Ⅰ. Current Economic Conditions

• Recovering fast from the financial crisis, the Korean economy registered a growth high growth rate of 7.5 percent in the second quarter of 2010, and then gradually normalized with a growth rate of 4.2% in the first quarter of 2011.
  - Korea's potential growth rate was estimated to be at a low to mid 4% level before the global financial crisis and this potential growth rate still holds, considering the causes of the recent crisis and Korea's response to the crisis.
• The production in both the mining & manufacturing and service industries recently show signs of slight moderation in the adjustment process of the rapid upward trend since the second quarter of 2010.
• Production․inventory cycle appears to gradually return to the normal business cycle of the pre-crisis period, as the growth in inventory declines while the growth in the mining & manufacturing production is being maintained.
  

• Private consumption continues to rise at a moderate pace, as household incomes rises due to the improvement in employment conditions.
  - In 2011, household income is projected to grow steadily, as the proportion of labor income (the salary payment of employees against GDP) recovers at a gradual pace after a sharp fall in 2010.
• Equipment investment maintains a favorable upward trend, but investment in construction appears to remain weak even up until recently with a delay in its recovery.
• Meanwhile, exports continue a steady growth pace, as emerging market economies sustain the growth momentum and advanced economies are gradually improving.
  

• Employment growth has been sustained with approximately 400,000 persons since the mid 2010, mainly supported by the private sector. Influenced by growing employment possibilities, the labor force participation rate has risen.
• The rise in employment is increasingly evident particularly in the manufacturing industry and among regular workers, which indicates improvement in the quality of employment.
  

• CPI inflation, which was mainly triggered by the supply-side factors, such as the agricultural, livestock and marine products and international raw materials, combined with the aggregate demand pressure, which has been accumulated during the economic recovery process, spread to the service industry.
• As the high inflation raises the expectation for price hikes, there are concerns of continuing inflation due to a vicious cycle of the 'price-wage spiral.'
  - The rate of wage growth, which in the past was close to the nominal economic growth rate, fell much lower, in relative term after the financial crisis.
  - As the Demand for salary increase is expected due to the improved corporate performance and employment conditions along with the rising expectation of inflation, which will amplify the demand for wage increase.
  

• Korea's household debt against income is at a relatively high level, compared to that of OECD nations, such as the US and UK.
  - In the US and UK, household debts have been under adjustment since the global financial crisis, whereas in Korea, household debts continue to rise despite a gradual increase in the base interest rate.
  

• Notwithstanding the contraction in the US housing market, the concern over fiscal instability of some European nations, and the recent massive earthquake in Japan, advanced economies are recovering at a moderate pace.
• Emerging market economies are adopting contractionary fiscal stance in response to the spread of inflationary pressure, while most countries, including China, maintain a steady pace of growth.
• Reflecting these conditions, major economic forecasting institutions, such as the IMF, maintain an overall positive outlook for the global economic growth rate.
  

• Crude oil and raw material price fluctuations have increased due to geopolitical instability in some oil-producing countries and the massive earthquake in Japan, while the increasing demand, particularly from emerging markets, raises the price of raw materials.
• The rising crude oil and raw material prices worsen terms of trade holding back the GDI growth rate below the GDP growth rate.
  - The price hike of crude oil and raw materials limits the purchasing powers of an economy, such as corporate profits and household income, negatively affecting investment and consumption.
  - The Korean economy faces a growing burden due to the increasing crude oil import costs in the share of the (nominal) GDP, as the international oil prices have risen rapidly since 2002.
  

• Exports are expected to continue a steady upward trend in midst of sustained growth momentum of the global economy, while domestic demand faces some restraints, such as aggravated terms of trade and delay in the construction economy, despite improved employment conditions.
• Accordingly, it is expected that Korea's growth rate, in general, will be maintained similar to its potential growth rate, while the growth contribution of domestic demand will decrease compared to 2010, and that of net exports will turn into positive territory.
  

• In a short-term perspective, it is necessary to build capacity for managing possible external shocks by restoring fiscal soundness, while reinforcing policy efforts to stabilize inflation, such as interest rate normalization, and resolving internal instability relating to household debts and savings banks.
• Meanwhile, when terms of trade worsen due to the price rise in crude oil and raw materials, it will be necessary to instill policies that will promote effective use of energy.
• Furthermore, in order to strengthen growth potential it is necessary to sharpen competitiveness through expanding market openness along with consistently pursuing restructuring and at the same time, enhance social integration by extending social safety net as well as improving labor-management relations.
  

Ⅱ. Economic Outlook for 2011

1. Major Assumptions

2. Major Forecasts for 2011~2012

• Korea's GDP is forecast to record a growth rate of 4.2% in 2011, as both exports and domestic demand continue to rise. And, in 2012, the rate is forecast to reach 4.3%, as advanced economies gather substantial momentum at a gradual speed.
• Private consumption is expected to register 3.5% growth in 2011, slightly lower than the GDP growth rate, as employment conditions and household income improve but while GDI weakens due to the rising oil prices.
  - In 2012, private consumption is expected to register 3.8% growth rate, as terms of trade, including oil prices, stabilize.
• Equipment investment is projected to register a steady growth rate of 6.9% in 2011, influenced by high operation ratio, favorable corporate profits, and decrease in the import cost of capital goods.
  - In 2012, equipment investment is projected to maintain a stable growth rate of 6.5%.
• Construction investment is forecast to decrease by 0.9% amid the sluggish investment by the public sector in 2011, as the housing sector experiences a delayed recovery due to the worsening financial conditions and restructuring in construction companies.
  - In 2012, construction investment is forecast to record 3.4% growth as a rebound from the poor performance thus far, as the restructuring in construction companies gradually come to an end and the housing market is being restored slightly.
• The goods export (in volume terms) in 2012 is forecast to register a relatively high growth rate of 12.8%, due to the recovery trend of the global economy. Goods export is expected to reach 11.1% in 2012, as advanced economies show a stronger recovery momentum.
• The goods import (in volume terms) is expected to register 12.1% growth in 2011 and 10.9% in 2012, as domestic demand continues to rise and the won's value rises.
  

