The Korean economy is gradually slowing with decreased growth in manufacturing, moderated improvements in services and continued sluggishness in construction.
The nominal growth rate remains below the recent trend and the GDI growth rate is fast receding on deteriorating terms of trade.
On the demand side, domestic demand is stagnating with weaker investment and slower consumption growth.
Facilities investment is undergoing a rapid adjustment due to the base effect from the sharp increase in semiconductor-related investments last year while construction investment turned to a decrease.
Private consumption is improving at a slower pace as commodities consumption remains relatively favorable but services consumption is comparatively weak and CCSI plunges.
Led by semiconductors, exports maintained favorable growth but those of other items have been sluggish, widening the industrial gap.
- Export growth has been below that of global trade volume, raising concerns over the weakening competitiveness of the manufacturing industry.
As such, the imbalance between consumption, investment and exports has deepened the differing conditions across industrial sectors.
Accordingly, manufacturing is increasingly rely on semiconductors and services are slowing gradually, serving as the main reason for the stagnant employment.
The global economy is sustaining moderate growth but concerns over a slowdown are mounting on unstable economic conditions in emerging markets influenced by the US rate hike and looming risks from the US-China trade disputes.
International forecasting institutes such as the IMF amended their previous optimistic projections for a global recovery after seeing other major economies beside the US lose their growth steam.
Considering the recent changes in internal and external economic conditions, the short-term macroeconomic policy should maintain its current accommodative stance to counter possible economic instability.
Fiscal policies must be flexibly managed in response to changing economic conditions in the future and the pace of fiscal expenditure should be properly adjusted based on reviews of the mid- to long-term fiscal demand.
Monetary policies should remain accommodative, considering that demand-side inflationary pressure is still low while domestic demand growth is slowing.
Meanwhile, it is becoming increasingly difficult to sustain steady growth even in the long-term due to the internal and external economic landscape and changing global trade conditions.
Global trade volume is exhibiting signs of weakening growth and Korea’s dependence on exports remains high, fueling concerns over slow growth resulting from the diminished competitiveness of the export manufacturing industry.
Accordingly, policy efforts are strongly needed to enhance the sustainability of growth, such as by finding new growth engines in the services industry while, at the same time, heightening the competitiveness of the manufacturing industry.
To bolster economic activities and increase growth potential, structural reform policies must be more actively executed. At the same time, long-term policy alternatives should be prepared and implemented to mitigate the possible side effects from the reform.
A productivity-friendly environment must be created through the smooth transition of human resources which can be achieved when ineffective factors such as rigidity of labor conditions are removed from the economy.
Active countermeasures are required to enhance competitiveness of the export manufacturing industry by implementing restructuring and regulatory reforms aimed at heightening the competitiveness of key industries.
Attention must be paid to reinforcing the driving force of structural reform by exercising policy leadership to actively resolve problems such as conflicts of interest and the lack of social safety nets that can arise during the structural reform process.
- Instead of being put to use for short-term economic stimulus, fiscal space obtained through strengthened fiscal discipline should be used to consolidate policy leadership necessary in securing social safety nets and promoting seamless structural reforms such as retraining human resources and to implement supplementary measures.
Ⅱ. Domestic Economic Outlook for 2019
1. Assumed External Conditions
The global economy will continue to grow in 2019 at a similar rate to 2018.
The IMF foresees the global economy growing 3.7% in 2019, the same as 2018, as major advanced economies recede slightly but emerging market grow at a favorable pace.
However, the gap between the growth rates of advanced economies is widening and the financial markets in a few emerging countries are showing signs of instability, escalating uncertainties over global growth.
Crude oil prices will climb by 7% from 2018 to around $77 per barrel in 2019.
The value of the Korean won, in terms of the real effective exchange rate, will descend by 1% in 2019.
2. Outlook for Domestic Economy
Korea is projected to grow 2.6% in 2019, an inch down from 2018 (2.7%), as export growth moderates and domestic demand slows.
