Korea's Economy Above Potential

Politics

Korea's Economy Above Potential

The report notes a rapid recovery from the global financial crisis, growth in 2010 reached an impressive 6.2 percent, led by exports and domestic demand.

Momentum eased in the first half of 2011, reflecting the maturing of the expansion, the adjustment in global inventories, and the weaknesses in the construction sector.

Growth in 2011 is projected above potential at 4 and a half percent, led by exports and firming domestic demand, before easing to 4.2 percent next year. Risks to the outlook are broadly balanced.

Exports have been strong, primarily to China and other fast growing emerging markets, but with rising fuel prices and increasing domestic demand for imports, the current account surplus has narrowed relative to last year. Korea is now the world’s seventh largest holder of international reserves, which have risen to 304 billion dollars.

The real effective exchange rate has appreciated 2.1 percent from end-2010 through June 2011, but still remains below the pre-crisis levels and its 2000–07 average.

Against the background of ample global liquidity, Korea’s strong growth and a perceived one-way bet on the currency have led to large portfolio inflows, boosting equity prices to near all-time highs. The external short-term debt of Korean banks has been maintained below pre-crisis peaks, although these flows have strengthened recently.

Despite subdued credit growth from commercial banks, overall credit to households continues to be robust, driven primarily by nonbank financial institutions. As a result, household debt remains high at 125 percent of household disposable income.

The commercial banking system’s capital adequacy ratio stood at 14.3 percent, while the nonperforming loan ratio remains low at 1.3 percent. Commercial banks have also reduced their reliance on wholesale funding, with loan-to-deposit ratios declining to 96½ percent. However, the large exposure of Mutual Saving Banks (MSB) to the weak construction and real estate sector has led to deposit runs on eight MSBs, which have been suspended.

The authorities moved decisively toward fiscal policy consolidation since last year. The budget deficit, excluding social security funds, is projected to decline to 0.6 percent of GDP in 2011, from 1.1 percent of GDP in 2010, driven by expenditure restraint and efforts to broaden the tax bases. This implies a broadly neutral fiscal stance in 2011.

Executive Directors welcomed the solid, broad-based recovery of the economy from the global financial crisis, buttressed by the authorities’ skilful economic management.

Growth is expected to continue robustly above its potential this year, and the medium-term outlook remains favourable. Directors noted the build-up of inflationary pressures and near-term risks linked to uncertainties in the global economy and financial markets. They agreed that the immediate policy priority is to ensure a soft landing and safeguard financial stability—through proactive monetary tightening, greater exchange rate flexibility, and ongoing fiscal consolidation, complemented by macro prudential
policies.

Directors underscored the need to rebalance the sources of growth, reducing Korea’s vulnerability to shocks and promoting inclusive growth. This requires comprehensive reforms aimed at enhancing productivity and competition in the nontradables sector—creating a level playing field with the manufacturing sector while also reducing household indebtedness and social disparities.

Further efforts are needed to deregulate the service sector and expedite a bank-led restructuring of small-and medium-sized enterprises. Directors supported labour market policies to increase formal employment opportunities for women and the elderly, while expanding the coverage of the social safety net to address dualities in the labour market.


Details

Language: English

Year of Production: 2011

Length: 2:30 mins

Country: Korea, Republic of

License

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Directors:

  • Mo Sacirbey (UNTV-IMF)

Producers:

  • Susan Sacirbey (UNTV-IMF)