Economic Outlook KDI Economic Outlook 2023-2nd Half November 09, 2023
The Korean economy is expected to undergo a modest recovery of 2.2% in 2024, with exports driving the growth amid slowing domestic demand growth.
- Headline inflation is projected to ease to 2.6% in 2024, down from the previous year's 3.6%, due to slowing domestic demand growth.
- The number of employed persons is expected to increase by 210,000, a decrease from 2023’s 320,000, as the pace of domestic demand growth eases, and the unemployment rate is expected to tick up from 2.7% to 3.0%.
- Private consumption growth is projected to stay at 1.8% in 2024, similar to the previous year’s 1.9%, as high interest rates continue to contract goods consumption.
- Equipment investment is expected to maintain a subdued pace due to prolonged high interest rates; however, a 2.4% growth is forecasted, bolstered by a modest recovery in exports and the base effect of 2023’s 0.2% growth.
- Construction investment is expected to decline by about 1.0%, reflecting the downturn in construction orders received, particularly within the housing sector.
- Exports are expected to continue robust growth; goods exports, especially semiconductors, are projected to see a mild recovery, while service exports, buoyed by gradually increasing travel demand, are forecasted to maintain strong growth.
Ⅰ. Current Economic Conditions
- □ The Korean economy is exhibiting signs of a gradual easing of the slowdown, primarily propelled by a resurgence in exports.
- · Third-quarter GDP growth attained 1.4% YoY, surpassing the previous quarter's 0.9%, and registered a 0.6% SA MoM increase (annualized rate: 2.5%).
- □ On the domestic demand front, private consumption and equipment investment remain subdued amidst persistently high interest rates, while indicators for construction investment still exhibit high growth. Exports are witnessing a moderated decline, with semiconductor demand rebounding, even as global trade momentum diminishes.
- · Private consumption exhibits slowing growth, specifically in the segment of goods consumption that is highly sensitive to elevated interest rates, accompanied by a somewhat diminished consumer confidence.
- · Equipment investment has reversed into a downturn, while construction investment maintains strong growth, though a slowdown looms due to reduced construction orders and deteriorating sector conditions.
- · Inflation is exhibiting a declining trajectory, influenced by the contraction in domestic demand, with the pace of employment expansion also losing momentum, notably within the service sector.
- · While the decline in exports slows, the current account surplus grows, reflecting the domestic demand deceleration.
- □ Considering both domestic and external economic conditions, the Korean economy is projected to see a gradual deceleration in domestic demand growth, but as exports begin to rebound, the contraction in economic activity is expected to moderate.
- · As a result of elevated interest rates aimed at tempering high inflation, a slight decrease in consumption and a substantial contraction in construction investment are expected.
- · With major economies maintaining high interest rates, global growth is expected to continue at low levels. Nonetheless, improvements in the global semiconductor market are expected to drive a recovery in Korea's exports.
- · The Korean economy is anticipated to see a modest recovery, leading to a slight increase in growth.
- □ Given these conditions, macroeconomic policies should continue to be stringent for the time being to ensure inflation stability, while also emphasizing the maintenance of fiscal prudence over the medium to long term.
- · Despite the slowdown in inflation rates due to high interest rates, inflation still significantly exceeds the target, necessitating the maintenance of a tight macroeconomic policy stance.
- · The rapidly aging population and the resultant increase in fiscal demand threaten medium- and long-term fiscal prudence, necessitating a comprehensive restructuring of fiscal expenditures, including mandatory spending.
- · When companies and financial institutions face insolvency, it is essential to encourage restructuring to bolster fiscal responsibility and prevent the accumulation of insolvency.
- □ Concurrently, structural reforms across the entire economy are essential to enhance the dynamism of the Korean economy.
- · The Korean economy is anticipated to see a gradual slowdown in potential growth, burdened by rapid demographic shifts and also face escalating global market competition due to technological advancements in China and other nations.
- · To adeptly navigate changing domestic and international landscapes and strengthen economic vitality, policy initiatives should concentrate on structural reforms, such as the reduction of market entry barriers, increased labor market flexibility, and education system reform.
Ⅱ. Domestic Economic Outlook for 2024
1. Major Assumptions on External Conditions
- □ The global economy is assumed to persist in its slow growth in 2024, following 2023's trends.
- · The IMF forecasts a global economic growth rate of 2.9% for 2024, a slight decrease from 2023’s 3.0%, amid extended periods of high interest rates in major economies and a slowdown in China’s economy.
- □ Crude oil import prices (Dubai) in 2024 are assumed to be in the mid-$80s per barrel, following the trends from 2023.
- □ The Korean won, in terms of the real effective exchange rate, is assumed to remain little changed from recent levels.
2. Domestic Economic Outlook for 2024
- □ The Korean economy is expected to experience a modest 2.2% recovery in 2024, led by exports, amidst slowing domestic demand growth.
- · The GDP growth for 2024 is anticipated to be marginally above the potential growth rate of 2%, partially due to the base effect of the slow growth in 2023, which was 1.4%. Consequently, the recovery is expected to be modest.
- · Private consumption growth is projected to stay at 1.8% in 2024, similar to the previous year’s 1.9%, as high interest rates continue to contract goods consumption.
