KDI Korea Development Institute

Economic Outlook Korea Development InstituteFebruary 09, 202312p KDI ECONOMIC OUTLOOK | UPDATE 2023.02
Ⅰ. Current Economic Conditions □ The Korean economy is slowing down further due to sluggish exports as external conditions deteriorate. GDP growth for Q4 saw a decrease of 0.4% quarter on quarter, driven by private consumption slowdown and export contraction. As the global economic downturn dragged down export by a huge falloff, especially in semiconductors, domestic demand had a limited recovery on persistent high inflation and interest rates. The global economy is slowing down with a decline in trade, and China is facing a temporary setback as the COVID-19 pandemic rapidly spreads after lifting restrictions. □ At the same while, there is growing anticipation for an economic recovery backed by improving economic sentiment in China and a gradual decline in inflation in major countries. In light of favorable weather conditions in Europe and the widespread effects of stringent monetary policy, energy prices are decreasing and inflation in major nations is receding. Positive signals of future global economic recovery are emerging, including the weakening dollar due to declining expectations for a rate hike in the US and improved economic sentiment following China's resumed economic activity (reopening). □ The Korean economy is expected to experience a deeper slowdown in the first half of 2023, before gradually recovering in the latter half. Due to China's resumed economic activity leading to a temporary increase in infections and economic contraction, the growth of the Korean economy in the first half may underperform the previous projection. Conversely, a rebound of China's economy may positively impact Korea's exports in the latter half, potentially driving economic growth beyond previous projections. Ⅱ. 2023 Domestic Economic Outlook 1. Assumed External Factors □ The global economy is expected to slow down in 2023. The IMF projects its world economic outlook in 2023 to fall from 3.4% in 2022 because of stringent monetary policies. However, its 2023 outlook has been slightly revised upward to 2.9% from the October projection of 2.7%, considering the effect of China's reopening efforts. □ Crude oil price (Dubai) is expected to drop by 17% from 2022 ($96 per barrel), marking around $80 per barrel in 2023. □ The value of the Korean won, in terms of the real effective exchange rate, is expected to appreciate by about 4% in 2023, reflecting a weaker dollar in recent months. 2. Domestic Economic Prospects □ Whereas the estimate for private consumption growth is slightly lower than the earlier outlook, the Korean economic outlook remains unchanged at 1.8% as the export slump eases due to the rebounding global economy. The economy is expected to see a deeper slowdown in the first half of 2023 followed by a faster recovery in the latter half, keeping the annual growth outlook unchanged from the previous projection. Private consumption is projected to increase by 2.8%, lower than the previous projection (3.1%), due to the decrease in real income caused by the increase in public utility rates. Facilities investment is anticipated to rise by 1.1%, a slight upward revision from the previous projection (0.7%), due to improving external conditions. Meanwhile, the estimate for construction investment remains unchanged. Exports are expected to see a 1.8% increase, up from the previous projection (1.6%), mainly driven by the growth of service exports resulting from a surge in Chinese tourists and China’s reopening. □ The current account surplus is projected to reach $27.5 billion in 2023, higher than the earlier projection ($16.0 billion), reflecting the upward adjustments in export growth as well as terms of trade driven by falling oil prices (a larger decrease in import prices). □ Despite the downward adjustment of global oil prices, headline inflation is expected to reach 3.5% in 2023, up from the previous projection (3.2%), due to the deferred impact of supply-side inflationary pressure on public utility rates. □ The number of employed is anticipated to rise by 100,000 in 2023, up from the earlier projection (80,000), reflecting the growth in the domestic face-to-face service industry backed by China’s reopening. 3. Risks to the Outlook □ Suppose sustained economic recovery in China or extended rate hikes against persistent high inflation, and it may hamper the pace of economic recovery in Korea. Considering the potential impact of China’s economic recovery on Korea’s rebound in the latter half, if China’s efforts to contain the spread of COVID-19 prove ineffective or if a setback in the real estate market causes a ripple effect on economic activity, Korea may experience a slower-than-anticipated growth due to a delayed recovery in exports. In the event that the decline in inflation slows due to risks like the escalating Ukraine crisis, US-led global trends in monetary policy may get tighter, destabilizing financial markets and limiting the pace of recovery in the world economy. □ Domestically, if the decline in the real estate sector spills over into the real economy, Korea’s economic growth could be hindered, particularly inprivate consumption and construction investment.
