Public Information Notice: IMF Executive Board Concludes 2008 Article IV Consultation with the Republic of Korea
IMF News, September 12, 2008
Source details
- Canonical URL
- Public Information Notice: IMF Executive Board Concludes 2008 Article IV Consultation with the Republic of Korea
Other formats
Bibliographic details
- Published: September 12, 2008
Background
- PIN No. 08/117: On September 8, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Korea.
- Contextual factors:
- Global slowdown contributing to moderating economic activity in Korea.
- Surging global commodity prices and a weakening of the won contributing to rising domestic inflation.
- Korean financial system described as remaining in good health, but increased global volatility raising near-term risks.
- Structural changes to the financial sector (including the Capital Market Consolidation Act taking effect in 2009) present opportunities and regulatory challenges.
Economic outlook and risks
- Growth:
- After reaching 5 percent in 2007, growth is expected to moderate to 4.1 percent in 2008, before recovering to 4.3 percent in 2009.
- Inflation:
- Headline inflation reached 5.6 percent in August, exceeding the Bank of Korea's target of 2½−3½ percent for a tenth consecutive month.
- Slowing domestic demand and moderating food and fuel price inflation are expected to help bring headline inflation down early next year.
- External balances:
- Reflecting a sharp deterioration in Korea's terms of trade, a current account deficit of 1¼ percent of GDP is expected in 2008, declining to about 1 percent in 2009.
- Uncertainty and downside risks:
- Outlook is subject to substantial uncertainty, including the possibility of a deeper global slowdown, further volatility in global financial conditions, or still higher oil prices.
Monetary and fiscal policy
- Monetary policy:
- After a one-year pause, monetary policy was tightened in August 2008, with the Bank of Korea raising its policy rate by 25 basis points to 5¼ percent, citing concerns about liquidity growth and the need to anchor inflation expectations.
- Directors welcomed the August policy rate hike and emphasized anchoring expectations; some Directors suggested further tightening might be warranted, while others recommended proceeding cautiously.
- Directors noted that a more accommodative monetary policy could be envisaged if inflation eases and growth remains soft.
- Fiscal policy:
- 2008 fiscal stance provides an expansionary impulse of about 1½ percent of GDP, including about 1 percent of GDP in measures adopted after the budget to address higher fuel prices.
- Directors saw the slightly expansionary fiscal stance in 2008 as broadly appropriate but underscored limited scope for further fiscal stimulus given inflation pressures and medium-term fiscal challenges.
- Any further transfers to protect the vulnerable against high oil prices should be temporary, timely, and well targeted.
Financial sector issues and oversight
- Financial stability and exposures:
- Direct impact of the global financial crisis described as small owing to limited exposure to subprime assets, but Korea experienced declines in stock prices, increased volatility, and wider spreads on external debt.
- Heavy reliance of Korean banks on wholesale financing has focused supervisory efforts on containing liquidity risk.
- Short-term external debt has risen sharply in recent years (as a counterpart to hedging activity and foreign purchases of sovereign bonds); it should be monitored but risks are judged moderate given different sources and uses compared with a decade earlier.
- While overall bank loan quality is strong, an economic slowdown could reveal vulnerabilities, particularly in SME lending.
- Regulatory and structural reform:
- Capital Market Consolidation Act (taking effect in 2009) expected to increase competition and innovation in the financial sector, requiring enhanced financial oversight.
- Directors welcomed authorities' efforts to strengthen risk monitoring and enhance regulatory and supervisory capacity, and their intention to privatize remaining state-owned banks.
- Directors emphasized that any loosening of constraints on bank ownership by nonfinancial corporates should not threaten corporate governance progress.
- Directors encouraged continued upgrading of banks' risk assessment in line with Basel II to help address potential risks from SME, real estate, and construction exposure during a downturn.
Executive Board assessment and policy recommendations
- Overall appraisal:
- Directors commended authorities for skillful economic management that contributed to resilience in challenging global circumstances.
