IMF Urges Korea to Shift from Crisis Response to Medium-Term Challenges

Post-crisis, focus on sustainable growth, say IMF economists

Fund backs calibrated withdrawal of macroeconomic stimulus

Challenges arising from aging population, indebtedness, and slower export growth

Korea has rebounded rapidly from the global crisis, backed by supportive macroeconomic and financial policies, and output is expected to expand by 6.1 percent in 2010. In their annual assessment of the country’s economy, the Fund’s economists said the country must now shift its focus to future sustainable growth.

“If Korea is to enjoy robust growth over the medium-term, and reduce its vulnerability to external demand shocks, it will be important to improve the country’s resilience by enhancing macroeconomic and financial policy frameworks, as well as raising productivity in the nontradables sector,” said Subir Lall, the IMF’s mission chief for Korea.

Time to withdraw macroeconomic stimulus

The Korean authorities have already started to plan for the future with the gradual withdrawal of stimulus measures. They have set a target budget deficit (excluding social security) of around 1½ percent of GDP—down from 4.1 percent in 2009—and frontloaded budgetary spending in 2010. The benefits from this public sector spending are expected to help smooth the transition to self-sustaining private sector-led growth.

Support for the financial sector is also being withdrawn as financial market conditions have normalized. With the economy expected to reach its potential in the near future, the IMF is recommending continued withdrawal of fiscal support in 2011, along with the sustained normalization of interest rates.

Following discussion of the report, the IMF’s Executive Board backed the call for a “carefully calibrated exit from the supportive macroeconomic policies.”

Learning from the crisis

A key theme of the IMF’s report was the importance of drawing lessons from the recent crisis. The downturn has demonstrated the critical need to have fiscal room to respond to adverse shocks to the economy. Over the medium-term, and given the rapidly aging population, Korea is set to face further pressure on the public purse.

The economists recommended that the authorities take steps to further strengthen their medium-term fiscal framework, including through the introduction of a fiscal rule. This would make fiscal targets more binding and strengthen prioritization of fiscal measures.

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