KDI

[Summary]

□	The Korean economy is projected to experience a 1.5% growth in 2023, driven by a downturn in exports, particularly semiconductors, before seeing a 2.3% growth in 2024 driven by an accelerating export growth resulting from a recovery in external demand.

• Headline inflation is set to follow a decelerating trajectory, with an expected rise of 3.4% in 2023 and 2.4% in 2024.
• Employment figures are forecast to rise by 270,000 in 2023, fuelled by an increase in services production, with a steady increment of 170,000 anticipated for 2024.

Ⅰ. Current Economic Conditions

□	The Korean economy remains sluggish due to a contraction in exports, primarily driven by faltering external conditions.

• Despite an upswing in private consumption, the Q1 GDP growth presented a lackluster 0.8% YoY due to a sharp dip in exports.
• By industry, services exhibited high growth, spearheaded by face-to-face businesses, while manufacturing showed an accelerated contraction due to weak exports.

□	Domestic demand revealed a modest resurgence in private consumption, whereas investment stayed weak due to a deceleration in the manufacturing and housing markets.

• Private consumption sustained high growth due to a partial restoration of consumer sentiment and increasing travel demand.
• The demand for equipment investment is limited due to the manufacturing slowdown, while construction investment has shown moderate growth, despite leading indicators stagnating as a result of a setback in the housing market.

□	Exports continued a significant downturn as external demand shrank, predominantly centering on semiconductors.

• Amid a shrinking global trade volume, the semiconductor industry plunged keeping exports subdued.
• The current account diminished with sluggish exports and moderating slump in domestic demand.. Nevertheless, Korea's external financial stability remains commendable given the considerable size of net foreign assets.

□	Although the manufacturing industry weakened, employment conditions remained favorable thanks to strong growth in services production, while core inflation remained elevated.

□	Considering the overall economic conditions, both external and internal, the Korean economy is expected to experience a moderation in economic slowdown during the second half of the year, following a sharp decline in the manufacturing sector in the first half.

• In the first half of 2023, Korea's economic growth rate is likely to fall to around 1% due to the slump in semiconductors, its main export item, amid a global economic slowdown. However, a modest recovery is anticipated in the second half due to the recuperation of the Chinese economy and easing of the semiconductor slump.
• Consequently, despite a resurgence in private consumption, the Korean economy is projected to grow by only 1.5% in 2023 due to sluggish exports, marking a deceleration from the 2.6% growth rate achieved in 2022
• The Korean economy is projected to follow a moderate recovery trajectory in 2024, with inflation gradually stabilizing and macroeconomic conditions anticipated to return to normal levels by year-end.

□	With regards to macroeconomic policy, it is advisable to maintain the current monetary and fiscal stance for the time being, while also preparing for possible turbulence in financial markets.

• The recent economic deceleration is largely due to a contraction in goods exports, an outcome of deteriorating external conditions beyond our control. However, the contraction in domestic demand has been showing signs of easing, particularly in consumption.
• Despite the economic slowdown, employment conditions remain favorable and core inflation high, necessitating a stringent macro-policy stance to achieve inflation stability.
• Monetary policy should maintain the current interest rate level to allow inflation to converge to the target of 2%. Fiscal policy, on the other hand, should prioritize securing mid- and long-term growth engines and protecting the vulnerable over stimulating the economy.
• Potential disruptions to financial market stability due to persistently high interest rates, both domestically and internationally, must be taken into account. Hence, policy measures should be implemented to safeguard the financial system from such risks

□	Additionally, structural reforms to invigorate economic dynamism and ensure sustainable growth must be prioritized.

• The policy emphasis should be on constructing public consensus on labor, education, and pension reforms, which the government has recognized as critical issues, and on fully implementing these reforms.

Ⅱ. Domestic Economic Outlook for 2023~2024

1. Assumed External Conditions

□	A deceleration in the global economy is projected in 2023 and 2024, relative to 2022.

• According to IMF forecasts, global economic growth is poised to decline to 2.8% in 2023 from 3.4% in 2022, and remain subdued at 3.0% in 2024, attributable to persistent high interest rates in major economies and escalating financial market uncertainty.

□	Crude oil prices (Dubai) are expected to gradually decelerate, from $96 per barrel in 2022 to around $76 in 2023 and further to $68 in 2024.

□	The Korean won, in terms of the real effective exchange rate, is anticipated to remain relatively stable at the recent level.

2. Domestic Economic Outlook for 2023~2024

□	The Korean economy is projected to experience a 1.5% growth in 2023, driven by a downturn in exports, particularly semiconductors, before seeing a 2.3% growth in 2024 driven by an accelerating export growth resulting from a recovery in external demand.

