## 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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## Bibliographic details
- Published: August 9, 2009

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### 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.*

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## References

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_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/pn09103_