• Current account surplus is expected to record $11.2 billion in 2011 and $8.2 billion in 2012, as goods account surplus decreases and services account deficit increases due to a stronger won and the rising international oil prices.
  

• Headline CPI inflation in 2011 recorded an annual average growth rate of 4.1% in 2011, and is expected to decrease to 3.3% in 2012 due to base effects despite the continuing inflationary pressures.
• Meanwhile, the core inflation is expected to record 1.8% in 2010 and 3.4% in 2011 and 2012, gradually reflecting the expansionary pressure of aggregate demand due to the continuing upward trend of economic growth.
  

• Unemployment rate is expected to decrease by an annual average growth rate of 3.5% in 2011 and 3.3% in 2012, recovering towards the pre-crisis level.
• Influenced by the continuing economic recovery, it is expected that the labor force participation rate will rise and the upward trend of the number of employed, currently over 300,000 particularly in the private sector, will continue to rise.
  

Economic Forecast for 2010~11

(year-on-year basis, %, USD 100 million)

• The fiscal policy stance for 2011 is considered somewhat contracted (based on the fiscal impulse index).
• If the budget is implemented accordingly, the recovery trend of fiscal soundness will continue with a slight surplus in the consolidated fiscal balance and the fall in the national debt against GDP.
• The draft budget for 2012 needs to establish fiscal regulations based on the 'fiscal rules' of the National Fiscal Management Plan for 2010~14 which sets the growth rate of the total expenditure lower than the growth rate of the total revenue by 2~3%p.
  - It is necessary to establish fiscal regulations so as to minimize negative effects brought by political factors, such as the upcoming general and presidential elections next year.
  

• As for the fiscal expenditure, it is necessary to improve the efficiency and effectiveness of the rapidly growing expenditure for welfare and R&D, while responding to the rising demand for welfare expenditure by reducing the expenditure for the economy section.
• As for the fiscal revenue, it is necessary to continue efforts for expanding more tax bases, such as by reconsidering tax exemptions and reduction systems.
• Meanwhile, given that the debt ratio of public enterprises is on a constant rise despite moderate improvement in their management performance in 2010, it is necessary to reinforce the supervision and management assessment on the fiscal soundness of public enterprises so as to encourage them to restructure their debts.
  

2. Monetary Policy

• The rapid rise in CPI is moderately slowing down, but the demand-side inflation pressures seem to be expanding at a fast pace, influenced by the continuing growth momentum of the Korean economy.
• Nevertheless, current base interest rates remain still at a low level, compared to economic conditions, such as the growth rate. As long as the low interest rate policy remains unchanged, inflation expectations are not likely to be stabilized easily.
• Under this context, it is necessary to secure the confidence of economic players on "inflation stability," the main objective of the monetary policy and the government's policy commitment by implementing more active responses, such as raising interest rates.
  - The core of "Inflation Targeting System" is to secure the confidence of economic players on the central bank, and the most important instrument of delivering the policy commitment of the central bank is the adjustment of the base interest rates.
• Meanwhile, considering that the rise in the Korean won's value caused by the changes in economic conditions, such as the rising interest rates and continuing growth, would contribute to stabilizing inflation, it is necessary to make efforts to settle the foreign exchange policy that enables the decision on the exchange rate within the market.
  

3. Financial Policy

• Concerns are growing over potential risks caused by household debts, as household loans by non-bank financing corporations are recently on a rapid rise amid the already high household debts.
  - Recently, household debts by non-bank financing corporations--deemed to have a relatively weaker risk management ability--and credit card loans with a relatively higher lending rates have been on the rapid rise, compared to household loans by banks.
• In this regard, it is necessary to steer the components of mortgage loans toward offsetting the structural weakness of household debts in the short-run, while strengthening the monitoring mechanism on household loans by non-bank financing corporations.
  

• The recent problems caused by savings banks are not only the result of excessive risk-taking behaviors by the management who abused the deposit insurance system, but also the result of the malfeasance stemmed from poor governance.
• Therefore, it is necessary to prevent excessive risk-taking behaviors by savings banks through a reform on the deposit insurance and financial supervision systems.
  

4. Labor Market Policy

• It is necessary to immediately establish a social safety net for the poor self-employed who are highly likely to fall into poverty.
  - Immediate actions are required to pass the revised bill that allows the self-employed to become temporary insurant to the unemployment insurance (unemployment benefits) so as to relieve their risk of income loss due to involuntary business closure.
• It is necessary to change the recruitment practice towards putting more focus on the career in the job market in order to alleviate the contraction in the youth employment caused by the prolonged period of employment preparation.
  

• It is necessary to reinforce expertise and the functionality of labor relation commission in order to properly respond to various disputes caused by legally allowing multiple unions.
• It is necessary to develop measures to eliminate discrimination against in-house subcontracted workers who are currently under no protection by the Non-regular Workers Act.