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KDI Economic Outlook 2023-1st Half Recent Fluctuations in Current Account: Factors and Implications May 03, 2023

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KDI Economic Outlook 2023-1st Half Recent Fluctuations in Current Account: Factors and Implications

May 03, 2023

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    Kim,Junhyong
Summary
■ The analysis results show that the recent decline in the current account balance was driven by a sustained increase in expenditure despite a decline in income due to deteriorating external conditions.

- The decline in the current account in 2H 2022 was largely due to a decrease in income caused by the decline in the terms of trade, with some contribution from domestic demand.

- In 2023, the current account surplus is expected to narrow to 1.0% of GDP as domestic demand maintains a relatively high increase amid the persistent global economic slowdown.

■ Given the current status of external soundness of the Korean economy, a sharp contraction in the foreign exchange market due to a decline in the current account is unlikely to occur.
- Currently, Korea’s foreign exchange reserves and net foreign assets are significantly different in size from those of countries that have experienced foreign exchange crises in the past, and even if the current account decline persists for one or two years, the likelihood of a foreign exchange crisis due to a decline in net foreign assets appears to be low.

■ Therefore, it is advised that the macroeconomic policy stance should not be sensitive to short-term fluctuations in the current account.

- It is important to note that the narrowing of the recent trade deficit may not guarantee macroeconomic stability.

- Consequently, when assessing the current situation and setting a policy framework, it is necessary to pay close attention to indicators closely related to macroeconomic conditions, such as prices, economic activity, and employment, rather than short-term fluctuations in the current account.
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|   Related information   |
The current account that turned into a deficit in the second half of 2022, has the red light become thicker in our economy? In fact, rather than the current account surplus or deficit itself being a problem, we need to look at the economic implications within it. We analyzed why the current account has recently fallen and what the current account will look like in 2023!
|   Script   |
Recently, Korea's current account experienced a significant decline. Is this an indication of weakening economic fundamentals?

The current account is basically the gap between imports and exports, or the difference between income and expenditure, which comes from economic players making choices based on what's happening locally and globally.
 
Income and expenditure are influenced by numerous factors, which can subsequently cause fluctuations in the current account.

For example, if global trade shrinks or trade terms get worse, income conditions suffer, causing the current account to drop.

Alternatively, when the won's value goes up, Korean exports lose their global edge, leading to less income. This decrease in imports then triggers more spending, which also brings down the current account.
 
The KDI analyzed short-term drivers of Korea's current account fluctuations over the past ten years.

A 1%p increase in global trade volume and terms of trade boosted the current account by up to 0.13%p and 0.43%p, respectively.
A 1% rise in the real effective exchange rate led to an increase of up to 0.09%p.
On the flip side, a 1% bump in domestic demand caused a drop of up to 0.6%p.

So, what's driving Korea's recent current account decline?
 
A key factor is worsening trade terms, like soaring raw material costs and dropping semiconductor prices, which resulted in a 2.4%p decrease in the current account

Meanwhile, domestic demand stayed relatively steady, contributing to a 1.0%p reduction in the current account.

Based on these findings, the KDI projected Korea's current account for 2023.

With domestic demand maintaining favorable growth amid the ongoing global slowdown, Korea's current account is anticipated to show a surplus of 1% of GDP in 2023, lower than in 2022.

The KDI also examined potential effects of the current account decline.

Right now, Korea's foreign currency reserves and net foreign assets are in a much healthier state compared to countries that dealt with foreign exchange crises before.

Plus, Korea is a net creditor nation, unlike net debtor countries, showing a weak link between a falling current account and the risk of a currency crisis.

So, even if the current account deficit lasts for a year or two, it's unlikely that Korea would face a crisis.

(Interviewee: Kim, Jun Hyong, Fellow at KDI)
The recent decline in the current account is primarily due to sustained expenditures in the face of falling income, resulting from worsening external conditions.
Nonetheless, considering Korea's robust external position, this drop shouldn't be a major concern.
 
It is not advisable to hastily adjust macroeconomic policy. We cannot easily control deteriorating external conditions, and attempting to reduce the trade deficit by suppressing domestic demand could adversely affect employment, which is closely linked to domestic economic activity.
In determining future policy direction, it is crucial to prioritize macroeconomic indicators like inflation, economic activity, and employment over short-term fluctuations in the current account.
 
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