Despite rises in household income and effects from job creation projects, private consumption growth will slightly decrease from 2018, influenced by falling asset prices and households’ debt repayment burden.
Facilities investment will continue to see slow growth in 2019, as the unprecedently huge investment in semiconductors is expected to subside and investment demand in other sectors will be marginal.
Construction investment will remain stagnant as the downward trend in the civil engineering sector eases and the building construction sector sees an increased decline led by residential building construction.
Exports will continue to grow at a rate exceeding GDP growth overall in spite of the slowing global trade volume and gradual decline in the high export of specific items such as semiconductors.
The current account is projected to run a slightly increased surplus from 2018 as the services account deficit decreases.
Headline inflation is expected to stay at a mid-1% influenced mostly by oil price hikes while core inflation is likely to remain similar.
Employment growth is projected to improve slightly from 2018 while the unemployment rate remains similar to 2018 as domestic demand slows and overseas demand moderates gradually.
Externally, the lackluster growth of the global economy and trade volume, falling unit prices of major export items and weakening global competitiveness could become downside risks to growth projections.
The growth of the global economy and trade volume will fall below projected figures if advanced economies (excl. the US) slow faster than anticipated or the US rate hikes incur and spread anxiety in emerging countries without strong fundamentals.
If semiconductor prices plunge or the global competitiveness of major export items weakens at an accelerating pace due to China’s catch-up, Korea’s terms of trade will deteriorate and export market shares will shrink, leading to slower-than-expected growth.
Meanwhile, if the US-China trade disputes protract and hence the growth in global trade volume slows faster than expected, this will likely have a negative effect on Korea’s economic growth.
Internally, soaring market interest rates and falling asset prices could pose downside risks and accelerating improvements in consumption driven by government policies will serve as an upside risk.
If asset prices plunge amid soaring market rates, the financial market will become highly volatile and marginal households’ repayment ability will be significantly diminished. As a result of the shrinking domestic demand, Korea‘s economic growth will likely contract faster than projected.
Meanwhile, if policies to enhance household income generate tangible benefits, consumer sentiment will continue to rise and private consumption will expand rapidly, meaning that Korea will grow faster than expected.
Ⅲ. Policy Recommendations
1. Fiscal Policy
Fiscal policies need to continuously enhance the efficiency of expenditure to prepare for an increase in the mid- to long-term fiscal expenditure while ensuring that budgets for key policy agendas are implemented seamlessly.
Budget bills for 2019 are expansionary in order to resolve the pending economic and social issues while enduring slight increases in national debt and operational balance deficit.
Budgets for key issues and policy agendas such as job creation, innovative growth and quality of life should be used as planned without any setbacks. And, the progress of major projects must be closely monitored followed by a thorough ex-post evaluation of their accomplishments.
Considering the projected increase in fiscal demands, efforts are required to achieve fiscal sustainability by formulating the rules for mid- to long-term fiscal management.
Reasonable fiscal management rules should be established based on the forecasting of tax revenue and expenditure demand, and fiscal aggregates need to be managed in the mid- to long-term perspective according to these rules.
2. Monetary Policy
Monetary policies should maintain the current accommodative stance in consideration of the recent inflation trend which is showing no signs of a sharp upward turn on slowing domestic demand and stagnant employment.
Influenced by growing inflationary pressure on the supply side, headline CPI growth neared the inflationary target (2%) while core CPI continued the low 1% growth, pointing to low inflationary pressure on the demand side.
When it comes to micro worries such as soaring house prices in the capital region and rising credit risks in certain financial markets, micro-policy tools are more recommendable than a shift towards a tightening stance including a base rate hike as such tools can directly respond to the imbalances in the market.
Meanwhile, to reduce concerns over the possible mounting uncertainties in the global economy leading to instability of the domestic financial market, the Bank of Korea should make concerted and consistent efforts to communicate with the market.