- · Equipment investment is expected to maintain a subdued pace due to prolonged high interest rates; however, a 2.4% growth is forecasted, bolstered by a modest recovery in exports and the base effect of 2023’s 0.2% growth.
- ·Construction investment is expected to decline by about 1.0%, reflecting the downturn in construction orders received, particularly within the housing sector.
- · Exports are expected to continue robust growth; goods exports, especially semiconductors, are projected to see a mild recovery, while service exports, buoyed by gradually increasing travel demand, are forecasted to maintain strong growth.
- □ The current account surplus is projected to widen as exports pick up and domestic demand growth decelerates.
- □ Headline inflation is projected to ease to 2.6% in 2024, down from the previous year's 3.6%, due to slowing domestic demand growth.
- □ The number of employed persons is expected to increase by 210,000, a decrease from 2023’s 320,000, as the pace of domestic demand growth eases, and the unemployment rate is expected to tick up from 2.7% to 3.0%.
- · Nevertheless, the number of employed persons is expected to see high growth in 2024, supported by an expanding labor supply, particularly from women in their 30s.
3. Risks to the Outlook
- □ If oil prices spike on escalating geopolitical tensions, or if China's real estate market plunge, the recovery of the Korean economy could be delayed.
- · Escalation of the Israel-Hamas conflict, potentially affecting the broader Middle East and pushing global oil prices higher, might lead to higher production costs and lower real income, thereby postponing economic recovery.
- · A marked decline in China's real estate market, along with a deterioration in the financial soundness of its construction firms and a significant deceleration in real investment, could slow the pace of Korea's economic growth.
Ⅲ. Policy Recommendations
1. Fiscal Policy
- □ The proposed 2024 budget calls for a 2.8% increase in total expenditures, marking the lowest increament since 2005, while projected total revenue is set to fall by 2.2%, leading to an expected widening of the fiscal deficit and national debt from 2023 levels
- · Affected by 2023's economic downturn and the slump in asset markets, national tax revenues are set to decrease in the 2024 budget bill to 367.4 trillion won, down from 400.5 trillion won in the previous year's main budget. This adjustment brings the total projected revenues to 612.1 trillion won, a reduction of 13.6 trillion won from the previous year.
- · Even with the restructuring of fiscal expenditures, the operational fiscal balance is forecasted to register a deficit of 3.9% of GDP, surpassing the government's fiscal rule ceiling of 3%.
- · Consequently, the ratio of national debt to GDP is anticipated to increase from 50.4% to 51.0%.
- □ To bolster fiscal sustainability, it is essential to implement policy measures aimed at restructuring overall fiscal expenditures, including mandatory spending.
- · The aging population will likely lead to increased public pension expenditures, such as for the national and basic pensions, and higher fiscal demand for national health insurance and long-term care insurance for the elderly. Conversely, income tax revenues and social security contributions are anticipated to diminish due to the declining workforce.
- · This trend could precipitate a sharp increase in national debt, posing a serious risk to medium- to long-term fiscal sustainability.
- · Managing mandatory spending, unlike discretionary expenditures, requires legislative action for adjustments, posing a challenge. Nevertheless, it is essential to rationalize this rapidly increasing expenditure to ensure fiscal stability in the medium to long term.
2. Monetary Policy
- □ The current stringent monetary policy should continue for the time being to help steer inflation towards the 2% target.
- · Given that inflation is slowing overall but still well above the target, maintaining the tight monetary policy is crucial.
- · Moreover, monetary policy should aim for the inflation rate to meet the stability target, rather than reacting to short-term inflationary fluctuations.
- □ Interest rate disparities between countries are a natural consequence of differing inflation rates and economic conditions. Korea's monetary policy should be independently implemented, customized to its domestic price levels and economic situation.
- · Korea's inflation rate remains above its target, which is lower compared to that of major countries, with expectations to meet the target in the near future.
- · This suggests that Korea might not require as stringent monetary tightening as other countries.
- · It is vital for Korea to formulate its monetary policy based on its own macroeconomic conditions rather than mirroring the US interest rate trends, which are set to address strong inflation and robust economic growth.
3. Financial Policy
- □ The expansion of policy financing prompted by the COVID-19 pandemic should be scaled back gradually. Policies must encourage self-reliance efforts, shifting away from bailouts for financial institutions and companies that have failed to manage financial risks effectively.
- · Given that information asymmetries tend to intensify during a crisis, ensuring the seamless functioning of financial markets through policy financing is essential. After the crisis, it becomes necessary to retract this financing to facilitate efficient resource allocation.
- · As the COVID-19 crisis subsides and systemic risk concerns are considered less severe, a gradual unwinding of defaulted assets is imperative to deter moral hazard among financial institutions and firms.
- · As delinquency rates rise among vulnerable sectors, including SMEs and individual business owners, continuous monitoring of financial institutions' loss-absorbing capacity is critical to prevent the need for future policy interventions.
- □ Houshold loans continue to expand despite high interest rates, warranting a phased reduction in exemptions to the Debt Service Ratio (DSR) regulations to uphold financial stability.
- · Since the second quarter of 2023, household loan growth has accelerated, notwithstanding the elevated interest rates.
- · To curb household loan expansion and mitigate prudential risks, it is essential to reduce exemptions to the DSR regulations and adopt a stress DSR rule, thus ensuring households incur debt levels aligned with their repayment capacity.
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