Economic Outlook Korea Development InstituteNovember 10, 2022187p KDI Economic Outlook 2022-2nd Half
Ⅰ. Current Economic Conditions □ Despite improving domestic demand, the Korean economy is losing growth momentum as exports turn weak on unfavorable external conditions. The seasonally adjusted GDP increased at a mere 0.3% (QoQ) in Q3, reflecting the declining contribution of net exports to GDP growth. □ Domestically, the trend of strong private consumption continues, and investment has gathered some steam. The labor market remained resilient owing to the service industry, while exports have slackened on the slowing global economy. External conditions are most likely to exacerbate in the coming quarters. Private consumption rebounded, led by the face-to-face service industry, and the contraction in investment has temporarily eased. With a huge gain in the number of employed persons, the employment rate maintained high growth, with unemployment kept low, which indicates strength in the labor market. However, the current account turned into a deficit while exports (value) shrank mainly in semiconductors due to the global economic slowdown. While headline inflation is rising fast, expected inflation picked up, too. The market interest rates moved higher amid rising private debt, putting a drag on the recovery of domestic demand. □ Given the overall external and internal economic conditions, the Korean economy is heading into a downturn due to lower exports and investment. Exports are expected to weaken further in the subsequent quarters as major countries move toward faster rate hikes to curb high inflation, taking a toll on the world economy. On the other hand, the recovery in private consumption led by face-to-face services will likely help partially offset the economic slowdown as it gradually shakes off the impact of the COVID-19 pandemic. In 2023, the Korean economy is expected to remain on a downward slope, reflecting the global economic slowdown and rising market interest rates. □ In the short term, macroeconomic policy needs to remain tight, given persistently high inflation, while sustaining efforts to improve financial soundness. Considering prolonged higher inflation, it is necessary to gradually raise the policy rate and control fiscal expenditure growth to manage inflation expectations within the target range. The pace and timing of macroeconomic tightening need careful calibration in light of the expected economic slowdown. The stance of normalizing macroprudential policy should be maintained, considering the risk of potential instability in both domestic and global financial markets. □ Tackling the economic slowdown contributed by the rapid aging of the population requires policy efforts to moderate the contraction in labor supply and improve productivity. Korea’s potential growth is expected to gradually diminish as the labor supply shrinks and capital accumulation slows, largely due to shifting demographics. Employment conditions should be improved to encourage the active participation of women who, despite high productivity, typically stay out of the labor force due to childbirth and rearing, as well as elderly citizens whose proportion is rapidly increasing. Also, a reduction in labor supply needs to be countered by actively accepting foreign workers. Concerted policy efforts are also required to achieve higher productivity by completing institutional reforms, such as trade openness and regulatory rationalization, which aim to strengthen Korea’s economic vibrancy. While efforts to strengthen the growth potential are of reasonable necessity, the government should not be myopic and focus only on short-term stimulus in seeking a goal that greatly exceeds its growth potential. Ⅱ. Domestic Economic Outlook for 2023 1. Assumptions on Internal and External Conditions □ The global economy is assumed to slow down in 2023. The IMF projected that the global economy would record a mere 2.7% due to tighter monetary stances in major economies and the possibility of an economic recession in China. □ Crude oil prices (Dubai) are assumed to mark around $84 per barrel in 2023, down 15% from 2022 ($98 per barrel). □ The Korean won, in terms of the real effective exchange rate, is assumed to depreciate by about 4% in 2023. 2. Domestic Economic Outlook for 2023 □ The Korean economy is projected to grow by a mere 1.8% in 2023 due to a considerable loss in export growth and a steady decline in investment. In 2023, the Korean economy is likely to remain on a recessionary course, growing slower than its potential rate of 2%. Consumer spending is expected to rebound as the pandemic’s impact wears off. Still, private consumption will likely decrease by 3.1% in 2023 from 4.7% in 2022, as real purchasing power weakens on high inflation and goods consumption decreases on increasing market interest rates. Equipment investment is expected to remain low at 0.7% in 2023, following the trend of 2022 (-3.7%) on a slowdown in the semiconductor industry and mounting external uncertainties. The contraction in construction investment (-3.0% in 2022) is expected to continue into 2023 (0.2%) as the housing market turns weak and financing conditions deteriorate. Despite the recovery in services exports backed by increasing human mobility between countries, exports are expected to increase by only 1.6% as goods exports remain stagnant due to the global economic slowdown. □ The current account surplus is projected to decrease to $16.0 billion in 2023 from 2022 ($23.0 billion) as the deficit in the service account widens. □ With stabilizing oil prices, headline inflation is projected to ease to 3.2% in 2023, but still well above the target (2%). □ In 2023, employment conditions will remain resilient, but the number of employed persons is expected to increase by about 80,000, a sharp drop from 2022 (790,000) due to the base effect and population aging. 