 2.3; 2013: 2.9; 2014: 3.3; 2015: 2.6; 2016: 2.7; 2017: 3.0.
  - Nominal GDP (in trillions of won): 2012: 1,377; 2013: 1,429; 2014: 1,486; 2015: 1,559; 2016: 1,622; 2017: 1,697.
  - CPI inflation (end of period): 2012: 1.4; 2013: 1.1; 2014: 0.8; 2015: 1.3; 2016: 1.5; 2017: 2.2.
  - Current account balance (in percent of GDP): 2012: 4.2; 2013: 6.2; 2014: 6.0; 2015: 7.7; 2016: 7.5; 2017: 6.5.

### Monetary and Financial Sector
- Household lending from non-bank financial institutions has been increasing rapidly.
- Credit growth to firms remains weak, albeit with some recent recovery.
- The banking sector remains sound; interest rates remain at historical lows.
- Household debt is sizable, but has not reached the highs of some other advanced economies.
- Banks’ short-term external debt remains below pre-GFC levels.
- Key indicators and series (preserved):
  - Y/Y growth in credit from depository corporations and from other financial corporations (quarterly series Q4-2005 to 2015).
  - Share of credit from other financial institutions in total credit to households (RHS).
  - Credit to Corporations (y-o-y growth, percent) series Q1-2006 to Q3-2015.
  - Banking Indicators (In percent) series 2010Q1–2016Q1: Total Loan to Deposit Ratio, Nonperforming Loans/Total Assets (in percent), Capital Adequacy Ratio.
  - Household Debt, 2014 (In percent of disposable income): country comparisons where Korea sits among peer advanced economies.
  - Share of Short-Term External Borrowing: Domestic Banks (USD, bn) and Foreign Banks (USD, bn) with Share of Banks in Gross ST External Borrowing (In percent, RHS).
  - Interest Rate series (In percent): 3-yr KTB, Bank Lending Rate (CSBs newly extended), Policy Rate (2010M1–2016M4).

### External Sector
- Korea experienced moderate capital outflows in late 2015 and early 2016.
- Portfolio net flows turned negative after the “RMB” tantrum.
- The current account surplus reached record highs as oil imports shrank.
- In recent months the won depreciated against the Japanese yen and the US dollar.
- In spite of the sizable current account surplus, reserve accumulation was moderate.
- Key series and facts (preserved):
  - Trade Balance and Oil Imports (In percent of GDP) 2009–2015.
  - Capital Flows (in billions of U.S. dollars): Private Capital Outflows by Residents and Private Capital Inflows by Non-residents (2012Q1–2016Q1).
  - EPFR Mutual Funds and ETF Flows (Equity Flows and Bond Flows in billions of U.S. Dollars): daily markers from 1-Jan-14 to 1-Jun-16.
  - Current Account Balance (In billions of U.S. dollars) 2010Q1–2016Q1 with components: Trade Balance, Service Balance, Other Current Account.
  - Exchange Rates (Jan. 2013=100): WON/USD, WON/100YEN, REER (2013M1–2016M4).
  - Changes in FX Reserves versus Real Effective Exchange Rate Movements against U.S. Dollar: percentage changes between March 2015 and March 2016 for a set of economies including KOR.

### Projections and Medium-Term Outlook
- Table 2. Korea: Medium-Term Projections, 2014–2021 (selected figures preserved):
  - Real GDP (percent change) by year: 2014: 3.3; 2015: 2.6; 2016: 2.7; 2017: 3.0; 2018: 3.1; 2019: 3.0; 2020: 3.0; 2021: 3.0.
  - Consumer price (period average, percent change): 2014: 1.3; 2015: 0.7; 2016: 1.2; 2017: 1.9; 2018: 2.0; 2019: 2.0; 2020: 2.0; 2021: 2.0.
  - Credit growth 2/ (Depository corporations credit to private sector): 2014: 7.4; 2015: 7.6; 2016: 6.7; 2017: 6.5; 2018: 6.1; 2019: 5.9; 2020: 5.9; 2021: 5.9.
  - Current account balance (in percent of GDP): 2014: 6.0; 2015: 7.7; 2016: 7.5; 2017: 6.5; 2018: 5.9; 2019: 5.8; 2020: 5.6; 2021: 5.2.
  - Nominal GDP (in trillions of won) projections: 2014: 1,486; 2015: 1,559; 2016: 1,622; 2017: 1,697; 2018: 1,779; 2019: 1,868; 2020: 1,960; 2021: 2,058.
- Table 3. Korea: Balance of Payments, 2012–17 (selected figures preserved):
  - Current account balance (in billions of U.S. dollars): 2012: 50.8; 2013: 81.1; 2014: 84.4; 2015: 105.9; 2016: 103.6; 2017: 93.1.
  - Exports (f.o.b., in billions of U.S. dollars): 2012: 603.5; 2013: 618.2; 2014: 613.0; 2015: 548.8; 2016: 521.5; 2017: 541.9.
  - Imports (f.o.b., in billions of U.S. dollars): 2012: 554.1; 2013: 535.4; 2014: 524.1; 2015: 428.5; 2016: 398.1; 2017: 423.7.
  - Gross reserves minus gold (in billions of U.S. dollars): 2012: 323.2; 2013: 341.7; 2014: 358.8; 2015: 363.2; 2016: 350.9; 2017: 334.8.

### Fiscal and Public Finances
- Table 4. Korea: Statement of Central Government Operations, 2012–17 (selected figures preserved, in trillions of won and percent of GDP):
  - Revenue (trillion won): 2012: 304.7; 2013: 308.0; 2014: 315.0; 2015: 332.6; 2016: 356.1; 2017: 367.5.
  - Tax revenue (trillion won): 2012: 203.0; 2013: 201.9; 2014: 205.5; 2015: 217.9; 2016: 236.7; 2017: 247.7.
  - Expenditure (trillion won): 2012: 283.2; 2013: 298.7; 2014: 308.8; 2015: 327.3; 2016: 342.5; 2017: 349.9.
  - Net lending (+) / borrowing (-) (trillion won): 2012: 21.5; 2013: 9.3; 2014: 6.2; 2015: 5.3; 2016: 13.6; 2017: 17.6.
  - Overall balance (trillion won): 2012: 18.5; 2013: 14.2; 2014: 8.5; 2015: -0.2; 2016: 4.8; 2017: 8.8.
  - Overall balance excluding Social Security Funds (percent of GDP): 2012: -1.3; 2013: -1.5; 2014: -2.0; 2015: -2.4; 2016: -2.3; 2017: -2.0.
  - Central government debt (trillion won): 2012: 425.1; 2013: 464.0; 2014: 503.0; 2015: 556.5; 2016: 593.6; 2017: 628.0.
  - General government debt (in percent of GDP): 2012: 32.2; 2013: 34.3; 2014: 35.9; 2015: 37.9; 2016: 38.7; 2017: 39.0.

### Financial Soundness Indicators
- Table 5. Korea: Financial Soundness Indicators (selected figures preserved):
  - Credit to Private Sector (growth rate, in percent): 2010: 4.9; 2011: 6.8; 2012: 3.7; 2013: 3.2; 2014: 7.4; 2015: 7.6.
  - Loans to Households (growth rate, in percent): 2010: 8.1; 2011: 8.5; 2012: 5.2; 2013: 6.0; 2014: 6.7; 2015: 11.0.
  - Bank Loans to Households (growth rate, in percent): 2010: 5.4; 2011: 5.7; 2012: 2.5; 2013: 3.0; 2014: 8.0; 2015: 8.5.
  - Regulatory Capital to Risk-Weighted Assets 2/: 2010: 14.3; 2011: 14.0; 2012: 14.3; 2013: 14.5; 2014: 14.2.
  - Regulatory Tier 1 Capital to Risk-Weighted Assets: 2010: 11.3; 2011: 10.7; 2012: 11.1; 2013: 11.4; 2014: 11.7.
  - Non-performing Loans to Total Gross Loans: 2010: 0.6; 2011: 0.5; 2012: 0.6; 2013: 0.6; 2014: 0.6.
  - Return on Assets and Return on Equity: 2010–2015 series shown (e.g., Return on Assets 2010: 0.7; 2011: 1.0; 2012: 0.7; 2013: 0.3; 2014: 0.6).

