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SINGAPORE, April 25, 2024 – The near-term outlook for the Korean economy has improved, supported by the recovery of exports, and inflation is expected to decline further toward the target. As the economic outlook remains highly uncertain, the authorities are encouraged to stand ready to recalibrate monetary and fiscal policy stance to safeguard economic and financial stability, while continuing with efforts to boost growth.
These are highlighted in the 2023 Annual Consultation Report on Korea published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report is based on AMRO’s Annual Consultation Visit to Korea from December 7 to 20, 2023, and information available up to February 22, 2024.
Recent developments and outlook
Real GDP growth declined to 1.4 percent in 2023 from 2.6 percent in 2022, mainly due to the decline in net exports and subdued private consumption. The economy is forecast to rebound to an above-potential rate of 2.3 percent in 2024, supported by continued strengthening in goods exports, especially semiconductors.
Headline inflation declined to 3.6 percent in 2023 from 5.1 percent in 2022, driven by declines in energy prices, and is expected to continue its downward trend toward the target of 2 percent at the end of 2024. Core inflation has been trending down steadily but stickier than headline inflation. Moderate wage growth, despite the tight labor market, and gradual declines of short-term inflation expectations helped limit the second-round effects of inflation.
Monetary policy has remained restrictive due to concerns over lingering high inflation, the U.S. dollar strength amid the Fed’s hawkish stance, as well as increases in household loans. The Bank of Korea (BOK) has kept the Base Rate unchanged at 3.5 percent since February 2023.
The fiscal deficit, excluding social security funds, is estimated to narrow from 5.4 percent in 2022 to 3.8 percent of GDP in 2023, albeit higher than the budgeted 2.6 percent mainly due to revenue shortfall. Over the medium term, the National Fiscal Management Plan 2023-2027 envisages a slower pace of fiscal consolidation compared to the previous plan. The fiscal deficit is set to fall below 3 percent of GDP in 2025 and gradually approach mid-2 percent of GDP by 2027.
Risks, vulnerabilities, and challenges
In the near term, inflation may be higher than expected, thereby leading to higher-for-longer interest rates. Economic slowdown in the United States and the European Union could be sharper than expected, while China’s economic recovery may falter. Locally, financial distress in the project finance market could emerge and spread to the broader financial system.
Over the medium term, heightened geopolitical tensions could disrupt manufacturing activities and weaken investment sentiment. The high level of household debt could weigh on private consumption and lead to distress and defaults, especially among households with lower credit ratings, income, and wealth.
In the long term, the rapid increase in government debt in recent years has raised concerns about fiscal sustainability. Deteriorating demography will continue to be a drag on economic potential.
Policy recommendations
The BOK should maintain its restrictive monetary policy stance until clear signs of disinflation toward the target level appear. The calibration of the monetary policy path should remain data dependent amid uncertainties in the environment. The reforms of the BOK’s lending facilities to both banks and non-bank depository institutions will mitigate risks of liquidity crunches and enhance financial market stability. Meanwhile, strengthening the regulatory, supervisory, and risk management frameworks, and enhancing information and data sharing among the BOK and other financial supervisory authorities are essential.
Efforts to safeguard financial stability should continue. Credit support measures for small and medium enterprises should be time-bound and targeted. In addition, macroprudential measures should be finetuned to be commensurate with the developments in the housing market while additional policies can be considered to contain household indebtedness. As volatility in the short-term money markets has subsided, the authorities should unwind temporary regulatory support to strengthen financial institutions’ buffers and restore market functioning.
Continued fiscal consolidation in line with an expected economic recovery in 2024 is deemed appropriate and helps keep inflation in check. Should downside risks to the economic outlook materialize, fiscal policy could be employed to provide targeted support without compromising the fiscal consolidation path. To ensure fiscal sustainability, the government should spearhead the legislation of a fiscal rule, while articulating a fiscal consolidation plan featuring clear targets with specific reform measures and timeline.
The authorities should continue fostering innovation, promoting human resource development, and strengthening supply chain resilience to boost long-term growth. In view of the deteriorating demographic trend, comprehensive and proactive policies are needed to foster innovation and enhance productivity, and a public pension reform should be conducted. To achieve carbon neutrality, the authorities should periodically review and adjust carbon reduction targets, provide direct fiscal support to renewable energy technologies and enhance carbon pricing mechanisms, as well as further promote green bond financing.
About AMRO
The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute toward securing macroeconomic and financial resilience and stability of the ASEAN+3 region, comprising 10 members of the Association of Southeast Asian Nations (ASEAN) and China; Hong Kong, China; Japan; and Korea. AMRO’s mandate is to conduct macroeconomic surveillance, support regional financial arrangements, and provide technical assistance to the members. In addition, AMRO also serves as a regional knowledge hub and provides support to ASEAN+3 financial cooperation.
About AMRO’s Annual Consultation Report
The Annual Consultation Report was prepared in fulfillment of AMRO’s mandate. AMRO is committed to monitoring, analyzing, and reporting to its members on their macroeconomic status and financial soundness. AMRO also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.