[SEOUL G20 BUSINESS SUMMIT]Korea: At the Front End of the Global Economic Recovery

Korea’s impressive recovery from the sharp global downturn in late 2008 was ignited by a decisive policy response that encompassed sizable monetary and fiscal stimulus and financial policies designed to prevent the type of massive deleveraging seen in other parts of the world.

However, this easing of momentum does in our view not signal the beginning of a protracted downturn. The moderation of growth in Korea is only natural following the rapid recovery of the economy to pre-crisis levels of activity, and the sequential decline in the headline numbers therefore partly reflect a simple base effect. That being said, growth is also expected to slow in Korea and more broadly in Asia as macroeconomic policies shift their focus appropriately on unwinding the stimulus, including in economies outside the region.

The short term outlook for Korea and the rest of Asia remains positive overall. Korea’s growth is in our baseline forecast expected to reach 6.1 percent in 2010 and moderate to a more sustainable (but still robust) pace of 4.5 percent in 2011. The continuing, albeit sluggish recovery in advanced economies during 2010 should support exports from Korea and the rest of Asia, although growth rates will be somewhat lower than during the earlier stages of the recovery.

In Korea’s case, exit from fiscal stimulus measures is already at an advanced stage, while monetary policy rates remain well below “neutral” levels, i.e. levels consistent with keeping GDP in line with potential and maintaining stable inflation. With the economy now already operating at potential, the normalization of policy rates in Korea is, therefore, expected to continue and will help anchor inflation expectations. The ample global liquidity as well as the growth differential between the region and advanced Western economies, should continue to fuel capital flows to the region. This raises the risk of excess domestic liquidity in some countries and inflated asset prices, and may call for faster adjustments of macroeconomic policies, further macro-prudential tightening, and more upward flexibility in exchange rates.

The main risk to the outlook for Korea is the external environment. As discussed in the Regional Economic Outlook, while global financial conditions have improved since June 2010, underlying sovereign and banking vulnerabilities in advanced economies remain a significant challenge, and concerns linger over the strength of the global recovery. Despite Korea’s strong economic and policy fundamentals, important trade and financial linkages with advanced economies suggest that a further deterioration in global financial conditions and a slowing of the global recovery would have important repercussions for the economy. In particular, a weaker than expected recovery of final demand in advanced economies and more volatile capital flows could hurt private domestic demand in Korea and the rest of the region by lowering consumer and business confidence and increasing the cost of capital.

Anoop Singh IMF Director of Asia and Pacific Department