Man checks his mobile phone near a vendor stall in Seoul. For more balanced growth, Korea needs to address low productivity in the services sectors (photo: Kim Hong-Ji/Reuters/Corbis)
ECONOMIC HEALTH CHECK
In their regular annual report on the health of the Korean economy, IMF economists suggest that the country’s current weak outlook could have a lasting impact on its growth. They call on the government to take additional fiscal and monetary policy actions if clear signs of a recovery do not emerge to shore up Korea’s economy.
“The recent policy steps aimed at boosting demand are in the right direction, but their impact is still uncertain,” said Brian Aitken, the IMF’s mission chief for Korea.
“A preemptive policy stance would protect against the risk of weak growth and low inflation becoming entrenched,” he added. In particular, there remains room for further monetary easing, if needed, and Korea’s low public indebtedness provides ample room for additional fiscal stimulus and reinforced social safety nets.
Stalled growth momentum
Korea’s growth momentum has stalled somewhat during 2014 and the outlook remains challenging, with sluggish domestic demand, low inflation, and increased external uncertainties. IMF economists expect the country’s growth to be in the range of 3 percent, with momentum picking up later in the year.
With a highly open economy, Korea faces global cross-currents and the outlook will depend on a number of uncertain factors. As one of the world’s largest importers of oil products, Korea will clearly benefit from lower oil prices, says Aitken, but it may take some time before this translates into growth through higher investment and consumption.
The main external risks include slower-than-expected growth in Korea’s main trading partners, the impact of a persistently weak Japanese yen on Korean export industries, and side-effects from global financial conditions, although the country’s solid external buffers will mitigate the impact of any renewed global financial volatility.
Strong financial fundamentals
Korea’s financial fundamentals are relatively strong, suggests the IMF report, which limits sources of short-run systemic risk. Banks remain well capitalized, and their funding and liquidity conditions are stable, it adds.
Household debt as a share of income has been rising steadily over the last decade, but cautious consumer spending has kept household leverage low and stable, and the sector’s aggregate net worth is comparable to that in many other advanced economies. While pockets of vulnerability exist, particularly for some low-income households, the rise in debt does not appear to be a systemic threat to financial sector stability. At the same time, the structure of household debt could be strengthened, and a key challenge will be to facilitate the transition by households and financial institutions toward a more stable, long-term mortgage market.
The corporate sector’s aggregate balance sheet appears sound, with capital buffers and adequate provisioning limiting direct risks to the banking sector. But corporate investment may be constrained by the need of many firms to shore up their balance sheets.
Challenges to long-term growth
Korea is facing long-term challenges to growth including a rapidly aging population. In the report, the IMF economists call on the authorities to continue with their policy of expanding sources of growth beyond the country’s current focus on manufacturing exports.
The report supports structural reforms to address low service sector productivity and bring about a more dynamic corporate and small-and-medium-enterprise sector. It welcomes the government’s recent moves to address labor market, and other rigidities, but says the desired changes will require a process of consensus-building among the stakeholders, which will take time and require overcoming significant political and economic hurdles.
These measures would lead to higher productivity growth in the nontraded goods sector, and together with continued exchange rate flexibility, would lead over time to a reduction in the country’s external imbalances, says the report.