*Republic of Korea — INTERNATIONAL MONETARY FUND (content unit as provided).*

### Annex I. Korea—Debt Sustainability Analysis

### Annex I. Korea—Debt Sustainability Analysis

### Debt levels and market indicators
- Nominal gross public debt (percent of GDP): 2013: 28.0; 2014: 32.5; 2015: 33.9; 2016: 35.7; 2017: 36.6; 2018: 37.0; 2019: 36.8; 2020: 35.8; 2021 (projection row ends at 2020): 34.8.
- Public gross financing needs (percent of GDP): 2013: 5.4; 2014: 6.0; 2015: 6.7; 2016: 7.4; 2017: 7.6; 2018: 7.4; 2019: 6.7; 2020: 5.7; 2021: 5.7.
- Sovereign spread indicators (as reported): EMBIG (bp): -4; 5Y CDS (bp): 64.
- Ratings (foreign / local): Moody’s: Aa2 / Aa2; S&Ps: AA- / AA-; Fitch: AA- / AA.
- Effective interest rate (interest payments divided by debt stock, percent): 2013: 4.5; 2014: 3.1; 2015: 3.0; 2016: 2.8; 2017: 4.2; 2018: 5.1; 2019: 5.1; 2020: 4.8; 2021: 5.9.

### Growth, inflation, and nominal GDP growth
- Real GDP growth (percent): 2013: 3.9; 2014: 2.9; 2015: 3.3; 2016: 2.6; 2017: 2.7; 2018: 2.9; 2019: 3.1; 2020: 3.0; 2021: 3.0.
- Inflation (GDP deflator, percent): 2013: 2.1; 2014: 0.9; 2015: 0.6; 2016: 2.2; 2017: 1.5; 2018: 1.7; 2019: 1.7; 2020: 1.7; 2021: 1.8.
- Nominal GDP growth (percent): 2013: 6.1; 2014: 3.8; 2015: 4.0; 2016: 4.9; 2017: 4.2; 2018: 4.6; 2019: 4.8; 2020: 4.8; 2021: 4.9.

### Contributions to changes in public debt (percent of GDP)
- Change in gross public sector debt, cumulative: 2013: 1.3; 2014: 1.6; 2015: 1.4; 2016: 1.9; 2017: 0.9; 2018: 0.4; 2019: -0.2; 2020: -0.9; 2021: -1.1; cumulative: 0.9.
- Identified debt-creating flows: 2013: -0.1; 2014: 2.9; 2015: 2.5; 2016: 2.5; 2017: 1.2; 2018: 0.7; 2019: 0.0; 2020: -0.7; 2021: -0.7; cumulative: 2.9.
  - Primary deficit (percent of GDP): 2013: -0.1; 2014: 1.2; 2015: 1.6; 2016: 2.2; 2017: 1.2; 2018: 0.5; 2019: -0.1; 2020: -0.7; 2021: -1.0; cumulative: 2.0.
  - Primary (noninterest) revenue and grants (percent of GDP): 2013: 17.4; 2014: 16.5; 2015: 16.2; 2016: 16.3; 2017: 16.3; 2018: 16.1; 2019: 16.1; 2020: 16.1; 2021: 16.1; cumulative: 97.0.
  - Primary (noninterest) expenditure (percent of GDP): 2013: 17.3; 2014: 17.7; 2015: 17.8; 2016: 18.4; 2017: 17.5; 2018: 16.6; 2019: 16.0; 2020: 15.4; 2021: 15.1; cumulative: 99.0.
- Automatic debt dynamics (percent of GDP): 2013: -0.4; 2014: -0.2; 2015: -0.3; 2016: -0.7; 2017: 0.0; 2018: 0.2; 2019: 0.1; 2020: 0.0; 2021: 0.3; cumulative: -0.1.
  - Interest rate/growth differential (percent of GDP): same series as automatic dynamics: -0.4; -0.2; -0.3; -0.7; 0.0; 0.2; 0.1; 0.0; 0.3; cumulative: -0.1.
    - Real interest rate contribution (percent of GDP): 2013: 0.6; 2014: 0.7; 2015: 0.8; 2016: 0.2; 2017: 0.9; 2018: 1.2; 2019: 1.2; 2020: 1.1; 2021: 1.4; cumulative: 5.9.
    - Real GDP growth contribution (percent of GDP): 2013: -1.0; 2014: -0.9; 2015: -1.0; 2016: -0.8; 2017: -0.9; 2018: -1.0; 2019: -1.1; 2020: -1.1; 2021: -1.0; cumulative: -6.0.
  - Exchange rate depreciation (percent of GDP): 2013: 0.0; 2014: 0.0; 2015: 0.0; 2016: ... ; (ellipsis in source).
- Other identified debt-creating flows (percent of GDP): 2013: 0.4; 2014: 1.9; 2015: 1.1; 2016: 1.0; 2017: 0.0; 2018: 0.0; 2019: 0.0; 2020: 0.0; 2021: 0.0; cumulative: 1.0.
- General government debt — change (funding for reserve build up) (percent of GDP): 2013: 0.4; 2014: 1.9; 2015: 1.1; 2016: 1.0; 2017: 0.0; 2018: 0.0; 2019: 0.0; 2020: 0.0; 2021: 0.0; cumulative: 1.0.
- Residual, including asset changes (percent of GDP): 2013: 1.4; 2014: -1.3; 2015: -1.1; 2016: -0.6; 2017: -0.3; 2018: -0.3; 2019: -0.2; 2020: -0.2; 2021: -0.3; cumulative: -2.0.

### Scenarios and baseline assumptions
- Baseline scenario (selected underlying assumptions, percent where indicated):
  - Real GDP growth (2015–2020): 2015: 2.6; 2016: 2.7; 2017: 2.9; 2018: 3.1; 2019: 3.0; 2020: 3.0.
  - Inflation (GDP deflator, 2015–2020): 2015: 2.2; 2016: 1.5; 2017: 1.7; 2018: 1.7; 2019: 1.7; 2020: 1.8.
  - Primary balance (percent of GDP, 2015–2020): 2015: -2.2; 2016: -1.2; 2017: -0.5; 2018: 0.1; 2019: 0.7; 2020: 1.0.
  - Effective interest rate (percent, 2015–2020): 2015: 2.8; 2016: 4.2; 2017: 5.1; 2018: 5.1; 2019: 4.8; 2020: 5.9.
- Historical scenario (comparison):
  - Real GDP growth (2015–2020): 2015: 2.6; 2016: 3.7; 2017: 3.7; 2018: 3.7; 2019: 3.7; 2020: 3.7.
  - Primary Balance (2015–2020): -2.2; -0.4; -0.4; -0.4; -0.4; -0.4.
  - Effective interest rate (2015–2020): 2.8; 4.2; 5.1; 5.0; 4.6; 5.7.
- Constant Primary Balance Scenario:
  - Primary Balance held constant at -2.2 (2015–2020).
  - Real GDP growth and inflation follow baseline projections.
  - Effective interest rate sequence: 2.8; 4.2; 5.1; 5.0; 4.7; 5.7.

