Korea: Robust Expansion, But Further Tightening Needed

At 4 1/2 percent, Korea set to grow above potential

Need to contain risks of overheating

Policy framework should improve resilience, ensure sustainable growth

But the robust performance of this heavily export-dependent country is giving rise to worries about risks from overheating.

To mark the publication of the IMF’s annual assessment of the Korean economy—the Article IV report—Subir Lall, the IMF’s mission chief for Korea, reviews the performance of this northeast Asian economy over the past year, and identifies the challenges ahead.

IMF Survey online: What you do see as the near-term outlook for Korea?

Lall: The growth outlook for Korea is robust over the near term. Korea has been at the forefront of the recovery from the global crisis, and in the second half of 2010 the recovery transformed into an expansion. So we have a growth forecast of 4.5 percent for 2011. This is above Korea’s potential growth, which we estimate at about 4 percent. Next year, we expect growth to remain slightly above its potential.

IMF Survey online: Many emerging countries—however well they weathered the crisis—are now suffering the risk of overheating and rising inflation. Is that a danger for Korea?

Lall: Indeed, one of the key policy recommendations we have coming out of this year’s Article IV consultation is that monetary policy now needs to move decisively to reduce the risk of overheating. The economy is performing above potential, and monetary conditions still remain highly accommodative.

Let me put this in context. When the crisis hit, obviously it was important for monetary, fiscal, and financial policies to help cushion the downturn and set the stage for the recovery that followed. Fiscal stimulus was withdrawn last year and the fiscal stance is broadly neutral this year, but monetary policy remains accommodative. And real interest rates are actually negative. So we are of the view that policy rates need to rise further so the economy again operates at potential, and inflation expectations remain tightly anchored.

IMF Survey online: So the Article IV for Korea has just been released and obviously you’ve presented it to the authorities. What would you like to convey to them as the headline message for the Article IV?

Lall: There are two main messages; one is for the immediate future and one is for the medium term. The near-term message is what I just mentioned, that the macroeconomic policy stance now needs to reflect the underlying...