Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with the Republic of Korea
IMF News, August 9, 2009
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- Published: August 9, 2009
Background
- Korea was hit hard by the global financial crisis towards the last quarter of 2008; capital left the country at a faster pace than during the 1997-98 crisis, causing sharply lower asset prices, dislocations in money markets, and a spike in bank CDS spreads.
- The Korean economy contracted by 5.1 percent quarter/quarter (not annualized) in the last quarter of 2008.
- Policy responses:
- US$55 billion in foreign exchange reserves set aside to provide swaps or loans to banks and trade-related businesses.
- Bank of Korea (BOK) cut interest rates by a cumulative 325 basis points between October and February and relaxed conditions for its repo operations.
- A 2009 fiscal stimulus package equivalent to 3.6 percent of GDP.
- Generous quasi-fiscal support for SMEs, mostly in the form of credit guarantees.
- A bank recapitalization fund and a toxic asset fund were set up to shield the banking sector and prevent major deleveraging.
- Exchange rate and reserves:
- BOK intervened only exceptionally; secured swap lines from other central banks totaling US$90 billion.
- Reserves declined by US$38 billion in the last quarter of 2008 to US$200 billion and have since recovered.
- The steep won depreciation helped redirect domestic demand from imports to domestic production and, with falling oil prices, turned the current account into a solid surplus in the first quarter of 2009.
- Inflation and activity:
- Core inflation at 3.5 percent in June; headline inflation declined to 2 percent.
- External defaults and a credit crunch were avoided; economic activity stabilized in Q1 2009.
- Bank credit continues to grow at a healthy pace; domestic bond issuance in the first five months of 2009 (relative to GDP) is close to an all-time high.
- In Q1 2009, government consumption, construction investment, and private consumption rose; the economy expanded by 0.1 percent q/q.
- Outlook and risks:
- Growth projected at -1¾ percent in 2009 and 2.5 percent in 2010.
- Recovery likely to moderate in H2 2009 and be followed by a drawn-out recovery as fiscal impulse and exchange-rate effects fade.
- Downside risks: another bout of global risk aversion, rising oil prices, permanently higher savings rates in Western economies reducing demand.
- Upside risk: stronger impact from stimulus measures in Korea and abroad.
Executive Board Assessment — Key Findings
- Directors noted that Korea was hard hit despite strong macroeconomic policies and limited direct financial sector exposure to subprime assets.
- Commendation for speedy and comprehensive measures that stabilized the economy and financial system.
- Recovery dependence:
- Recovery hinges critically on external demand and global financial conditions due to highly leveraged households and SMEs.
- Continued focus on supporting growth until a self-sustained recovery is firmly established was recommended.
- Fiscal policy:
- Directors supported the sizeable and frontloaded fiscal stimulus package and the intention to maintain fiscal stimulus in 2010 given uncertainty.
- Noted distortionary nature of quasi-fiscal SME support and welcomed plan to withdraw such support gradually as conditions permit.
- Directors looked forward to announcement of a medium-term fiscal consolidation plan with concrete revenue and expenditure measures.
- Monetary policy and housing:
- Current accommodative monetary policy stance deemed appropriate.
- Vigilant monitoring of monetary conditions necessary; asset price impacts should be considered in monetary policy deliberations.
- Rising house prices concerns best addressed through prudential regulations, pending housing market reforms.
- Exchange rate and reserves:
- Staff assessed the won as undervalued relative to its medium-term equilibrium level; expected to reverse as capital inflows resume.
- Directors endorsed Korea’s free floating exchange rate regime; foreign exchange intervention should remain limited to smoothing volatility.
- Some Directors praised large reserve buffers for providing liquidity and confidence; a few Directors pointed to potential costs of holding excessive reserves from the global perspective.
- Financial sector resilience:
- Financial system well-positioned to withstand deterioration in asset quality associated with the downturn.
- Preemptive bank recapitalization succeeded in preventing a credit crunch; establishment of an impaired asset purchase fund welcomed.
- Importance of linking future capital injections more clearly to progress on bank-led SME restructuring underscored.
- Given increased reliance on wholesale funding, consideration should be given to introducing prudential regulations limiting banks’ wholesale financing, and improving stress testing by banks and regulators.
- Crisis framework and insolvency:
- Crisis response framework worked well.
- Encouraged consideration of a more formal approach to coordinating financial policies and sharing information among the government, financial regulators, and the central bank.
- Recommended further improvements to the insolvency regime, including decriminalizing personal bankruptcies.
- Structural reform priorities:
- Urgent need to rebalance growth toward the nontradable sector.
- Priority measures: eliminating the preferential tax treatment of the manufacturing sector, deregulating the service sector, and expediting SME restructuring.
- Labor market reforms: reducing employment protection for regular workers and expanding social protection for nonregular workers to improve labor market flexibility.
IMF Staff Projections and Key Statistics (2005–10)
- Real GDP (percent change):
- 2005: 4.0
- 2006: 5.2
- 2007: 5.1
- 2008: 2.2
- 2009: -1.8
- 2010: 2.5
- Consumption (percent change):
- 2005: 4.6
- 2006: 1.6
- 2007: -1.4
- 2008: 1.3
- 2009: [not provided in table cells]
- Gross fixed investment (percent change):
- 2005: 1.9
- 2006: 3.4
- 2007: 4.2
- 2008: -1.7
- 2009: -6.4
- Net foreign balance (contribution to GDP growth) 1/:
- 2005: 0.3
- 2006: 0.7
- 2007: 1.1
- 2008: 2.7
- 2009: [not provided in table cells]
- Prices (percent change):
- Consumer prices (end of period):
- 2005: 2.6
- 2006: 2.1
- 2007: 3.6
- 2008: 4.1
- 2009: 1.7
- 2010: 3.0
- GDP deflator:
- 2005: -0.1
- 2006: 3.2
- Labor market (in percent):
- Unemployment rate:
- 2005: 3.7
- 2006: 3.5
- 2007: 3.3
- 2008: 3.8
- Wage growth, manufacturing:
- 2005: 7.8
- 2006: 5.6
- 2007: 6.8
- 2008: 6.0
- 2009: 5.0
- Consolidated central government (In percent of GDP):
- Revenues 2/:
- 2005: 22.1
- 2006: 23.1
- 2007: 25.0
- 2008: 24.5
- 2009: 23.7
- 2010: 22.7
- Expenditure:
- 2005: 20.3
- 2006: 21.3
- 2007: 21.5
- 2008: 23.3
- 2009: 26.6
- 2010: 26.8
- Balance 2/:
- 2005: 1.8
- 2006: 1.2
- 2007: -2.9
- 2008: -4.0
- Money and interest rates (in percent):
- Overnight call rate:
- 2005: 2.9
- M3 growth:
- 2005: 7.4
- 2006: 10.5
- 2007: 10.0
- 2008: 9.1
- Yield on corporate bonds:
- 2005: 5.5
- 2006: 5.3
- 2007: 7.7
- Balance of payments:
- Current account balance (In billions of U.S. dollar):
- 2005: 15.0
- 2006: 5.4
- 2007: 5.9
- 2008: 25.6
- 2009: 17.9
- 2010: 0.6
- [additional cell:] -0.7
- Won per U.S. dollar (Period average):
- 2005: 1024
- 2006: 955
- 2007: 929
- 2008: 1102
Public Information Notice (PIN) No. 09/103 — August 9, 2009. Executive Board conclusion of the 2009 Article IV Consultation with the Republic of Korea.