### External position and sustainability assessment
- Net international investment position (NIIP): increased to 14½ percent of GDP in 2015; projected to strengthen to 19½ percent of GDP in 2016.
- Net external debt position: -23½ percent of GDP in 2015.
- Banks’ short-term external debt: remains below pre-crisis levels; bulk of short-term external debt held by exporters who hedge with forwards, limiting currency-mismatch risk.
- Current account (CA):
  - CA in 2015: around 7¾ percent of GDP, 1½ p.p. higher than in 2014.
  - EBA cyclically adjusted CA for 2015: 7.1 percent; EBA norm: 1¼ percent; EBA gap: 6 percent.
  - Staff-assessed CA gap range for 2015: 1¾ to 4¼ percent of GDP (accounts for Korea-specific factors such as prospective reunification costs, demographic factors, and BPM6 treatment of foreigners’ retained earnings).
  - CA expected to decline moderately over the medium term as output gap narrows and population aging proceeds.
- Real effective exchange rate (REER):
  - Won appreciated on a trade-weighted basis since 2012; appreciated by 1½ percent in 2015 relative to 2014 average.
  - REER as of April 2016: depreciated by 2 percent from 2015 average.
  - EBA REER regressions give wide range: index model suggests won stronger by 1½ percent; level model suggests won weaker by 14¼ percent.
  - Staff assesses REER for 2015 to be 4 to 12 percent weaker than level consistent with fundamentals and desired policies (range based on EBA level model/top and staff elasticity/bottom).
  - Staff notes high uncertainty in REER assessment due to inelastic short-run export response to exchange rates and diverse model estimates.
- Capital and financial accounts:
  - Net capital outflows in 2015: 8 percent of GDP, driven chiefly by decreased non-resident portfolio investment since 2014.
  - Government initiatives (mid-2015) to promote residents’ overseas investment and attract nonresident inflows.
  - Assessment: moderate capital-flow volatility has occurred, but net and gross flows appear sustainable.
- Reserves and FX intervention:
  - Korea maintains a floating exchange rate.
  - Reserves increased from 2009 through mid-2014 and have since remained stable at around 121 percent of the IMF’s composite reserve adequacy metric.
  - In dollar terms, reserves increased by $4 billion in 2015.
  - Assessment: reserves sufficient to buffer external shocks; intervention should be limited to smoothing excessive volatility.

### Policy conclusions and recommendations
- Near-term policies to boost domestic demand:
  - Build domestic demand growth momentum to help reduce external imbalances.
  - Recent monetary, fiscal, and other steps to boost domestic demand are steps in the right direction.
  - More durable reduction in imbalances requires a shift away from heavy reliance on manufacturing exports—raise productivity in the non-traded sector through structural reforms, particularly labor market reforms.
  - Expansionary fiscal stance (this year and over the medium term) could narrow imbalances, especially if coupled with an expanded social safety net to reduce precautionary savings.
- Exchange rate policy:
  - Real exchange rate appreciation should play a role over time.
  - Exchange rate should remain market determined with intervention limited to smoothing excessive volatility.
- External-risk management:
  - FX intervention limited to disorderly market conditions; maintain adequate reserves.
  - Use fiscal easing, monetary easing, and exchange rate flexibility to respond to adverse global shocks; ease capital flow measures (CFMs) aimed at curbing inflows when appropriate.
- Structural and fiscal measures to enhance resilience:
  - Structural reforms to increase productivity in non-traded sectors, reduce labor market duality, and boost labor force participation.
  - Expand social safety net to lower precautionary savings and support domestic demand.
  - Continue diversification of export markets and manufacturing base to reduce vulnerability to shocks in major trading partners.

### Key risks identified (selected)
- Global risks: tighter or more volatile global financial conditions; surge in the U.S. dollar; hard landing in China; slowdowns in other large EMs/frontier economies; structurally weak growth in key advanced and emerging economies.
- Domestic risks: rebound in private consumption failing to materialize; disorderly corporate restructuring; sharp deterioration in housing market; relationship with North Korea.
- Typical policy responses recommended across risks: fiscal easing, monetary easing, exchange rate flexibility with limited FX intervention, macroprudential tightening where needed, structural reforms, and targeted fiscal support including safety-net reforms.

*Source: IMF staff (Annex I. Korea—Debt Sustainability Analysis, as of April 30, 2016).*

### 2.      Directors welcomed the monetary, fiscal, and other policy changes that the authorities

### 2.      Directors welcomed the monetary, fiscal, and other policy changes that the authorities implemented to reinvigorate domestic demand

### Policy assessment and authorities’ response
- Directors welcomed monetary, fiscal, and other policy changes implemented to reinvigorate domestic demand.
- Directors agreed there remained room for further monetary easing, if needed.
- Directors noted Korea’s low public indebtedness provided ample room for additional fiscal stimulus and a strengthening of social safety nets.
- Given the weak conjuncture and downside risks, authorities responded proactively with measures to spur economic recovery:
  - In 2015, a supplementary budget introduced stimulus of about 1 percent of GDP.
  - In 2016, the authorities frontloaded spending within the year, extended tax cuts, and most recently announced a 1¼ percent of GDP stimulus package.
  - The Bank of Korea cut its policy interest rate by 50 basis points over the past year.
  - Household debt management measures implemented: more stringent bank loan application screening, accelerating the loan conversion program, and tighter LTV limits on nonbanks’ nonresidential mortgages.
  - Plans to unwind some earlier macroprudential measures aimed at curbing capital inflows.
  - Progress on corporate restructuring, especially in the shipbuilding and shipping industries.
  - Government issued policy guidance aimed at reducing labor market rigidities.

### Structural concerns and medium-term adjustment
- Directors emphasized that Korea’s ability to continue growing through heavy reliance on gaining export market share is increasingly limited.
- Achieving a more balanced growth path depends critically on addressing long-standing barriers to higher productivity in the non-traded goods and services sectors.
- Directors noted the structure of household debt could be strengthened through additional steps to facilitate the transition of the mortgage market toward more stable, longer-term lending.
- Directors stressed that maintaining a flexible exchange rate is essential to facilitate Korea’s adjustment toward domestic sources of growth; official foreign exchange intervention should be limited to preventing disorderly market conditions and not prevent needed exchange rate adjustment.

### Key statistics and fiscal/monetary space (from policy discussion)
- Stimulus in 2015: about 1 percent of GDP.
- Stimulus package announced: 1¼ percent of GDP.
- Bank of Korea policy rate cuts: 50 basis points over the past year.

---

### Annex V. Korea’s Challenges—Parallels with Japan

### A. Structural issues and balance sheets
- Theme: Parallels between Korea and Japan primarily in rapid aging, slowing growth, and low inflation; Korea has stronger corporate and public balance sheets than Japan did.
- Demographics:
  - Japan: working-age population ratio peaked at 63 percent in 1995 and declined to about 56 percent in 2015.
  - Korea: working-age population ratio is projected to peak at 66½ percent in 2017, and then fall quickly to 56 percent in less than 20 years.
  - Japan’s population started to contract in 2010; Korea’s population is expected to begin its decline in 2025–35.
  - Working-age population defined as share of population aged 20–64 in total population; projections based on United Nations “medium variant scenario.”
- Potential growth:
  - Japan: potential growth plunged from an average 4 percent in the late 1980s to less than 1 percent in the 2000s.
  - Korea: potential growth dropped from a record high of 8 percent in 1991 to below 3 percent in 2015.
  - Drivers: declines in labor contributions, capital inputs, and productivity; slow restructuring and balance sheet repair contributed to productivity slowdown.
- Productivity:
  - Korea: labor productivity rose at an annual rate of 4.6 percent in 1995-2001, but remains only 40 percent of that of the three most productive OECD countries.
  - In Korea, labor productivity in the service sector is only half what it is in manufacturing.
  - Japan: labor productivity about half that of frontier OECD economies; service sector productivity increased by 25 percent since 1970 while manufacturing roughly tripled.
- Labor market segmentation:
  - Japan: share of non-regular workers grew from 20 percent in the early 1990s to 35 percent.
  - Korea: share of temporary workers was nearly 22 percent in 2014, double the OECD average.
- Balance sheets:
  - Japan: corporate debt over 140 percent of GDP in the 1990s; corporate debt just over 100 percent of GDP in 2015 after deleveraging.
  - Korea: current corporate debt to GDP ratio is just over 100 percent of GDP; certain sectors (shipbuilding, shipping, petrochemicals) need restructuring.
  - Household debt:
    - Japan: household debt to GDP ratio fairly steady at 65–70 percent.
    - Korea: household debt rose from 40 percent of GDP in the early 1990s to nearly 90 percent of GDP today.
  - Public debt:
    - Japan: public debt to GDP ratio rose from 70 percent in 1990 to over 250 percent in 2015.
    - Korea: public debt less than 40 percent of GDP in 2015; authorities project it could reach 60 percent of GDP by 2060 on account of population aging (or even higher if growth slows, or if fiscal outlays related to possible future reunification are considered).
  - Policy implication: Korea’s stronger public-sector balance sheets provide space to use fiscal policy to incentivize structural reforms and cushion short-run negative effects.