3. Risks □ If the US accelerates its rate hikes or the global economy tumbles, the Korean economy will likely see a further contraction, particularly in exports and manufacturing. If the strong dollar persists with faster rate hikes in the US, other countries may face further inflationary pressure with shrinking global trade, which can negatively impact Korea’s exports. If the Chinese economy plummets on its zero-COVID policy and property slump, the demand fall in China can cause a decline in Korea’s exports. Also, the production disruptions in China may lead to more disruptions in global supply chains, adding to downside risks. Not only that, if raw material and grain prices soar as a consequence of the deepening crisis in Ukraine, the pressures of rising inflation and the economic slowdown will rise significantly worldwide. □ Internally, if the base rate rises sharply or a credit crunch occurs in the financial market, the Korean economy is likely to see a further contraction. While private debt is high, raising the base rate creates significant downside risks to economic activity. In case of corporate financing troubles led by the corporate bond market and if they spill over into other sectors, Korea’s economic growth might fall quite sharply, mainly in investment. Ⅲ. Policy Recommendations 1. Fiscal Policy □ The 2023 budget bill puts a heavier emphasis on achieving fiscal soundness compared to this year’s stance. The government’s total tax revenue growth (13.1%) exceeded expenditure growth (5.2%). Hence, the fiscal deficit and government debt as a percentage of GDP is set to decrease from the 2022 main budget. In line with the monetary authority’s high priority on price stability, the budget bill focuses on the economy’s structural transformation and support for the vulnerable instead of stimulus programs. □ The medium-term fiscal management plan adjusted the COVID-19-related additional expenditures as part of the effort to strengthen fiscal soundness, and this may be a step in the right direction. An efficient fiscal management plan is required to achieve stronger fiscal sustainability. The 2023 budget bill aims to manage the government debt ratio within 50% in the medium term by revising the previously set spending increase under the 2022-26 fiscal management plan in response to the COVID-19 crisis. The government needs to create sufficient fiscal space and improve fiscal sustainability by flexible management of the fiscal structure in response to changing demographics, such as low fertility and population aging. 2. Monetary Policy □ The monetary policy needs to remain contractionary for the time being to keep inflation expectations stable while allowing for the possibility of economic slowdown when determining the pace of future rate increases. The inflation rate has been well above the target (2%) since Q4 2021, and bringing it down requires a significant monetary-policy response. Still, the forward-looking monetary policy recommends slowly raising the policy rate, given the possibility of severe contraction in economic activity. □ At the same time, the monetary policy needs to pay particular attention to domestic inflation and economic conditions. A rapid rate hike adopted in the US and Eurozone should not necessarily be the case for Korea considering its current domestic economic conditions. It is recommended that the monetary policy should focus on the stabilization of macroeconomic fundamentals, such as inflation, economic activity, and financial system while tolerating currency fluctuations in line with the purpose of the free-floating exchange rate system. In addition, if the FX market becomes unstable, the monetary authority should take needed actions to resolve a foreign currency liquidity crunch and resulting risks to the financial system. 3. Financial Policy □ While maintaining the stance for stronger macro-prudentiality, the government should also reexamine the protocols for ex-ante risk management to prevent a series of insolvency. Banks' business loans continue to grow, but the bond market is experiencing a temporary liquidity crunch, indicative of instability in the financial market. The higher the risk of instability in the financial market, the more efforts are required to strengthen financial soundness in parallel with clearing out insolvent assets. Accordingly, it calls for effective policy intervention to alleviate the credit crunch only when the risks from a few defaulted assets may transfer to the entire system. Meanwhile, the government needs to identify the systemic risks in each financial institution and lay out a soundness management plan that corresponds to their status. □ The policy needs to manage the legal maximum interest rate in a more flexible manner, considering that soaring interest rates will likely make loan refinancing more difficult for vulnerable households and small self-employed workers. Furthermore, policy programs for vulnerable borrowers are needed to protect them in case of an economic slowdown. Under the fixed statutory interest rate ceiling, vulnerable households may have difficulties refinancing their loan despite rising funding rates. In this sense, the statutory ceiling adopted to protect vulnerable households may pose an obstacle to them. It is necessary to enhance the vulnerable’s access to the financial market by linking the legal maximum interest rate with the market interest rate. Also, since the demand for credit guarantees for small business owners may increase during an economic downturn, preemptive policy actions are required to strengthen the soundness of the balance sheet of the guarantee institutions.
