KDI

Ⅰ. Current Economic Conditions

□	Economic activity is exhibiting a modest export-led recovery despite the continued spread of Covid-19.

• The seasonally adjusted GDP in Q1 grew 1.6% QoQ to surpass the pre-Covid 19 level (Q4 2019), and is gradually returning to its normal growth trajectory.

□	Exports and equipment investment made a rapid recovery as external demand improve but domestic demand, including private consumption and construction investment, remain stagnant.

• Goods exports rebounded as semiconductors showed favorable conditions―a positive outcome of the pandemic―with rebounds in automobiles and petroleum products, and a partial alleviation of the contraction in service exports.
• Equipment investment posted a rapid increase led by the semiconductor industry, while construction investment continued to slide on the sluggishness in both building construction and civil engineering sectors.
• Private consumption showed only a small increase despite the base effect, as durable goods consumption spiked but in-person services remained limited due to the pandemic.
• Headline inflation slightly exceeded the 2% target as the prices of agricultural, livestock, and fisheries, and petroleum products soared, but inflationary pressure on the demand side remains weak.

□	Given the overall external and internal conditions, the Korean economy is projected to recover at a modest pace. However, the economic shock and recovery pace may be uneven across industry.

• Despite the repeated fluctuations in line with the conditions of the pandemic, the Korean economy seems to be gradually bottoming out since Q2 2020.
• Korea’s growth trajectory is greatly dependent on the pace of the pandemic and vaccine rollouts, and uncertainties about in-person services will likely run high for the time being.

□	In the short-term, the expansionary policy stance should be maintained to stabilize macroeconomic conditions as should the protection of vulnerable groups considering that the pace of the economic recovery is not very strong.

• The Covid-19 crisis has had a varying impact on different economic entities, and as such, the effectiveness of fiscal expenditure should be maximized by concentrating the support on vulnerable groups.
• Monetary policies should remain accommodative as the current recovery pace and inflation are yet to be sufficiently robust.

□	Furthermore, policy normalization plans are needed for the Korean economy in preparation for the recovery from the Covid-19 crisis.

• Preemptive efforts are needed for a return to normalcy with policy plans that take into account the time lag between design, implementation and exposure.
• Above all, the exceptional financial measures deployed to counter the health crisis should be normalized in phases since a protraction could damage financial soundness.
• Next, plans should be established to gradually reduce the fiscal deficits that have rapidly ballooned during the crisis as economic activity gradually recovers.
• Given that core inflation continues to remain low in the long-term, the monetary policy stance should be carefully adjusted to allow for inflation to steadily stand within the target range.

□	In the mid- to long-term, policy reform must continue in order to achieve sustainable economic development.

• Deepening polarization could hinder social integration and economic growth, and as such, inclusive policies such as strengthening social safety nets are needed.
• New infrastructure and institutional reform should make headway to achieve a structural transition towards a more eco-friendly economy and society so that Korea can better deal with climate change.
• The expansion in fiscal expenditure driven by structural factors such as changing demographics and industrial structure should be managed with affordable plans for fiscal expenditure restructuring and revenue expansion.

Ⅱ. Domestic Economic Outlook for 2021-2022

1. Expected External Conditions

□	The global economy is expected to rally in 2021 led by the US and China thanks to stimulus programs and vaccine rollouts followed by slower growth in 2022.

• The IMF projected that the global economy will grow 6.0% and 4.4% in 2021 and 2022, respectively.

□	Crude oil prices (Dubai) are expected to mark around $60 per barrel in 2021, up by approximately 43% from a year ago, and to stand at the mid-$50 range in 2022.

□	The Korean won, in terms of the real effective exchange rate, is expected to appreciate by about 1% in 2021 and remain little changed in 2022.

2. Outlook for Domestic Economic Activity

□	The Korean economy is projected to grow 3.8% in 2021 thanks to improving exports, and 3.0% in 2022 as private consumption recovers.

• The Korean economy will likely remain below its normal trajectory in 2022, considering that the annual growth for 2020-2022 is a mere 1.9%.
• The recovery in private consumption may be limited in 2021 on the continued spread of Covid-19, but a swift turnaround is projected in 2022 led by service consumption.
• Equipment investment is expected to sustain a solid growth thanks to the favorable conditions in the semiconductor market and recovery in the global economy.
• The contraction in construction investment will likely moderate gradually owed to the recent orders received for large-scale projects led by housings.
• Exports and imports are expected to rapidly grow driven by the recovery of the global economy.

