Analysis of Pending Economic Issues in 2023

Published on January 31, 2023
Published by Industry & Energy Analysis Division

Review of Economic Status and Growth Path
   Although there are looming concerns about an economic slowdown, attempts at proactive responses by adopting macroeconomic policies are hindered by inflationary pressures. Trying to protect the economy through expansion of fiscal spending may inadvertently cause a rise in prices, and additional interest rate hikes aiming to stabilize prices may accelerate the economic downturn. To overcome these limitations, it is more important than ever to comprehensively analyze the real economy, the financial/forex market, employment, etc., and to devise alternatives accordingly. First of all, assessment of the growth path indicates that the growth rate of the Korean economy in 2023 is expected to be lower than the initial estimate of 2.1%. The domestic economy is highly likely to have entered a contraction phase following a peak phase in the third quarter of 2022, and exports are sluggish due to the global economic slowdown. In order to overcome difficulties expected in 2023, a detailed analysis of various risks, such as the timing of inflation to subside, the trajectory of global interest rates, and the direction of fiscal management after the pandemic, is necessary. Next, ways to turn around the economy in areas of investment and export, etc., and new growth strategies to address low marriage rates, climate and energy crises need to be devised.

Prices: Inflation not easy to rein in
   Whether or not the Korean economy will make a soft landing in 2023 is expected to largely depend on the timing and pace of inflation alleviation. By analyzing inflation determinants, the timing of inflation easing was ascertained, and the impact on price stability and fiscal affairs was reviewed. The analysis, using a model that takes into account aggregate demand pressure, oil prices, exchange rates, and inflation persistence, found that consumer prices are projected to stabilize after the fourth quarter of this year. The actual time frame for the mitigated inflation is expected to be determined by raw material prices and whether restrictions on global supply chains will ease; whether the economic phase and aggregate demand pressure will weaken; whether the policy interest rate gap between Korea and the US will widen; and whether exchange rate instability will re-emerge. At a time when there is limited room for monetary policy to take effect, micro-policy responses are crucial in early achievement of price stablity goals. In the first half of this year, it is necessary to focus on extending tax support for energy and agricultural/livestock products and relevant supply/demand management measures, while enhanced monitoring and proper management of public utility rates seem desperately needed as well.

Financial affairs: Trajectory of rising global interest rates and risk factors
   Along with the US Fed's rate hikes, interest rates in domestic and major markets are rising. A rise in interest rates is expected to adversely affect the Korean economy via various channels. An increase in the base interest rate by the US Federal Reserve will cause instability in the foreign exchange market in emerging economies and the exit of investment capital, etc., which in turn is likely to aggravate instabilities in our financial market. There is a negative (-) correlation between interest rate fluctuations and housing price changes, suggesting that when interest rates rise, it puts downward pressure on housing prices. In addition, an increase in interest costs for treasury bond yields is likely to reduce fiscal capacity and compromise the effectiveness of relevant policies. And based on the issuance volume in 2022, the annual additional interest burden due to interest rate hikes compared to 2021 is estimated to be 2.3 trillion won. To cope with the negative impact of rising interest rates on the Korean economy, the financial market's ability to respond to crises needs to be improved and financial risk management capabilities need to be further strengthened.

Fiscal affairs: Direction of fiscal management post-pandemic
   Because economic slowdown and inflation are looming concerns in 2023, fiscal affairs need to be managed in a prudent manner. Although advanced countries have been proactive at responding to economic fluctuations by implementing fiscal means between 2001 and 2021, they kept their fiscal austerity measures in place for an extended period of time to keep inflation in check, during which their post-Recession economies were going through cycles of recovery and slowdown. In other words, advanced economies made gradual shifts in their fiscal policies after the economic crisis. Cases of fiscal management in developed countries suggest the need to adopt a judicious fiscal management stance that will enable addressing post-pandemic economic situations and managing prices. Furthermore, considering that the examples of advanced countries show that fiscal expansion could put upward pressure on already high prices after a major economic crisis, in 2023, we need to improve fiscal effectiveness during the economic slowdown by offering tailored fiscal support, fiscal spending and fiscal execution for the economically disadvantaged while assuming a fiscal stance that will not induce inflation.