Economic Outlook Korea Development InstituteMay 18, 2022187p KDI Economic Outlook 2022-1st Half
Ⅰ. Current Economic Conditions □ The Korean economy is continuing a moderate recovery on improving exports despite weak domestic demand resulting from the COVID-19 spread and global supply disruptions. It maintains a moderate recovery nearing the existing growth path, even as the seasonally adjusted GDP grew at a slower pace of 0.7% in Q1 than the previous quarter (1.2%). □ By expenditure item, domestic demand slowed on the rapid spread of COVID-19 and strained global supply chains, but exports continued high growth, led by semiconductors. The recovery in private consumption was limited by the coronavirus spread, while equipment and construction investment plunged on lingering instability in global supply for auto parts and construction materials. Exports grew fast on continued improvements in semiconductors despite the contraction in automobiles caused by global supply chain disruptions. As the supply-side price pressure, coupled with the recovery in domestic demand, rippled through the economy, the expected inflation increased, and headline and core inflation far exceeded the target range. Employment remained solid, with huge growth mainly in non-face-to-face businesses and industries closely tied to the government’s job projects. □ Given the overall internal and external factors at play, the Korean economy is likely to continue a modest recovery led by private consumption despite external risk factors. Domestic inflation is under strong upward pressure from persistent high energy and food prices amid deteriorating export and investment from supply chain disruptions and economic slowdown worldwide. However, the service industry will fuel a gradual recovery to continue as private consumption returns from suppressed spending during the pandemic. After the COVID-19 crisis, Korea is expected to see a gradual slowdown in exports, with private consumption emerging as a new growth engine to bolster the economic recovery. □ Macroeconomic policy needs to gradually normalize its accommodative stance in light of the pace of recovery and, simultaneously, tame high inflation and ballooning debt. Monetary policy should slowly raise the base rate to keep the expected inflation within the target range. While retaining policy support for the vulnerable groups, fiscal policy should refrain from stimulus measures considering the recovery pace and high inflation. Financial policy needs to prepare for effective risk response while maintaining a tough stance on macro-prudential regulations. □ New political and economic challenges meet the Korean economy coming out of the COVID-19 crisis, and they require special attention to medium- to long-term structural reform of the economy. Korea is confronted with multiple structural problems demanding immediate action, including demographic changes, polarization, global value chain reconstruction, and the climate crisis. Since those structural issues involve a conflict of interest between stakeholders, their resolution requires leadership to bring out cooperation and understanding among economic actors. At the same time, efforts for international cooperation should continue to work on structural problems facing the globe. Ⅱ. Domestic Economic Outlook for 2022~2023 1. Assumptions on Internal and External Conditions □ The global economy is assumed to rapidly decelerate in 2022~2023. The IMF recently forecasts global economic growth at a much slower pace of 3.6% in 2022 than 6.1% in 2021 due to the Russia-Ukraine war, and the growth will be moderate(3.6%) in 2023. □ Crude oil prices (Dubai) will remain high at $105 per barrel in 2022 and slide a little to $92 in 2023. □ In terms of the real effective exchange rate, the Korean won is assumed to depreciate by about 4% in 2022 and remain little changed in 2023. □ It is assumed that the second supplementary budget bill currently under discussion will be executed as planned in the government’s draft. 2. Domestic Economic Activity Outlook □ The Korean economy is forecast to grow 2.8% in 2022 on shrinking investment and rebounding private consumption but 2.3% in 2023 on slower exports. Private consumption is expected to maintain a solid recovery in 2023 after rebounding mainly in service consumption in 2022, owing to the lifting of social distancing rules and the effect of financial support. Equipment investment is expected to recede in 2022 as the semiconductor-driven surge enters an adjustment phase, followed by moderate growth in 2023. Construction investment is expected to contract in 2022 due to rising construction costs, followed by a gradual moderation in 2023 as supply conditions for construction materials improve. Exports and imports are expected to slow in growth, mainly in the goods sector, due to worsening external conditions. However, the service sector will improve as the cross-border movement of people gradually restarts. □ The current account surplus is expected to narrow sharply in 2022 from the previous year due to deteriorating terms of trade amid slowing exports and imports in volume terms. In 2023, it will rebound slightly as service imports will increase significantly despite the terms of trade improving. □ Headline inflation is expected to rise fast in 2022 led by gradual economic recovery and soaring oil prices and moderate in 2023 as oil prices stabilize. □ The number of employed persons is expected to increase significantly by about 600,000 in 2022 as face-to-face services are back. The favorable growth will continue into 2023 with a reduced increase to 120,000 due to the base effect. The unemployment rate is expected at 3.3% in 2023 after recording 3.1% in 2022, sharply down from the previous year (3.7%). 