- Growth momentum supported by strong exports; financial sector health and limited direct subprime exposures contained direct impact of global turbulence.
- Noted developments: softened growth, weakened equity prices and won, and higher inflation due to high oil prices.
- Baseline projections point to modest slowing of growth and a return of inflation to the Bank of Korea's target band during 2009, but risks are skewed to the downside.
- Policy guidance:
- Support for macroeconomic policy mix prioritizing control of inflation.
- Emphasis on keeping inflation expectations well-anchored to avoid more forceful tightening later; importance of effective communication regarding monetary policy and inflation developments.
- Support for flexible exchange rate regime; view that foreign exchange intervention should be limited to smoothing excessive volatility.
- Confirmation that Korea's inflation targeting framework remains the most effective tool for addressing inflation; some Directors suggested exchange rate management could also play a role.
- Fiscal policy: limit scope for further stimulus; ensure transfers are temporary, timely, and well targeted.
- Financial sector: prioritize strengthening liquidity risk management by banks and regulators in line with emerging best practices; close monitoring of short-term external debt; upgrade risk assessment and supervisory capacity ahead of market growth and innovation.
- Structural reforms: support plans to boost investment and growth through privatization and deregulation; encourage addressing longer-term implications of an aging society; underscore that proposals for reducing taxes should be part of a broader reform plan to address longer-run fiscal challenges.
Key statistics (selected figures from Korea: Selected Economic Indicators)
- Real GDP (percent change):
- 2004: 4.7
- 2005: 4.2
- 2006: 5.1
- 2007: 5.0
- 2008: 4.1 (IMF Staff Projections)
- 2009: 4.3 (IMF Staff Projections)
- Consumption (percent change):
- 2004: 0.4
- 2005: 3.9
- 2006: 4.8
- 2007: 3.0
- 2008: 3.6
- Gross fixed investment (percent change):
- 2004: 2.1
- 2005: 2.4
- 2006: 4.0
- 2007: 1.6
- 2008: 5.3
- Net foreign balance (contribution to GDP growth):
- 2004: 3.3
- 2005: 1.3
- 2006: 1.2
- 2007: 0.6
- Prices (percent change):
- Consumer prices (end of period): 2007: 2.6; 2008: 5.6
- GDP deflator: 2004: 2.7; 2005: -0.2; 2006: -0.5; 2007: 2.9
- Labor market:
- Unemployment rate: 2007: 3.7; 2008: 3.5
- Wage growth, manufacturing: 2004: 10.0; 2005: 7.8; 2006: 6.8
- Consolidated central government (In percent of GDP):
- Revenues 2/: 2004: 22.9; 2005: 23.6; 2006: 24.7; 2007: 27.0; 2008: 26.1; 2009 (IMF Staff Projections): 25.8
- Expenditure: 2004: 20.7; 2005: 21.7; 2006: 23.3; 2007: 24.5; 2008: 24.0
- Balance 2/: 2004: 2.2; 2005: 1.9; 2006: 1.8; 2007: 3.8
- (Notes: 2/ Excluding privatization receipts and rollover of KDIC/KAMCO bonds.)
- Money and interest rates:
- Overnight call rate: 2007: 4.6
- M3 growth: 2004: 7.1; 2005: 7.4; 2006: 10.5
- Yield on corporate bonds: 2007: 5.5
- Balance of payments:
- Current account balance (In billions of U.S. dollar): 2004: 28.2; 2005: 15.0; 2006: 5.4; 2007: 6.0; 2008: -12.7; 2009 (IMF Staff Projections): -10.3; 2009 (alternate): -1.3; 2009 (alternate projection): -1.0
- Won per U.S. dollar (Period average):
- 2004: 1,146
- 2005: 1,024
- 2006: 955
- 2007: 929
Public Information Notice: IMF Executive Board Concludes 2008 Article IV Consultation with the Republic of Korea (Public Information Notice No. 08/117, September 12, 2008).