□	Despite worsening terms of trade, the current account surplus is projected to edge up in 2021 from the previous year thanks to the huge gains in goods exports. Additionally, a slightly reduced surplus is projected in 2022 due to growing imports led by the recovery in domestic demand.

□	Headline inflation is projected to pick up sharply in 2021 on soaring prices of oil and agricultural, livestock, and fisheries products, and to slow in 2022 as oil prices stabilize.

□	The total number of employed persons is expected to gain a mere 190,000 in 2021 despite the base effect from a year ago (-220,000) due to a limited recovery in the service industry. But, 2022 will see an increase of 330,000 led by the recovery of in-person service businesses.

3. Risks

□	The growth trajectory for the Korean economy is expected to vary greatly depending on the pace of the pandemic and vaccine rollouts.

• Korea will make a strong recovery that is centered around the in-person service industry if the spread of Covid-19 slows and quarantine measures can be maintained at low levels, and conditions improve for vaccinations and early herd immunity can be achieved.
• On the other hand, the recovery will be extremely limited if the pandemic intensifies or vaccine supply is disrupted.

□	Countries are exhibiting different recovery paces, and as such, the global economy could destabilize if the policy normalization efforts of major countries do not proceed seamlessly with the economic recovery.

• Although it is showing a solid recovery, if the US experiences problems in normalizing its monetary policies, the global financial market may become unstable which could negatively impact Korea's exports.
• In addition, Korea may see its economic recovery delayed if the conflict between the US and China exacerbates due to its heavy dependence on the two powerhouses.

Ⅲ. Policy Recommendations

1. Fiscal Policy

□	Korea’s fiscal policies are deemed to have actively responded to the Covid-19 crisis, and decisions on additional expenditure are needed while a close eye is kept on the spread of the virus and economic conditions.

• Expenditures that have been approved should be promptly executed, and additional spending should be actively considered if conditions are found to be deteriorating.
• However, even if it has been determined that additional fiscal responses are needed, the spending should be temporary and reversible. If structural and long-term spending is required, it should be reflected in the main budget or mid-term fiscal management plan along with separate plans to secure the fiscal revenue.
• Once the pandemic is under control through more vaccine rollouts and economic recovery is robust, the fiscal stance may have to be tightened and a counter-cyclical stance pursued.

□	In the mid- to long-term, efforts must be made to reduce the swollen fiscal deficit and to control the higher national debt so that the fiscal burden does not become protracted.

• Due to the active fiscal management in recent months, fiscal deficit has risen sharply and national debt has increased rapidly.
• If national debt is left to steeply climb in the long run, it could weaken Korea‘s fiscal response capacity. Therefore, plans should be established to narrow the gap between fiscal expenditure and revenue.

2. Monetary Policy

□	Inflation could temporarily pick up on the back of the price hikes in oil and agricultural, livestock, and fisheries products. However, an accommodative monetary stance should be maintained as the pace of economic recovery and inflation remains subpar.

• Despite the recovery in goods exports owing to increasing external demand, domestic demand continues to be sluggish especially in the service industry, suggesting that monetary policies should remain eased for a time being to support economic activity.
• Headline inflation may face temporary upward pressure as oil prices rise on improving global economic conditions and fluctuating supply and demand of crude oil. However, core inflation, which simulates domestic demand, will stay far below the target despite the base effect.
• The pace of economic recovery is not highly robust and inflation has hovered below the target in the long-term, implying that there is no strong need to adjust the monetary stance at this time.

3. Financial Policy

□	Exceptional measures have been maintained thus far, but financial regulations should gradually normalize so that potential insolvency does not lead to a weakening of financial soundness.

• The financial authorities extended the exceptional measures deployed at the beginning of the pandemic in 2H of this year, such as deferring interest payments and treating potential non-performing loans as normal loans.
• Indicators of lending soundness may look favorable, but given that this is probably attributed to relaxed regulations, real soundness may have weakened.
• To accurately identify the degree of insolvency and prevent an accumulation, deferrals should be normalized and policy support should be provided for voluntary private sector-driven debt restructuring.