### B. Inflation and aging
- Recent inflation patterns:
  - Korea’s average headline inflation plunged from 4 in 2011 to 1.3 percent in 2013, remaining around 1–1.5 percent since then, and below the authorities’ target since late 2012.
  - Movements in Korea’s headline inflation since January 2011 appear similar to Japan in the early 1990s (Japan: inflation slid from nearly 4 percent in early 1991 to 1 percent in 1993, then negative by 1995).
- Differences versus Japan:
  - Korea’s core inflation remained around 2 percent in 2014 and 2015, with some moderation in early 2016; declining fuel and energy prices explain the positive differential between core and headline inflation over this period.
  - In Japan, core inflation was lower than headline inflation in the early 1990s and then followed headline down.
  - Korea: share of consumption items with negative inflation rose from less than 20 percent in 2012–13 to nearly 40 percent in mid-2015, and includes almost exclusively fuel-related items.
  - Japan: fraction of the consumption basket with negative inflation rose from less than 10 percent in 1990–91 to 50 percent at end-1995 and comprised items from several different product groups.
- Demographics and inflation:
  - Aging could affect inflation by changing relative prices (e.g., land) and by discouraging demand for investment as lower labor supply and productivity depress potential output and real rates of return.
  - Empirical studies cited assess aging effects on Japan’s inflation (Katagiri, 2012; Shirakawa, 2012; Anderson, Botman and Hunt, 2014).

### Econometric analysis and quantitative findings
- Methodology:
  - A modified Phillips-curve model estimated that includes aging among explanatory variables.
  - Dependent variable: annual average inflation.
  - Regressors include expected inflation, domestic output gap, world oil price changes, and the old-age dependency ratio; population growth included in some specifications; indicators of globalization also included.
  - Most parameters allowed to vary across countries; coefficients on demographic and globalization indicators assumed constant.
  - Sample: 12 large advanced economies and China.
  - Estimation period: 1990–2015; technique: Seemingly Unrelated Regressions.
- Model findings:
  - The cumulative change in Korea’s inflation over 2012–15 (3.3 percentage points) is almost fully explained by expected inflation, the output gap, world oil price changes, and the old-age dependency ratio.
  - The increase in the old-age dependency ratio is estimated to have lowered inflation by nearly 0.2 percentage points over 2012–15.
  - Comparison Japan vs Korea:
    - Historically, changes in the old-age dependency ratio have been more disinflationary in Japan than in Korea.
    - Going forward, aging will exert more disinflationary pressure in Korea because Japan has already aged while Korea’s aging will accelerate.
  - Projection from estimates:
    - Aging could contribute to a further decline in the inflation rate by 0.3 percentage points over the next five years.

### C. Conclusions and policy implications
- Main conclusions:
  - The speed of population aging, prospects of a declining population, and lagging productivity due to structural problems are the main ways in which Korea resembles Japan.
  - Compared to Japan, Korea is entering accelerating aging with stronger corporate and public sector balance sheets, but needs to progress with restructuring of nonviable firms.
  - Japan’s experience shows delayed balance-sheet repair compounded with structural problems can lead to protracted stagnation.
- Policy recommendations and priorities:
  - Ensure expeditious recognition of NPLs and strengthen balance sheets to avoid prolonged financial fragility.
  - Implement reforms to reduce labor market duality and promote more competition and productivity gains in the service sector to support productivity given a shrinking workforce.
  - Central bank action and inflation monitoring:
    - Korea has low inflation but does not appear to be headed toward deflation.
    - Given possible downward pressure on inflation from aging, the central bank must closely monitor inflation expectations and act decisively should expectations start to trend down consistently.
  - Structural reforms to raise the fertility rate could help reduce deflationary pressure from aging.
  - Use fiscal space (given modest public debt) to incentivize essential structural reforms and cushion short-run negative effects of aging and weak demand.

*Source: IMF staff report excerpt (Annex V and paragraph 2–5 summary) contained in the provided content.*

### Annex VI. Korea—Quantifying the Impact of

### Annex VI. Korea—Quantifying the Impact of China’s Rebalancing on Korea

### Model and calibration
- Multi-country, multi-sector Ricardian trade model (generalization of Caliendo and Parro (2015); follows Eaton and Kortum (2002)).
- Calibrated to fit trade flows and input-output structure of production in 2011 across 40 economies and the rest of the world, with each economy consisting of 34 traded and nontraded sectors.
- Model solved in changes from the base year of 2011, following Deckle et al. (2012).
- Key limitations explicitly noted:
  - Excludes trade in services (may understate benefits to Korean service exports from rising Chinese household income).
  - One-period model (does not capture dynamic adjustment frictions and transition costs).
  - Policy responses to scenarios are not considered.

### Scenarios analyzed
- Scenario 1 (preference shock): China consumes more and moves away from investment (full shift of China’s final demand to match that of the U.S. is assumed for this scenario).
- Scenario 2 (move-up-the-value-chain shock): China becomes more competitive in higher-tech manufacturing (illustrative productivity shock of 1 percent used in baseline experiments; sensitivity analysis performed).
- Scenario 3 (services-manufacturing rebalancing shock): China’s services sector outperforms manufacturing (also modeled as increased productivity in nontraded and decreased in traded sectors).

### Main cross-cutting findings
- Korea is particularly vulnerable to China moving up the value chain (Scenario 2).
- Scenario 2 generates the most adverse spillovers to Korea as long as the underlying productivity shock is more than 3 percent.
- Many adverse effects across scenarios are driven mostly by changes in terms of trade (ToT) rather than volume of trade (VoT).
- The model focuses on trade-channel spillovers and value-chain changes; other channels (notably services demand) are not captured and could offset some negative effects.

### Scenario-specific quantitative outcomes (selected)
- Scenario 1 (preference shift toward consumption in China)
  - Korea: income contraction of 0.25 percent.
  - Korea: real wages and imports from China contract; exports to China remain broadly unchanged.
  - Taiwan POC: income falls by 0.47 percent (more adversely affected than Korea).
  - Adverse effects largely attributable to ToT rather than VoT.

- Scenario 2 (China moves up the value chain; illustrative productivity shock)
  - Korea and Taiwan POC: real incomes falling by 0.08 (reported as 0.08 in text; tables show negative changes).
  - Income and real wages decline across all large countries except Australia and the U.S.
  - Relatively small changes in China’s position in the value chain can generate materially adverse spillovers to Korea.
  - Sensitivity: Scenario 2 spillovers become most adverse when productivity shock exceeds 3 percent.

- Scenario 3 (services outperformance / increased nontraded productivity in China)
  - Effects concentrated domestically in China; spillovers to other large countries are modest.
  - Korea: modest positive change reported in scenario tables (income change shown as 0.04 in scenario table).

### Additional model outputs (structure and diagnostics)
- Sectoral reallocation and export-share changes across detailed sectors (34 sectors) reported in tables for China, Korea, Japan, Taiwan POC, Germany, USA, Australia and others.
- Normalized Herfindahl indices and before/after export shares by sector are provided in the source tables to illustrate concentration and reallocation patterns.

*Source: IMF staff calculations presented in Annex VI of the Korea country chapter (prepared by Rui C. Mano).*

### 2.      As a consequence of the global growth slowdown, earnings of Korean manufacturing

### 2.      As a consequence of the global growth slowdown, earnings of Korean manufacturing

### Export dependence and recent earnings trends
- Korea is an export-oriented economy; the share of export in GDP is about 50 percent.
- Average export revenue share across manufacturing is about 50 percent; in export-oriented industries (shipbuilding, petroleum, electronics, automobiles, and steel) it is on average 65 percent.
- Earnings in export-oriented manufacturing held up until 2013, but took a dive in 2014. The report expects further deterioration once 2015 data are available.
- Since 2011, the EBIT of Korean manufacturing firms has on average declined by about 3.5 – 4.5 percent annually.

