Over the past several decades, real estate project financing (PF) has repeatedly triggered economic disturbances in Korea, with no fundamental remedies in sight until now. Project sponsors are at the heart of this issue, investing minimal equity while heavily relying on guarantees from third parties, such as construction firms, to push forward development projects entirely on debt. This financing structure is unheard of in major advanced countries. Korea needs to reform its unique PF structure by augmenting capital and reducing dependence on guarantees. - Over several decades, real estate project financing (PF) has repeatedly destabilized the Korean economy, but fundamental improvements have not been made. - The root cause of PF problems lies in the unique financing practice of relying almost entirely on debt, where developers invest very little equity and depend heavily on third-party guarantees. - In Korea, the equity ratio of developers is around 3%, while in major advanced countries, it exceeds 30%. - In major countries, land is secured with equity capital, and only construction costs are financed through loans. This approach prevents the issue of refinancing bridge loans into main PF loans, which is typical in Korea. - In major countries, it is rare for third parties, rather than developers, to guarantee PF loans, unlike in Korea. - The low-equity and highguarantee structure leads to more developers becoming smaller in scale and underfunded. - The low-equity and highguarantee structure leads to poorer assessments of project feasibility, no-questions-asked investments, and increased macroeconomic volatility. - The low-equity and highguarantee structure shifts all risks to the national economy, not developers. - Since advanced countries base loan issuance on project feasibility and financial structure per PF principles, capital augmentation is a prerequisite for developers to obtain loans. - However, when Korea introduced PF, the market consisted of small developers and large construction firms. This disparity led to a low-equity, high-guarantee structure, which was reinforced by the pre-sale system. - The prudent direction would be to raise the equity ratio to the level of advanced economies and abolish third-party guarantees. To that end, Korea should introduce regulations on capital augmentation. - While regulations to increase capital may constrain the quantity of housing supply, they are expected to improve its stability. - Even in environments unfavorable for scaling up, some developers have started small and grown into conglomerates, while others are affiliates of large corporations. - The pool of potential equity investors is not limited. - Because REITs socialize development profits and are already subject to equity ratio regulations, it is desirable to revitalize their equity investments or foster their direct participation as project sponsors. - During the transition, it is necessary to implement support policies that encourage capital increases. - The acute lack of data on real estate PF makes it difficult to even stay current, which in turn only allows temporary measures during crises and hinders regular monitoring or early crisis detection. - A database system should be set up to collect official statistics on financial and business information by project and company.

■ The rate hike has contributed to the reduction in housing prices and starts and is anticipated to result in a decline in future housing construction, ultimately weakening economic growth. - The analysis found that the decline in housing starts, due to high interest rates, is projected to hinder economic growth by 0.3%p in 2023 and 0.4%p to 0.5%p in 2024. ■ Recent rate hikes are intentionally designed to control inflation by managing economic growth at a slower pace, with the decline in the housing economy being understood as part of that process. - The current tight monetary policy stance aims to stabilize inflation despite the broader economic slowdown. - With low-interest rates in 2020 and 2021, real transaction prices of apartments soared by 16.7% and 18.1%, respectively, and are now entering a correction period. - With the recent timing of rate hikes, the housing market encountered credit crunches centered on real estate PFs, exacerbating the challenges faced by construction companies. However, the need for policy response is not urgent unless the risk of a financial system crisis escalates. ■ Nevertheless, if housing construction stays contracted for a significant period of time in the future due to the recent decline in housing prices, a shortage of housing supply may arise, necessitating ongoing efforts to enhance housing supply resilience to demand changes. - Housing supply takes considerable time, and mismatches between supply and demand often occur. It is essential to create conditions that can support housing supply, such as through public residential sites preparation, when housing demand begins to recover. - Simultaneously, due to rising construction costs, construction companies and homeowners' associations frequently engage in conflicts, causing delays in construction. Relevant systems must be overhauled for improvement to ensure construction projects are executed as planned.

