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Contents | Executive Summary | How to obtain this publication | Additional information
The following OECD assessment and recommendations summarise Chapter 2 of the Economic survey of Korea published on 20 June 2007.
Contents
Growth decelerated in the latter part of 2006…
Economic growth slowed to less than 4% (at a seasonally-adjusted annual rate) over the year to the first quarter of 2007, reflecting weaker domestic demand. It is projected to pick up gradually in 2007, resulting in growth of 4¼ per cent for the year, down from 5% in 2006. Private consumption gains in 2007 may be limited to the rise in household income, as the scope for further cuts in the saving rate and increases in debt have been largely exhausted. The downward trend in investment as a share of GDP is likely to continue, in part because housing policies are slowing construction activity. Meanwhile, export growth is projected to moderate, given some deceleration in world trade growth and the impact of a stronger won.
Short term economic outlook for Korea
As published in OECD Economic Outlook, No. 81, May 2007
1. Contributions to changes in real GDP (percentage of real GDP in the previous years).
2. As a precentage of disposable income.
3. As a percentage of GDP.
Source: OECD, Economic Outlook database and Bank of Korea.
… in the context of a stronger currency…
The exchange rate has risen by 9% relative to the dollar since the end of 2005, driven in part by a large surplus in the capital account. Capital inflows increased during a period of rising domestic interest rates, as the Bank of Korea launched a pre-emptive tightening of monetary policy, raising the short-term policy interest rate from 3.25% to 4.5% between October 2005 and August 2006. Exchange rate appreciation was accompanied by foreign exchange market intervention intended to smooth the upward trend in the won, while accepting its trend increase. Korea should maintain a flexible exchange rate policy, given the costs and risks of intervention. With foreign reserves of $247 billion or 27% of GDP, more than double Korea’s short-term foreign debt, there is no need for continued reserve accumulation. The upward pressure on the exchange rate may be moderated by the recent measures to relax barriers to capital outflows. The objective should be to create a level playing field between foreign and domestic investment opportunities, while avoiding measures, such as the expansion of public support for overseas investment, which encourage outflows in the short run.
Interest rates and the exchange rate have risen markedly
1. This rate is targeted by the Bank of Korea in setting monetary policy.
Source: Bank of Korea.
… and the tightening of monetary policy
The surge in capital inflows has also boosted liquidity growth. The increase in the money supply (M2) accelerated to nearly 11% (year on year) in the fourth quarter of 2006, the highest since 2003, in part due to loan demand related to housing. To slow the growth of liquidity and bank lending, the Bank of Korea raised the reserve requirement for the first time since 1990. Monetary conditions have thus tightened considerably as a result of the interest rate hikes, the change in the reserve requirement and the stronger exchange rate. This has had an adverse impact on the highly indebted household and small company sectors, contributing to the deceleration of economic growth in the second half of 2006. Although economic growth slowed below its potential rate and inflation was below the target zone, monetary conditions tightened significantly. The tightening of monetary policy has been driven in part by concern about house prices and the Central Bank will “remain keenly alert to real estate market trends” in setting interest rates in 2007. However, monetary policy is a blunt instrument for influencing real estate prices, particularly as the largest house-price increases are limited to specific areas of the capital region. Moreover, giving too much weight to house prices risks distracting the monetary authorities from their primary objective of stable prices for goods and services. The Bank of Korea needs to take full account of recent developments in output and inflation in determining its monetary policy stance. The Bank should focus on keeping inflation, as measured by the overall consumer price index, in the medium-term target zone, while developments in the real estate market should be addressed by well-targeted measures.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. The Policy Brief (pdf format) in Korean is also available. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of Korea 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the Korea Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Randall Jones, Taesik Yoon and Tadashi Yokoyama under the supervision of Willi Leibfritz and Stefano Scarpetta.
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