### Earnings and debt vulnerability
- The share of firms with interest coverage ratio (ICR) < 1.5 has been relatively stable, if high, since the GFC.
- Export-oriented manufacturers were historically healthier, but their financial conditions were severely affected by the earnings decline in 2014.
- Construction, shipping, and services have also suffered deteriorating profitability and high corporate debt vulnerabilities. For these debt-intensive industries, vulnerability is defined as ICR < 1.
- As of end-2014 (Orbis aggregation):
  - Total debt in vulnerable firms (ICR < 1.5, or ICR < 1 in construction and shipping) was KRW 400 trillion, or 28 percent of GDP.
  - Total employment in those firms was 1.8 million, or 6.5 percent of the labor force.
- Counterfactual analysis: the Bank of Korea’s easing lowered debt service costs; without cuts from 3¼ percent in 2012 to 2 percent in 2014 (implying 60 percent higher interest costs fully passed to firms), the share of vulnerable firms would have been higher.

### Stress-testing corporate debt — model and elasticities
- Time-series OLS regressions for 2006–14 link aggregate EBIT growth of Korean manufacturing with changes in:
  - global GDP growth,
  - global trade growth,
  - China imports growth.
- Estimated elasticities (interpretation: change in Korean manufacturing EBIT growth when the global variable accelerates by 1 percentage point):
  - Change in the growth rate of global GDP: 1.428 (column 1)
  - Change in the growth rate of global trade: 0.366 (column 2)
  - Change in the growth rate of China imports: 0.451 (column 3)
- Alternative phrasing in text: EBIT growth increased by 1.4 percent when global GDP growth accelerated by 1 percentage point, by 0.37 percent when global trade growth accelerated by 1 percentage point, and by 0.45 percent when China imports growth accelerated by 1 percentage point.

### Stress-test scenarios and implied outcomes
- Two scenarios formulated using WEO projections and historical severe shocks:
  - Mild/baseline scenario (WEO 2016 central projections for 2015–2018):
    - Global GDP growth accelerates by 0.2 percentage points annually (from 2.4 to 3.0 percent).
    - Global trade growth accelerates by 0.43 percentage points annually (from 2.0 to 4.1 percent).
    - China imports growth accelerates by 0.38 percentage points annually (from 2.0 to 3.15 percent).
    - If past relationships hold, over the next three years EBIT of Korean firms may decline by about 10–15 percent (depending on the global factor considered).
  - Severe stress-test scenario (baseline plus a downturn similar to 2007–2009):
    - Historical shock magnitudes in 2007–2009: global GDP growth decelerated by 5.9 percentage points, global trade growth decelerated by 18.4 percentage points, China imports growth decelerated by 12.6 percentage points.
    - These shocks would imply an additional contraction of EBIT of 9.5 to 13.4 percent (depending on the global factor considered).
    - Combined with the baseline contraction of 10–15 percent, total contraction of EBIT would be about 20-25 percent.
- Stress-test impacts on debt and employment (from 2014 levels):
  - Mild/baseline: debt-at-risk can increase by 15 percent; employment-at-risk by 10 percent.
  - Severe: debt-at-risk can increase by 30 percent; employment-at-risk by 15 percent.
- Charts in the source illustrate consequences for debt-at-risk and employment-at-risk of EBIT contractions of 10, 15, 20, and 25 percent.

### Benefits of corporate debt restructuring (estimated effects)
- Firm-level panel regressions (2006–2014) find that firms with ICR < 1.5 have:
  - Lower fixed assets growth rates by about 2.5–3 percentage points (coefficients: ICR<1.5 ≈ -0.0285*** to -0.0246*** across specifications).
  - Lower employment growth rates by about 4.5–5 percentage points (coefficients: ICR<1.5 ≈ -0.0459*** to -0.0498*** across specifications).
- Quantified medium-term benefits if half of at-risk firms undergo debt restructuring that removes debt overhang:
  - Fixed assets in at-risk firms at end-2014 were KRW 670 trillion, or 47.5 percent of GDP.
  - Investment by those firms may increase by 0.6–0.7 percent of GDP.
  - Employment in at-risk firms was 1.8 million; hiring by those firms may increase by 45,000 per year, reducing the unemployment rate by 0.15-0.17 percentage points annually.

### Costs of corporate debt restructuring
- Assumptions for cost calculations:
  - Half of the vulnerable firms will need to be restructured.
  - A restructuring entails a 40 percent loss given default for the firm’s creditors.
- Estimated total cost of corporate debt restructuring:
  - About 6 percent of GDP in the baseline.
  - Up to 8 percent of GDP in the severe scenario.
- Note: this estimate is a gross cost and does not imply the fiscal cost; portions may be absorbed by bank capital, provisions, and existing bondholders.

### Net assessment and policy relevance
- Key qualitative result: corporate debt restructuring “pays off” in the medium term from society’s perspective; social benefits (higher investment, more hiring, faster output growth) offset economic costs of restructuring.
- Quantitative results are sensitive to assumptions (scale of restructuring, loss-given-default, share of firms restructured), but the qualitative conclusion is robust.
- Caveats:
  - Regressions are based on a small number of observations; statistical significance for some estimates is low.
  - The specification is not intended to capture steady-state relationships; long-term dynamics could change (e.g., corporate restructuring, sectoral shifts).
  - Social benefits may not be internalized by creditors or corporates.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16278.pdf*

### 3.      While credit risks have risen, policy banks have large exposure to the vulnerable

### 3.      While credit risks have risen, policy banks have large exposure to the vulnerable sectors

### Credit risks and policy-bank exposure
- Most firms’ credit ratings have been downgraded amid weakening performance, indicating rising credit risk to the banking sector.
- Banks’ credit exposure to shipbuilding and shipping firms is large.
- Policy bank lending (as of March 2016):
  - Korea EXIM: KRW 38 trillion (2¼ percent of GDP).
  - KDB: KRW 20 trillion (1¼ percent of GDP).
- These policy banks face potential loan losses that could affect their capital position and policy lending capacity.
- Authorities have made arrangements for policy bank recapitalization (described in main text).

### Three-track restructuring strategy (government)
- Objective: focus on key risks and facilitate industry-wide restructuring based on urgency and risk.
- Track 1 — industry-wide restructuring (cyclically sensitive industries: shipbuilding and shipping):
  - Public sector is closely involved because policy banks are main creditors.
  - Main creditor banks have encouraged debt-distressed firms to propose comprehensive revitalization plans.
  - Three major shipbuilding firms revealed revitalization plans including sale of non-core assets, business reorganization, and downsizing, amounting to KRW 10.3 trillion (0.7 percent of GDP).
  - Major shipping firms reached debt reduction agreements with creditors or negotiated charter fees.
- Track 2 — restructure individual weak firms through banks’ regular credit assessment under supervision:
  - Under the Corporate Restructuring Act, banks assess credit risk and reach agreements with vulnerable debtors on financial restructuring, possibly through workout or rehabilitation programs.
  - Number of corporates under debt restructuring rose to 229 as of end-2015 (including 54 large corporations), from 159 firms in 2014.
- Track 3 — preemptive industry restructuring (M&A, downsizing, business line exchanges) to address overcapacity (e.g., petrochemical, steel):
  - Led by industry, especially industry associations.
  - Corporate Vitality Enhancement Act (“One-Shot Law”), effective August 2016, aims to facilitate M&A and restructuring through streamlined legal procedures and tax incentives (e.g., deferral of capital gains tax from equity transfers, installment payments of transfer gains tax).

### Institutional strengths, delays, and areas for improvement
- Korea has a strong institutional environment and a good track record of corporate restructuring, but restructuring progress since 2011 has been slower than desired.
- Reasons for delay:
  - Highly uncertain industry outlook and banks’ fear of substantial loss realization.
  - Concerns about negative effects on employment, regional economies, and potential difficulties for major firms.
- Institutional improvement areas (drawing on international experience):
  - A larger role for capital markets in normal times:
    - Private equity funds are limited in size; M&A activity historically low; non-performing-loans market underdeveloped.
  - Strengthening the out-of-court restructuring framework:
    - Out-of-court restructuring hinges on main creditor banks, creating uncertainty about loss sharing with non-bank creditors.
    - Korea’s revised Corporate Restructuring Promotion Act (effective March 2016) extends coverage to all creditors (including bond creditors and offshore financial institutions) and strengthens the role of main creditor banks through a right to request other creditors to freeze the exercise of creditor rights.