• Growth in the first half of 2023 is projected to be a modest 0.9%, owing to weak exports, but is expected to rebound to 2.1% in the second half due to the spillover effects of China's economic recovery and a diminishing semiconductor market slump.
• Private consumption is set for moderate growth in 2024, following robust expansion in 2023 underpinned by an uptake in the service industry due to increasing tourism demand, although its pace of recovery remains tempered by persistent inflationary pressures and high interest rates.
• Equipment investment growth is anticipated to be a mere 1.1% in 2023, due to deteriorating external conditions, before expanding to 1.8% in 2024.
• Construction investment is expected to grow at a slow pace of 0.4% and 0.2% in 2023 and 2024, respectively, as housing construction remains sluggish due to the decline in the housing market.
• Exports are expected to witness an improvement in services exports due to the resumption of cross-border human mobility, but exhibit a modest recovery in 2024 after a contraction driven by goods exports caused by the global economic slowdown.

□	The current account surplus, standing at $16.4 billion, is projected to decrease significantly in 2023 owing to a contraction in exports, before expanding to $38.3 billion in 2024, driven by a revival in external demand and improved terms of trade.

□	Consumer prices are projected to rise at a slower pace in 2023 as supply-side inflationary pressures ease, with a continued deceleration anticipated in 2024.

□	The number of employed persons is expected to increase by 270,000 in 2023, facilitated by an increase in services production, followed by a steady increment of 170,000 in 2024.

3. Risks

□	The pace and timing of semiconductor demand recovery, alongside the extent of the spillover from China's economic revival, will significantly influence the growth trajectory of the Korean economy.

• Should the anticipated recovery in semiconductor demand not materialize by the second half of 2023, the resurgence of the Korean economy could be postponed.
• If China's economic recovery remains confined to the domestic service industry without spilling over into the investment sector, its positive impact on the Korean economy could be minimal.

□	Korea’s economic growth could further decelerate if the situation in Ukraine deteriorates, causing a surge in grain and energy prices, or if financial markets destabilize due to persistent high interest rates in major economies.

• Should headline inflation escalate, driven by increased food and energy prices, additional rate hikes could prolong the economic slowdown.
• Potential disruptions in financial markets due to a rise in credit risk in major economies could delay the global economic recovery and subsequently hinder Korean exports.

Ⅲ. Policy Recommendations

1. Fiscal Policy

□	The prolonged fiscal deficit in the post-COVID-19 era insinuates a protracted return to fiscal sustainability.

• Despite an economic recovery in 2022, the consolidated fiscal deficit, excluding social security, represented 5.4% of GDP, underscoring the need for a concerted effort to bolster fiscal sustainability.
• The deficit in 2023 could potentially increase beyond the budget estimates of 2.6% of GDP due to a decrease in tax revenues.

□	Although economic activity remains tepid, domestic demand and employment circumstances are relatively favourable, rendering expansionary fiscal measures unnecessary.

• The recent slowdown is primarily driven by a contraction in exports, with domestic demand contraction moderating due to rising consumption and favorable employment conditions. These trends, coupled with persistent high inflation, suggest limited scope for fiscal expenditure augmentation.
• Rather than advocating for stimulus initiatives, the policy stance should be towards securing medium to long-term growth potential and safeguarding programs for the vulnerable amidst weak economic activity and sustained high inflation and interest rates.

□	Additionally, policy makers should establish efficient fiscal management measures to enhance fiscal sustainability.

• The efficiency and effectiveness of fiscal expenditure should be improved; Policy makers need to adopt a Spending Review to assess microfiscal projects' performance and prioritize macrofiscal expenditures.
• Furthermore, the introduction of fiscal rules can be instrumental in considering future fiscal requirements, such as an aging population, and ensuring fiscal space for crises.

2. Monetary Policy

□	The monetary policy should sustain the prevailing interest rates for the time being, allowing for inflation convergence to the target (2%).

• Headline inflation is demonstrating a downward trend, yet persists considerably above the set target, and core inflation indicates only a marginal deceleration.
• Consequently, a stringent monetary policy stance should be preserved until a clear regression of inflation towards the target is discernible.

3. Financial Policy

□	In the face of potential financial market volatility domestically and globally, the resilience of domestic financial institutions warrants examination.

• Despite crises at institutions like Silicon Valley Bank (SVB) and Credit Suisse (CS), domestic financial markets have retained stability as corporate bond and money market tensions that emerged in late 2022 have since eased.
• However, increasing concerns about corporate debt distress, primarily in real estate PFs, and a rise in delinquencies in the vulnerable sectors underscore the need for financial institutions to expand loan loss provisions and assess their loss absorption capacity.

□	Policy efforts should be directed towards preventing systemic risk across the financial market, through measures such as the normalization of contingency programs introduced during the pandemic and gradual clearance of non-performing assets to preclude the accumulation of non-performing risks.

• The government should remain cautious about the risks of non-performing assets while systematically phasing out COVID-19 crisis-related financial measures, including the planned termination of the moratorium on principal and interest payments.
• In instances where the failure of individual firms or financial institutions is unlikely to develop into systemic risk, policy support is not recommended.