Economic Outlook KDI Economic Outlook 2022-2nd Half November 10, 2022
Ⅰ. Current Economic Conditions
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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.
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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.
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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.
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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.
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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
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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.
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Crude oil prices (Dubai) are assumed to mark around $84 per barrel in 2023, down 15% from 2022 ($98 per barrel). |
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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
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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
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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.
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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
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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.
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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
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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.
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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
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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.
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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.
Analysis of current economic issues
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Long-term Economic Growth: Projection and Implications■ According to the analysis, the declining growth rate of the Korean economy since the global financial crisis was mainly attributable to the slowdown in productivity improvement. - During 2001~10, the slowdown in capital supply growth was the main driver of falling economic growth. - In comparison, the contribution of labor supply to growth remained relatively steady in 1991~2019. ■ It is projected that the economic growth rate of Korea will slump to 0.5% in 2050 as the growth starts to slow gradually from the 2020s due to demographic changes like population decline and rapid population aging. - In 2050, the per capita GDP growth rate is expected to stand at 1.3% due to the accelerating pace of population aging, which causes decreasing working-age population and an increasing share of the elderly with low labor force participation. - This long-term growth projection is based on the premise that Korea’s productivity will maintain a 1% growth after a partial rebound from its lowest (0.7%) in 2011~19. - Meanwhile, the potential growth rate of the Korean economy will reach a 2.0% level over the next five years (2023~27). ■ The Korean economy needs to mitigate the negative impacts of demographic changes by actively pushing for structural reforms to enhance productivity. - Institutional reforms in trade openness and regulatory rationalization aiming to boost Korea’s economic vibrancy are necessary to achieve higher productivity. - Employment conditions should improve to facilitate 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 share is rapidly increasing. Also, a reduction in labor supply needs to be countered by actively accepting foreign workers. - At the same time, continued policy efforts are needed, with a particular focus on improving the qualitative capability of human capital through educational reforms. ■ Furthermore, the stance of macroeconomic policy needs to reflect the slowing pace of the long-term economic growth. - 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.
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Jiyeon Kim
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Kyu-Chul Jung
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HUR, Jinwook
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Increase in the Number of Employed Persons: Assessment and Projection■ Unprecedented gains in the recent job market can be mainly attributable to the higher labor demand related to non-face-to-face services and the digital economy resulting from responses and adaptations to the pandemic crisis. - The COVID-19 pandemic dealt a severe blow to employment in face-to-face services but expedited the transition into a non-face-to-face economy and the Fourth Industrial Revolution, creating jobs in the related sectors. ■ While the labor market will remain robust into 2023, the growth of the number of employed persons will decline sharply to 84,000 in 2023 from 791,000 in 2022 as shifting population structures cut down the employment number, and the base effect kicks in. - The number of employed persons is likely to significantly narrow its gain in 2023 owing to the base effect. Still, the employment rate, which reflects the change in employment conditions, is expected to keep favorable contributions at about 102,000. - However, structural changes in demographics, such as the share of the working-age population and age distribution, are expected to bring down the number of employed persons (-18,000) with more explicit negative impacts on labor supply. - The percentage of the prime-age population (30~59) will continue to fall, and the share of the working-age population (15+) will shift to decrease. Accordingly, such a structural change in the population is expected to be the leading cause of the slowdown in the number of employed persons. ■ Since a fall in labor input risks a decline in Korea's economic growth, policy efforts are required to boost the labor supply. - In parallel with enhancing the use of an underutilized workforce of women, young seniors, and foreigners, policy efforts should aim to raise the birth rate in the longer term. - On top of expanding the quantity of labor supply, there should be a human capital development system that can improve labor productivity and promptly respond to rapidly changing labor demand.
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Jiyeon Kim
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Impacts of Currency Fluctuations on Exports and Imports and the Trade Balance■ This study finds that the weakening of the Korean won reduces import value temporarily and, in the mid-term, expands export value, narrowing the trade deficit. - Since the US dollar is the usual choice for payment in international trade, the depreciating won has little impact on export volume in the short term. In contrast, import volume plunges due to the rising import value (in terms of the Korean won). - In the medium term, as product prices are gradually adjusted, the weaker Korean won has a growing impact on the volume of imports. ■ While the recent rise of the dollar has caused a short-term increase in the trade deficit, the analysis shows that the rising rate of won/dollar has partially offset the deficit. - The dollar rally in Q2 and Q3 this year brought about a contraction in overall trade, expanding Korea’s trade deficit by $6 billion for the said period. - On the other hand, the rising won/dollar rate is estimated to offset the trade deficit by $2 billion during that period. - Price adjustment via increasing the won/dollar rate progresses gradually, and the recent strength of the dollar is estimated to reduce the trade deficit by $6.8 billion in the next two years. ■ Fluctuating exchange rates can affect the economy through various channels, and this study reaffirms that currency fluctuations function to mitigate trade imbalance. - Monetary policies appropriate for the macroeconomic conditions of each country cause exchange rates to move, alleviating imbalances between countries. - Accordingly, the currency rate should be allowed to float in line with the supply and demand of the foreign exchange market as long as it operates smoothly and stably. ■ In addition to macroeconomic stability, policy efforts should also seek to protect vulnerable people in economic hardship due to soaring import prices in the dollar rally. - With persistent high inflation, rising prices of items like petroleum products, electricity, and gas, closely tied to import prices, may put further pressure on the vulnerable. - As sweeping policy support for the vulnerable risks conflicts of interest with the policy effort to tame high inflation, policy protection for vulnerable groups should look for ways to provide selective assistance. ■ To enhance the macroeconomic stabilization of foreign exchange rates in the longer term, an environment conducive to wider use of Korean won in international transactions in goods should be promoted. - When international transactions are settled mostly in dollars, the short-term effect of currency fluctuations on exports is insignificant, thus limiting the adjustment of trade imbalance. - In the medium to long run, the government should work to lay the ground for the Korean won to serve as a settlement currency in international trade by strengthening its macro-prudentiality and enhancing the financial and foreign exchange market systems.
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Junhyong Kim
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