### Lessons from international experience
- Swift, timely restructuring is crucial to reduce uncertainty (Japan): financial supervisory authorities should encourage banks to carry out loan restructuring, including debt-equity swaps.
- Clear guidelines facilitate a collective process for workouts and could be extended to non-financial creditors (U.K.).
- Market infrastructure matters (U.S.): transparent, reliable disclosure of firms’ business and financial conditions and deepening of financial markets (M&A, buyout funds) facilitate corporate restructuring in normal times.

### Empirical analysis: impacts of corporate restructuring on growth
- Model specification:
  - Panel fixed effects models for 33 advanced economies from 1992–2012.
  - Model estimates effects of reduction in debt-to-equity (D/E) and a corporate restructuring dummy (DUM_CDR) on per capita real GDP growth.
  - DUM_CDR defined as a more than 12 percent decline (y/y) in D/E of 75th percentile firms in a given year.
  - Financial channel effects estimated via interaction term (DUM_CDR × FID (Financial Institution Depth)).
  - Model also estimates effects of M&A on growth.
- Main empirical findings:
  - Corporate debt restructuring could have some positive effects on growth with a lag of one year (Panel 1). Main channel likely through a rise in investment and capital productivity.
  - Negative spillovers via financial channels could partly offset positive impacts of debt restructuring (interaction term), possibly because tighter lending conditions and a rise in NPLs lead to bank deleveraging.
  - M&A could have a positive effect on growth with a lag of two years (Panel 2), as M&A synergies take time to realize.
- Selected regression results (coefficients and p-values shown as in source):
  - Panel 1: Per capita real GDP growth_t
    - Lagged initial PPP per capita GDP: -0.08*** ( 0.000)
    - Lagged banking crisis dummy: -0.013*** ( 0.000)
    - Lagged Debt-to-equity: -0.005*** ( 0.002)
    - Lagged Corporate restructuring dummy: 0.02*** ( 0.002)
    - Constant: 0.858*** ( 0.000)
  - Panel 2: Per capita real GDP growth_t+1
    - Lagged initial PPP per capita GDP: -0.08*** ( 0.000)
    - Lagged banking crisis dummy: -0.011*** ( 0.001)
    - Lagged Debt-to-equity: - 0.0002 ( 0.909)
    - Lagged Corporate restructuring dummy: 0.0009 ( 0.716)
    - Lagged corporate restructuring dummy*financial institutions development: -0.025** ( 0.01)
    - Lagged M&A to GDP1/: 0.004*** ( 0.008)
    - Constant: 0.856*** ( 0.000)
  - Sample size and fit (as presented): Sampl e  si ze551452  R-sq0.600.66
  - Significance notation: *p <0.10, **p<0.05,***p<0.01.
  - Note: Unbalanced country panel fixed effects models for 33 advance economies, with roubust standard errors clustered by country in parantheses.
  - 1/ Data e x i st from 1995

### Household debt (Annex IX) — drivers and policy responses
- Overview:
  - Household debt in Korea is high and has been rising for many years.
  - Rise in debt was partly driven by rising house prices; Korea’s housing cycle has been relatively contained and current house prices do not appear to be overvalued by standard affordability measures.
- Household leverage and composition:
  - Household leverage (debt to net worth ratio) in Korea is around 15 percent, comparable to other OECD countries.
  - Nonfinancial assets account for 74 percent of total household assets in Korea (compared to 68 percent average of comparator countries).
  - Mortgage debt accounts for 41 percent of Korea’s total household liabilities (compared to 45 percent average of comparator countries).
- Structural drivers of household debt:
  - Demographics:
    - Large baby-boom generation (born between 1955 and 1963) is retiring.
    - Average Korean household starts to reduce debt after age 58 (BOK 2015); in the United States average household debt peaks in the 31–40 cohort (Garriga 2014).
    - Retirees often take loans to purchase small businesses to compensate for relatively low pension income.
    - Elderly group: high relative poverty rate of nearly 50 percent (versus 16 percent nationwide), high concentration of debt in bullet loans and nonbank loans, and disproportionate asset share in real estate.
  - Chonsei rental system:
    - Ratio of chonsei lease price to house sales price rose from 52 percent in 2009 to 74 percent in November 2015 (highest since statistics compiled) (BOK 2015).
    - Estimated total rental deposits reached 530 trillion won as of June 2014:
      - 90 trillion regular monthly rental deposits (53 percent of the tenants).
      - 440 trillion chonsei deposits (47 percent of the tenants).
    - Chonsei deposits are treated as transactions among households and excluded from official household financial liabilities data, but rising chonsei prices likely contributed to higher borrowing by tenants to pay deposits.
  - Mortgage market structure:
    - Large share of houses financed by short-term interest-only loans; less than 25 percent fixed-rate, amortizing loans in 2014.
    - High share of variable-rate loans in international comparison.
    - Interest-only and variable-rate features can contribute to rising household debt and vulnerability to positive interest rate shocks.
- Policy response: loan conversion program
  - Authorities implemented a loan conversion program to increase fixed-rate, amortizing loans from less than 25 percent in 2014 to 42.5-50 percent by 2017.
  - Average remaining maturity of bank home mortgage loans lengthened from 11.6 years at end-2010 to 17.5 years as of September 2015.
  - Increase in the share of amortizing loans from 35 percent in 2015 to 50 percent in 2017 should increase amortizing mortgage by about 47 trillion won.
  - Initial impact on household debt is small; over time amortization should lead to a more substantial decline in household debt as households build up equity.

_Source: _cr16278 - 3.      While credit risks have risen, policy banks have large exposure to the vulnerable sectors (IMF staff text)._

### 7.      A fourth driver is the sharp increase in

### _cr16278 - 7.      A fourth driver is the sharp increase in

### Non-bank (NBFI) household lending and structural drivers
- Growth in household loans via NBFIs has outstripped that of the banking sector for much of the time since 2011.
- As of 2015, NBFIs accounted for about half of household lending.
- Risks from non-bank lending:
  - Less regulated nature of NBFIs.
  - Tendency to lend to less creditworthy borrowers who cannot access bank funding due to tighter regulatory requirements.
- Cross-country comparison (qualitative from source): NBFI lending is high in Korea compared to Japan, Euro area and the United Kingdom (IMF 2014a).

### Macroprudential stance and regulatory parameters
- Korea’s macroprudential measures in the first half of the 2000s helped mitigate banking sector risks but contributed to increased lending via NBFIs.
- Current regulatory caps reported:
  - Loan-to-value ratio (LTV) currently at 70 percent.
  - Debt-to-income ratio (DTI) currently at 60 percent.
- Scope of DTI cap:
  - The DTI ratio only applies to mortgage debt in Korea.
  - Contrast noted: other countries (United Arab Emirates and Canada) imposed caps on DSI ratios on a borrower’s total outstanding household debt rather than mortgage loans only.

### Household expectations and macroeconomic linkages
- Increase in household debt also reflects household expectations of future income and asset prices.
- Empirical literature cited: Cecchetti et al (2011) suggest household debt can become a drag on growth for OECD countries.
- Staff exercise finds a negative correlation between household debt and private consumption.

### Empirical specification (dynamic panel)
- Dependent variable: final consumption as a percent of GDP of country i at time t.
- Debt proxy: household debt as a percent of GDP.
- Control variables include:
  - Lagged real GDP growth.
  - Lagged long-term real interest rate.
  - Lagged house price index (hp_{t-1}) and lagged stock price index (sp_{t-1}) as proxies for household asset values.
- First differencing applied to consumption and household debt to remove trends.
- Estimation method: GMM two-step system dynamic panel model.