3. Risks □ In case raw material supply shortage and global supply chain disruptions drag out long-term, or the Chinese economy takes a nosedive, the Korean The unemployment rate is expected at 3.3% in 2023 after recording 3.1% in 2022, sharply down from the previous year (3.7%). □ economic growth may take a hit, especially on exports. Amid the prolonged war in Ukraine, assuming the tension between Russia and the West escalates further, driving up raw material prices with global supply chain disruption extended, it may constrain Korea’s exports and investment to the point of economic contraction, mainly in the manufacturing industry. If China extends extreme COVID lockdowns, the Korean economy may be exposed to considerable downside risk, such as export contraction due to waning demand from China and supply disruptions for intermediate goods procured from China. □ In case the US interest rate hike accelerates and the global economic recovery is limited, especially in emerging countries with weak economic fundamentals, it is likely to have a negative impact on the recovery of the Korean economy. Moreover, if the US rate hike leads to pushing up the domestic market interest rate, it may limit the capacity of private consumption and corporate investment. Ⅲ. Policy Recommendations 1. Fiscal Policy □ Fiscal policy should gradually normalize the sharp widening of the fiscal deficit and the surge of sovereign debt during the COVID-19 crisis. Since the COVID-19 spread is coming under control and the Korean economy is gearing up for recovery, the fiscal stance should gradually move toward normalization from the current expansionary measures. The need for fiscal stimulus to support the economy is not strong for the time being, and putting an additional fiscal burden calls for careful consideration and weighing on recent inflation dynamics and fiscal conditions. □ Compensating damages resulting from COVID-19 measures is unavoidable, but the demand for public spending should dictate government expenditure rather than short-run government revenue fluctuations for fiscal sustainability. The second supplementary budget for 2022 contains fiscal expenditure earmarked to compensate for damages to small businesses and reinforce public safety measures, which are of great need. Deciding on the size of fiscal spending based on the needs and priorities is desirable in ensuring fiscal sustainability and counter-cyclicality. In addition, authorities should improve fiscal soundness and legitimacy of government expenditure by reforming systems for local grants and education subsidies, in which tax revenues determine their budgets. 2. Monetary Policy □ Monetary policy should gradually increase the base interest rate for stable expected inflation. As inflation remains persistently elevated in the overall economy, monetary policy action is needed to stabilize inflation. While maintaining the stance to raise the base rate for the time being, flexibility is required to respond effectively to changes in economic and inflation dynamics. □ Korea’s monetary policy should put more emphasis on domestic inflation and economic conditions as compared to US monetary policy. Instead of following suit with aggressive rate hikes in the US, how domestic inflation and economic conditions affect the changing economic landscape, both internal and external, including the impact of US monetary policy, should be considered in managing monetary policy. Given its economic fundamentals, a rate hike in a major country is not likely to lead to a massive capital flight in Korea. 3. Financial Policy □ Since the surge in private loans in the aftermath of COVID-19 can threaten financial instability, financial policy should maintain its tough stance on macro-prudential regulations and prepare for effective risk responses. Private debt has shot up since 2020, and domestic banks are expected to relax their lending attitudes from Q2 2022. The current trend of rate hikes amid the rapid growth in loan volume suggests higher credit risks in the foreseeable future. To avoid a future crisis and secure the capacity to respond, the financial policy needs to gradually tighten the regulations on banks’ financial soundness and to keep a strong debt service ratio (DSR).

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