Ⅰ. Current Economic Conditions □ The Korean economy appears to slow down rapidly, as the global financial crisis had negative repercussions on it. Early this year, the Korean economy was entering a phase of gradual slowdown, as its upward trend until the previous year was coming to an end. Under such condition, global credit crunch that has been spread fast after last September produced additional negative effects, accelerating the speed of economic slowdown of Korea. - Foreign portfolio investment has been rapidly retrieved during the re-capitalization and de-leveraging process, creating excess volatility in the Korean financial market which is relatively more exposed to foreign investment than other emerging economies. In particular, investors are increasingly concerned about the liquidity conditions of Korean banks that have expanded credit at rapid paces for the past 2~3 years. - Banks' asset has been growing by 12~13% since 2006, which is much higher than the nominal GDP growth rate (around 6%). □ Global financial crisis and recession are expected to impose an enormous burden on the Korean economy. While the ongoing financial market crisis appears to spread from developed countries to developing countries, recessions in developed countries are expected to take a considerable time to recover. The turmoil in the domestic financial market caused by the credit crunch in the global financial market is likely to shrink domestic demand. Among the most affected are exports, given that global growth projections have been marked down sharply. □ In contrast, the Korean economy is expected to benefit from the rapidly falling prices of oil and commodities. The prices of oil and commodities, which dropped to almost half of its highest price in the mid-July, are expected to significantly contribute to improving current account and to provide a buffer against a sudden drop in domestic demand. □ Though there exist some risk factors in the Korean economy, it seems that those risks have been controlled within a manageable range. After 2000, house prices in Korea registered a rapid rise in some areas, but the degree of nationwide house price appreciation is far smaller than those in the U.S. and developed countries in Europe. The management on mortgage loans has been under relatively strict supervision. Though household debt has been rapidly rising since 2000, most of the debt increase was led by the households with high income or wealth, suggesting that the possibility of debt distress is relatively low. The overall financial conditions of Korean companies is quite stable, and the delinquency rates have remained relatively low until now. The proportion of foreign investment in stock market and the external short-term debt is relatively high, but the amount of foreign reserve is sufficient enough to deal with temporal disturbances in foreign exchange market, and the government has room for fiscal stimulus. □ Considering all the risks on downside and upside comprehensively, it is desirable to implement policies to steer the financial market and real economy to a soft landing. It is prerequisite that the financial system restores confidence firmly and secure enough cash flow, and the efforts to enhance the transparency of overall financial market should be carried out. Additionally, both expansionary fiscal and monetary policies are needed to be implemented for a soft-landing for the economy. - Concerns about current economic situation were resulted from a sudden withdrawal of foreign capital, leading to soaring foreign exchange rate. Under this situation, the monetary policy alone may not be sufficient to stabilize the slowing economy. - Therefore, until the pressure on the foreign capital retrieval becomes stabilized, it seems appropriate to carry out active fiscal policies to alleviate the burden on the monetary policy. □ Along with the boosting policies, it is also recommended to make efforts to minimize latent side effects of stimulus policies on the economic system in the long-term. In order to achieve a soft-landing, it is desirable to adopt traditional macroeconomic policies such as fiscal stimulus and monetary easing rather than frequent changes in institutional rule or microeconomic policies. As for banking institutions which fail to manage its own risks and come to rely on the government aid, it is necessary to impose corresponding penalties upon them as a way to prevent moral hazard. During the process of restoring the confidence of banking systems, it should be ensured that the government does not intend to aid all the financial defaults, which is necessary to sustain market disciplines. Ⅱ. Economic Outlook for 2008~09* All growth figures are on a year-on-year basis unless otherwise noted. 　1. Major Assumptions □ Global economy: In 2009, global economy is assumed to sharply slow down, led mainly by advanced economies. The global growth rate (based on IMF's PPP exchange rate) is assumed to record a mid 2% range in 2009, down from a high 3% range in 2008. □ Oil Prices: The assumption about the oil price (import unit price) for the projection is around $70 a barrel in 2009, sharply down from 2008. □ Real Effective Exchange Rate (REER): In 2009, Korean won is assumed to moderately appreciate from the current level. The won has weakened against most other currencies in the second half of 2008. On the contrary to the 2008's trend, it is assumed to appreciate gradually over the course of 2009 to reach a similar level of 2008's on average for the whole year. 　2. Major Forecasts □ Korea's GDP growth is projected to slow to a low 3% range in 2009, as the domestic demand growth rate remains at a similar level of 2008 but the export growth rate dropped sharply. It is expected that after recording a low 2% growth rate in the first half, the growth rate will increase to a mid 4% range in the second half with credit crunch being alleviated gradually. Private consumption is expected to register around 2% after taking a downward pace in the first half of 2009.- Until the first half, private consumption is expected to drop due to the inflationary pressure by the rising exchange rate, the falling asset prices and the worsening employment condition. From the second half, however, it is expected that private consumption slowly recovers to the pace of income growth as the effects of the shocks are gradually eased. Equipment investment is assumed to register a growth rate of around 2%, as the uncertainty grows due to credit squeeze in domestic financial market and global economic slowdown. Construction investment, though a considerable rise in public works such as SOC investment is expected, is forecast to remain around 2% of growth as the recovery in building construction is likely to be delayed. □ Current account is expected to continue a surplus for a while, helped by the falling prices of crude oil and raw materials. Goods account surplus is expected to record around $24 billion, a steep rise from 2008 ($9 ~ $10 billion).