### Illustrative calibration from staff figure (Effect of Loan Conversion on Household Indebtedness)
- Charted illustrative values (In billions of Korean Won; interest rate assumed constant at 3.5 percent):
  - 4,406 (2020)
  - 14,150 (2030)
  - 35,000 (2045)

### Key empirical findings
- Estimated marginal effect:
  - A 1 percentage point increase in household debt as a share of GDP in the previous period translates into a 6 basis points reduction in household consumption as a share of GDP in the next period.
- Comparison to literature:
  - Calomiris et al. (2012) find a housing wealth effect on consumption of between 5 and 8 cents on the dollar.

### Regression results (selected coefficients and statistics)
- Two specifications shown: "No Asset Prices" and "With Asset Prices".
- Coefficients and reported standard errors (in parentheses):

  - Lagged change in consumption to GDP:
    - No Asset Prices: 0.11 (0.07)
    - With Asset Prices: 0.18*** (0.04)

  - Lagged change in household debt to GDP:
    - No Asset Prices: -0.06*** (0.02)
    - With Asset Prices: -0.06** (0.03)

  - Lagged real GDP growth:
    - No Asset Prices: 0.001 (0.03)
    - With Asset Prices: 0.05*** (0.02)

  - Lagged real long term interest rate:
    - No Asset Prices: -0.06*** (0.02)
    - With Asset Prices: -0.06** (0.03)

  - Lagged house price (only in "With Asset Prices"):
    - 0.01*** (0.002)

  - Lagged stock price (only in "With Asset Prices"):
    - -0.0004 (0.0004)

  - Constant:
    - No Asset Prices: 0.34*** (0.07)
    - With Asset Prices: -0.25 (0.28)

- Sample and specification diagnostics:
  - Obs.: 746 (No Asset Prices); 516 (With Asset Prices)
  - Countries: 34 (No Asset Prices); 29 (With Asset Prices)
  - AR(1): -3.06** (No Asset Prices); -2.58** (With Asset Prices)
  - AR(2): -1.26 (No Asset Prices); -0.86 (With Asset Prices)
  - Hansent test: 32.55 (No Asset Prices); 23.78 (With Asset Prices)

### Interpretation and thresholds
- Regressions do not show significant threshold effects of household debt on private consumption in the cross-country panel.
- Note: Some Bank of Korea (BOK) micro-level findings suggested debt would dampen consumption only once it exceeded a certain level; this cross-country analysis did not confirm precise thresholds.
- Cecchetti et al (2011) found thresholds for government debt (about 85 percent of GDP) and corporate debt (about 90 percent), but not precise household debt thresholds.

*Source: IMF staff analysis as presented in the provided content unit.*

### References

### _cr16278 - References

### References (bibliographic entries)
- Bank of Korea, 2015, Financial Stability Report, December 2015.
- Badarinza, Cristian, John Campbell, and Tarun Ramadorai, 2016, “International Comparative Household Finance,” NBER Working Paper 22066.
- Campbell, John, 2012, “Mortgage Market Design,” Review of Finance 2012, 17: 1–33.
- Calomiris, Charles W., Stanley D. Longhofer, and William Miles, 2012, “The Housing Wealth Effect: The Crucial Roles of Demographics, Wealth Distribution, and Wealth Shares,” NBER Working Paper #17740.
- Cecchetti, Stephen, M. S. Mohanty, and Fabrizio Zampolli, 2011, “The Real Effects of Debt,” BIS Working Paper No. 352.
- Garriga, Carlos, Bryan Noeth, and Don Schlagenhauf, 2014, “Household Debt in America: A Look Across Generations Over Time,” Federal Reserve Bank of St. Louis.
- IMF 2014a, “Global Financial Stability Report,” October 2014.
- IMF 2014b, “Staff Guidance Note on Macroprudential Policy.”
- Lea, Michael, 2010, “International Comparison of Mortgage Product Offerings,” Research Institute of Housing America.
- Scanlon, Kathleen, Jens Lunde, and Christine Whitehead, 2010, “Mortgage Product Innovation in Advanced Economies: More Choice, More Risk,” LSE Research Online: December 2010.

### Fund Relations — key factual data and financial arrangements
- Membership Status: Joined August 26, 1955; Article VIII.
- Quota: 8,582.70 SDR Million (100.00 percent).
- Fund holdings of currency (exchange rate): 7,889.21 SDR Million (91.92 percent).
- Reserve tranche position: 693.49 SDR Million (8.08 percent).
- New arrangements to borrow: 591.45 SDR Million.
- SDR Department — Net cumulative allocation: 2,404.45 SDR Million (100.00 percent); Holdings: 1,815.99 SDR Million (75.53 percent).
- Outstanding Purchases and Loans: None.
- Financial Arrangements (In SDR Million):
  - Stand-by Dec. 04, 1997–Dec. 03, 2000: Amount Approved 15,500.00; Amount Drawn 14,412.50.
    - Of which SRF Dec. 18, 1997–Dec. 17, 1998: 9,950.00 approved and drawn.
  - Stand-by Jul. 12, 1985–Mar. 10, 1987: 280.00 approved; 160.00 drawn.
  - Stand-by Jul. 08, 1983–Mar. 31, 1985: 575.78 approved; 575.78 drawn.
- Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming 2016–2020 Principal: 0.0 0.0 0.0 0.0 0.0
  - Charges/interest: 0.15 0.38 0.38 0.38 0.38
  - Total: 0.15 0.38 0.38 0.38 0.38
- Exchange rate system classification: “floating” since 2009; over 1997–2008 classified as “free floating” (“independently floating” under the older classification system).
- Exchange restrictions: maintained for security reasons in accordance with UN Security Council Resolutions and notified under Executive Board Decision 144 (52/51).
- FSAP update: conducted April and July 2013; Financial System Stability Assessment (FSSA) reported as Country Report No. 14/126.
- Technical Assistance (selected missions and topics with dates):
  - FAD: fiscal transparency discussions in June 2000; GFS technical assistance Nov 8–19, 2010; tax policy/administration Aug 31–Sep 16, 2005; budgeting/public expenditure Jan 8–19, 2001.
  - MCM: financial holding company supervision and derivatives regulation Dec 8–17, 2008; deepen money market Dec 4–14, 2007; debt management Sept 20–Oct 2, 2006; foreign exchange market reform Mar 30–Apr 13, 2006; macroprudential and derivatives supervision Oct 27–Nov 7, 2005.
  - STA: balance of payments and external debt stats Mar 29–Apr 12, 2000; GFSM 2001 framework Nov 28–Dec 11, 2007; GFS reform support Nov 28–Dec 11, 2007 and Nov 8–19, 2010.
- Resident representative office: opened March 1998; closed September 2008.

