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| Krishna Srinivasan, the Deputy Director of the Asia and Pacific Department at the IMF |
By Krishna Srinivasan and Martin Kaufman
Korea has been recovering well from the pandemic ― a testament to its strong economic fundamentals and appropriate policy responses. Economic output has surpassed pre-crisis levels despite multiple waves of infection. The recovery was supported by the effective containment of the pandemic, including rapid vaccinations last year and pursuing proactive economic policy support, which helped minimize economic scarring, sustain income growth and maintain financial stability. Given Korea's high degree of global integration, strong external demand has also provided support to the recovery.
Before the war in Ukraine, Korea's growth had been expected to remain robust this year and next, absorbing any remaining economic slack. Inflation had been projected to return gradually to target by next year, as reflected in the recent IMF report. But significant uncertainties had been already clouding the outlook, with downside risks arising mainly from pandemic-related disruptions to supply chains, geopolitical uncertainties and rising interest rates in major advanced economies. Moreover, Korea was facing domestic downside risks linked to weakening economic activity from rising numbers of COVID-19 infections, elevated household debt and real estate prices, as well as rising inflation.
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| Martin Kaufman, the Korea Mission Chief and Assistant Director of the Asia and Pacific Department at the IMF |
Against this backdrop, policy normalization remains appropriate, given Korea's relatively advanced recovery and rising inflation. But the pace should be balanced against the fast-evolving global conditions. In particular, the pace of monetary policy normalization should continue to be calibrated to ensure that inflation stabilizes at its target and expectations remain well-anchored.
Fiscal policy should be broadly neutral while continuing to provide targeted support for affected sectors, as needed. Macroprudential policies should continue to guard against systemic financial risks, notably to contain the buildup of vulnerabilities owing to the red-hot housing market and elevated levels of household debt.
Should risks to the outlook materialize, Korea is well placed to navigate challenging global conditions. Fiscal policy has ample space to provide further economic support, notably targeted to sectors facing stress. There's also room for monetary stimulus, if warranted, while further enhancing communications through forward guidance can help alleviate potential challenges if global supply disruptions further exacerbate inflationary pressures and hinder economic activity.
As global risks abate, the policy focus should shift to structural reform priorities to reinvigorate potential growth and foster greater inclusion, including in the context of the Korean New Deal. Renewed structural reform momentum, including the further articulation and implementation of this initiative, will be important in transitioning to life beyond the pandemic.
Reinvigorating long-term growth and fostering inclusion requires recalibrating policies to support productivity growth and innovation. It also demands providing transitory support amid reforms to address product, services and labor market rigidities, and ensuring that Korea's human capital remains a central pillar of the transformation process.
In this context, fiscal policy should be anchored in a medium-term framework that stabilizes public debt ― considering the expected implications of demographics, structural transformation costs and the potential need for additional fiscal support when necessary.
Krishna Srinivasan is Deputy Director of Asia and Pacific Department at the IMF. Martin D. Kaufman is the Korea Mission Chief and Assistant Director of the Asia and Pacific Department at the IMF.