- As the real export growth (in volume terms) is expected to slow down due to the global economic recession and the export unit price is expected to fall, the nominal export growth (in dollar terms) is forecast to slow to around 3%, a sharp drop from 2008 (around 20%).- Due to the wild fluctuations in oil and raw material prices, the imports (in dollar terms) in 2009 are expected to remain at an approximately same level as that of 2008, which rapidly grew by 27~28% from the level of 2007. Accounts of service·income·transfers are projected to record a deficit of around $15 billion, down from 2008 ($18 billion), affected by the slowdown in domestic demand. □ The unemployment rate is likely to increase due to economic slowdown, but only to around 3.6%, as the number of economically non-active population grows. □ Headline CPI inflation during 2009 is expected to be stabilized gradually and its annual average is forecast to record a mid 3% range, a large drop from a high 4% range in 2008. With the falling prices of crude oil driving the inflation for the first half of 2008, the prices of imported-goods show signs of stabilization, and the downturn of domestic economy is also expected to ease the burden on demand pressure. Accordingly, the inflation in 2009 is forecast to fall to a mid 3% range.- On the other hand, the core inflation, which is not directly affected by oil prices, is expected to record a growth rate of around 4%, higher than the headline inflation. Economic Forecast for 2008~'09 (year-on-year basis, %, USD 100 million)   2008 2009 First Halfp 3/4p 4/4 Yearly First Half Second Half Yearly GDP Private Consumption Equip. Investment Const. Investment Total Exports(Quantity) Total Imports(Quantity) 5.3 2.9 1.0 -1.2 12.2 8.8 3.9 1.1 4.9 -0.9 9.7 8.9 2.7 0.2 1.8 -0.4 4.9 2.4 4.2 1.7 2.1 -0.9 9.6 7.1 2.1 0.4 1.5 1.8 3.9 3.9 4.4 3.9 2.2 3.3 6.4 6.0 3.3 2.2 1.9 2.6 5.2 4.9 Current Account (USD 100 million) Goods Trade Balance Exports (%) Imports (%) Service·Income· 　Current Transfers -53 45 23.3 30.2 -98 -84 -33 25.1 43.4 -51 56 85 11.5 10.5 -29 -82 96 20.4 27.8 -179 54 129 3.2 -0.6 -75 32 112 3.3 0.7 -80 86 241 3.2 0.1 -155 CPI Inflation (Core inflation) 4.3 (3.5) 5.5 (4.8) 5.2 (5.1) 4.8 (4.2) 4.4 (4.8) 2.8 (3.3) 3.6 (4.0) Unemployment Rate 3.3 3.1 3.3 3.2 3.7 3.5 3.6 Note: 1) p denotes preliminary estimates. 2) Unemployment rate is based on the 4 weeks' job-seeking period. Ⅲ. Policy Recommendations 　1. Fiscal Policy □ The government's recently announced emergency measures seem appropriate in that active fiscal policies are needed to support a soft landing for the Korean economy. □ In particular, since the economic condition is expected to remain unstable up until the first half of 2008, fiscal expenditure needs to be executed as early as possible. □ Various efforts are also required to improve the efficiency of the fiscal expenditure. It is necessary for SOC projects to focus on shortening their construction periods and encouraging early commencement of the projects which completed feasibility study. This should shorten the time-lag between decision and execution and also minimize any possible inefficiencies that might occur during the process of expanding short-term fiscal expenditure. □ While the planned tax reduction needs to be implemented as scheduled, a cautious approach is required for any additional decisions on a permanent tax reduction. In dealing with short-term economic slowdown, it is appropriate to take a flexible stance for expanding fiscal spending temporarily, which is known to have a relatively stronger effect of boosting domestic demand than tax reduction does. □ Also, in order to prevent the expanded fiscal spending from undermining fiscal soundness, it is necessary to continue efforts to lay a stable fiscal structure from a long-term perspective. 　2. Monetary Policy □ It is desirable that the target interest rate is gradually adjusted downward in order to buffer against economic downturn. However, despite the fact that the extreme turmoil in the foreign exchange market has been alleviated after the government guarantee on payment of short-term foreign debt and the currency swap deal with the U.S., it should be noted that risk factors still remain in the market. 　3. Financial Policy □ While maintaining a selective payment guarantee and liquidity provision as a way to eliminate risk factors within the financial market, it is necessary to diminish the possibility of moral hazard. Although the government's emergency plans are inevitable during the financial turmoil, it is also necessary to reduce the possibility that the policy for financial stabilization could be misused as a way to compensate poor management or investment loss of banking institutions. □ It is recommended to immediately restructure non-viable savings banks due to the real estate PF loans. It is possible that a substantial amount of defaults is realized in the real estate PF loans of savings banks, but it is unlikely that these defaults will lead to a systemic risk of financial market. □ The deregulation on bank share holdings is considered positively in terms of rationalizing regulation, but it is recommended to adopt individual screening devices on large shareholders and specific supervisory measures. As in developed countries, it is needed to prepare specific measures to tighten the standards for the eligibility of large shareholders of banks. Furthermore, it is also necessary to consider some measures, under which major shareholders and related companies will be supervised as the banks are. □ It is needed to implement "The Capital Market and Financial Investment Service Act" as previously scheduled, while examining potential risks which might be brought out by its enactment. The Act, by allowing flexibility in regulations, can be understood as an improvement toward a direction where a flexible response to financial crisis is made possible. However, when adopting the Act, it is thought that measures related to prudential regulation need to be further complemented and reinforced.