### Statistical Issues — assessment and recommended improvements
- Overall assessment: Data provision is adequate for surveillance (As of June 17, 2016).
- National Accounts:
  - Structure follows 2008 System of National Accounts.
  - Chain-linked (reference year 2010) and nominal GDP compiled using production and expenditure approaches; nominal GDP also compiled using income approach.
  - Expenditure components estimation moved from commodity flow method (pre-2005) to direct estimation.
  - Informal sector size has not been measured.
- Consumer Price Index (CPI):
  - Coverage: 92.9 percent of total households; excludes farming and fishing households.
  - Geographical coverage: 37 urban areas; recommendation to extend to rural areas.
  - Consumption basket: updated every five years with plan to move to a three-year update; expenditure weights derived from the 2010 Household Income and Expenditure Survey.
  - Index compilation: adopts both geometric means and the ratio of arithmetic means; recommendation that geometric means be used for all unweighted aggregation.
  - Missing prices: currently imputed by price movements of similar products in same item/geography except seasonal items where last reported prices are carried forward; recommendation to impute missing prices for seasonal items rather than carry forward.
- Producer Price Index (PPI):
  - Coverage: all domestic industrial activities and a large segment of service activity; excludes exported products (Export Price Indexes compiled separately).
  - Rebasing: 2010 = 100; employs 2008 SNA concepts and definitions.
  - Missing prices: should make more use of imputing using prices of similar commodities rather than carrying forward last reported price.
  - Elementary index formulae: mostly simple geometric average and weighted geometric average; some indices use weighted arithmetic average; recommendation to change headline PPI to one based on geometric mean at elementary level.
  - Classification: PPI activity classification conforms to KSIC (based on ISIC with slight local modifications); commodity classification does not conform to CPC and adoption of a CPC-based classification is recommended as soon as possible.
- Government Finance Statistics (GFS):
  - Two sets compiled for central government: one using national definitions and one using GFSM 2001 standards.
  - Consolidated GFS data on general government resumed reporting for publication in the 2015 Government Finance Statistics Yearbook (GFSY), including general government operations and a full balance sheet.
  - General government data compiled with significant lags (latest available data are for 2014) mainly due to lack of timely local government source data.
  - High-frequency central government operations data disseminated under SDDS are not yet reported for inclusion in the International Financial Statistics (IFS).
- Financial Sector Data:
  - Monetary and financial statistics (MFS) compiled by Bank of Korea (BOK) broadly follow the IMF’s Monetary and Financial Statistical Manual.
  - Foreign currency items converted into Korean Won at previous business day's trading volume weighted average rate; data revalued monthly except monetary gold revalued semi-annually.
  - BOK reports monetary data for central bank and other depository corporations using standardized report forms (SRFs); does not report data for other financial corporations.
  - Financial Soundness Indicators (FSIs): Korea regularly reported FSIs to the IMF, but despite requests to reestablish regular reporting, latest available data are for 2014Q2.
- External Sector Statistics:
  - BOK compiles BOP and IIP statistics consistent with BPM6; BOK adopted BPM6 in March 2014.
  - Quarterly external debt statistics quality improving since 2006; BOK switched from annual to quarterly reporting of IIP in early 2007.
  - International reserves and foreign currency liquidity dissemination meets SDDS; since April 2006 reserves disseminated monthly rather than twice a month.
  - Some BOP and IIP data lack consistency.
  - Korea reports BOP and IIP data for the IFS (quarterly) and the Balance of Payments Statistics Yearbook (annual).
- Data Standards and Quality:
  - Korea subscribed to SDDS since September 1996 and uses SDDS flexibility options for timeliness of general government operations, central government operations, and analytical accounts of the banking sector; also uses flexibility option for coverage of exchange rates.
  - A Data ROSC reassessment was published in July 2010.

### Table of Common Indicators Required for Surveillance (selected entries, As of June 17, 2016)
- Exchange Rates: Date of Latest Observation 06/17/2016; Date Received 06/17/2016; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest Observation Mar. 2016; Date Received Jun. 2016; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Latest Observation Mar. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M; Data Quality – Methodological Soundness: O, O, O, LO; Data Quality – Accuracy and Reliability: O, O, O, O, O.
- Broad Money: Latest Observation Apr. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Central Bank Balance Sheet: Latest Observation Apr. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Consolidated Balance Sheet of the Banking System: Latest Observation Apr. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Interest Rates: Latest Observation 06/17/2016; Date Received 06/17/2016; Frequency D; Frequency of Reporting D; Frequency of Publication D.
- Consumer Price Index: Latest Observation May. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M; Data Quality – Methodological Soundness: O, O, O, O; Data Quality – Accuracy and Reliability: O, O, LO, O, O.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Latest Observation Apr. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- External Current Account Balance: Latest Observation May. 2016; Date Received Jun. 2016; Frequency M; Frequency of Reporting M; Frequency of Publication M; Data Quality – Methodological Soundness: O, LO, LO, LO; Data Quality – Accuracy and Reliability: O, O, O, O, O.
- GDP/GNP: Latest Observation Q1 2016; Date Received Apr. 2016; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q; Data Quality – Methodological Soundness: O, O, O, O; Data Quality – Accuracy and Reliability: O, O, LO, O, LO.
- Gross External Debt: Latest Observation Apr. 2016; Date Received Jun. 2016; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.
- International Investment Position: Latest Observation Q1 2016; Date Received Jun. 2016; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.

### Statement by Korean Authorities — substantive findings, outlook, and policy directions (July 29, 2016)
- General assessment:
  - Authorities welcome staff focus on structural issues to boost short- and medium-term growth, notably strengthening the service sector and developing the “creative economy.”
  - Authorities broadly agree with staff on overall economic development, outlook, and policy priorities but seek further discussion on some issues.
- Recent developments and outlook:
  - Economic growth characterized as "lackluster" but recent performance deemed satisfactory amid external and domestic risks (including China’s rebalancing and corporate restructuring).
  - Fiscal package announced June 28; intention for National Assembly to pass supplementary budget preferably in August and execute quickly.
  - Authorities expect pace of recovery to likely accelerate more sharply than staff projection due to fiscal stimulus and a policy rate cut in June.
  - Recent indicators: domestic demand and consumption improving; exports’ declining trend decelerating.
  - Employment: employment-to-population ratio (aged 15–64) rose to a record high of 66.5 percent over the past 37 months; unemployment rate remained flat at 3.6 percent in June.
  - Inflation: headline inflation remained at around 1 percent; core inflation close to 2 percent; expected Inflation hovers around 2.4 percent.
  - Financial markets: KOSPI index recovered to 2,012.22 points as of July 21 after plunging to 1,925.24 points (a 3.1 percent drop) on 24 June following the UK referendum; Korean won restored to KW 1140.2 as of July 22 after falling to KW 1183.3 (a 2.8 percent drop) vis-à-vis US dollar.
  - Authorities view Brexit impact on financial markets as less pronounced than initially anticipated.
- Potential growth and output gap:
  - Authorities estimate potential growth in recent periods at 3 to 3.2 percent, higher than staff estimate.
  - Authorities believe negative output gap will close faster than staff envisaged as supportive policies take effect and external headwinds dissipate; potential output expected to be lifted by corporate restructuring and labor reforms.
- Fiscal policy stance:
  - Korea's fiscal position described as healthy relative to other advanced countries with sufficient current account balance and strong buffers.
  - Authorities support continued fiscal support to promote consumption and investment and to preemptively address vulnerabilities from weaker activity.
  - Emphasis on balanced approach preserving fiscal sustainability medium- and long-term.
  - Authorities note importance of establishing a fiscal rule as a long-term anchor; discussions underway and a detailed proposal to be announced.
- Social expenditure and revenue mobilization:
  - Agreement with staff that carefully targeted expansion of social spending over the medium-term could promote inclusiveness, boost labor productivity, and help rebalance external sector.
  - Cautious stance urged on implementing social spending expansion and accompanying tax increases; priority on establishing national consensus.
  - Public opinion survey results cited:
    - 80.6 percent preference for strengthening efforts to improve expenditure efficiency and change composition (rather than financing via bonds issuance or taxation).
    - Bonds issuance preference: 9.9 percent; taxation preference: 9.5 percent.
    - 69.3 percent reluctant to expand social spending if it required paying more tax.
  - Authorities note current social spending level relatively low but projected to rise rapidly under existing system due to population aging and welfare system development.
  - Cultural context: tradition of large family systems and significant private transfers to elderly; elderly dependency ratio significantly higher than other countries.
- Macroprudential policy and household debt:
  - LTV and DTI regulations introduced in 2002 and 2005 respectively; strengthened since the global financial crisis.
  - Current caps: DTI cap is currently set to 60 percent; LTV cap is 70 percent across financial sectors.
  - Staff recommended tightening DTI cap toward 30 to 50 percent and extending it to other types of household debt.
  - Authorities note historical emphasis on LTV rather than DTI and relative looseness in income verification.
  - Policy measures:
    - Financial Services Commission (FSC) introduced “the Guidelines on banks’ mortgage loan screening” in February (year not specified in excerpt), requiring lenders to require new borrowers to prove income and repayment ability, shifting weight away from collateral.
    - Authorities plan measures to call for lenders to strengthen monitoring of the debt-service ratio (to capture banking, car financing, credit card, and other obligations) as a more comprehensive credit-risk gauge.
  - Authorities will closely monitor effects of newly introduced measures and undertake additional measures as recommended by staff where necessary.

*Italic line: REPUBLIC OF KOREA — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (Prepared by Asia and Pacific Department, July 14, 2016).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16278.pdf_