Investment: Maintaining vitality at risk of economic contraction
   The recent deterioration in financing and financial conditions of businesses, when coupled with the economic slowdown, may cause investment to contract. Although company-specific micro data suggests that growth potential is relatively favorable, their financial soundness has suffered a slight dip. In particular, poor financial soundness was found in industries such as real estate, aviation/shipbuilding, and food-related service industries. Empirical analysis demonstrates that corporate investment decreased by 3.5%p during the economic contraction, and it saw a further drop of 3.6% for those with less solid financial soundness. This suggests that deteriorating corporate financial conditions, coupled with economic slowdown, may lead to investment contraction. Accordingly, to turn around the economy and boost growth potential, micro-measures such as better monitoring of industries and businesses with weak financial conditions, improving the micro-investment environment for strategic technologies and emerging industries, and providing selective support to help overcome financial difficulties of companies need to take place.

Export: Seeking diversification of supply chains amid neo-protectionism
   With the economic strength of individual countries leveraged against others, mounting protectionism is rearing its head post-COVID-19. Consequently, trade security has become a hotly-debated topic around the globe, and the stance of major countries such as the US and the EU to refrain from trade with China is expected to continue into 2023 as well. Korea's trade reliance with China was high at 21.9% as of 2022, and such a heavy dependence is posing a supply chain disruption as Korea relies on China for a significant portion of imports of major raw materials and intermediate goods. Recently, as ASEAN's standing in the global supply chain has grown larger, although China is still Korea's largest trading partner, its share is gradually decreasing. For this reason, the Korean government needs to diversify its supplychains to improve their stability and offer relocation incentives to better respond to foreign manufacturers of materials, parts, and equipment trying to move away from China. In addition, the Korean government needs to devise ways to address any changes when protectionist legislation involving Korea is identified in the future.

Population: Society with falling marriage rate and low fertility rate
   Despite efforts to overcome the declining population issue, the number of marriages has plummeted sharply recently amid continued falling birth rates. Since the early 2000s, the younger population (in their 20s and 30s) has been on the decrease, and since the mid-2010s, economic instabilities, etc., caused many to opt out of marriage or marry late, resulting in a sharp plunge in the marriage rate. Since most births occur between married couples in Korea, the impact of the decreased marriage rate on the number of births was analyzed. Analysis indicates that 77% (42,000) of the decreased number of births (55,000) between 2019 and 2022 was attributable to a drop in marriage, and the recent drop in the number of births has more to do with the decline in the number of marriages than the falling rate of fertility in married couples. For this reason, in its efforts to address the low fertility rate, the government needs to include ways to boost the marriage rate as part of its childbirth and childrearing support measures; and come up with ways to help the younger population who are not tying the knot for financial reasons, and create a family-friendly society.

Climate and energy crisis: Responding to a new international order
   A New Climate Regime has given rise to a new international order that encompasses energy security, industry, technology and finance in relation to climate & energy crises, and major countries are putting in place zero-carbon economic systems by expanding RE100, strengthening ESG management, and introducing Carbon Border Adjustment Mechanisms (CBAM). Korea, for its part, aims to reduce greenhouse gas emissions by 40% by 2030 compared to 2018, but the analysis of the recent greenhouse gas emission trend indicates that its reduction target can be achieved only if the average annual reduction rate for the next eight years reaches 5.4%, which is 1.2% higher than the originally projected reduction rate. To respond to the international climate order, policy measures that are geared towards transforming the overall economy into a low-carbon structure need to be implemented. For example, in the fiscal sector, the government needs to advance methodologies to estimate greenhouse gas reductions, discover domestic projects to carry out international greenhouse gas reduction projects, and establish performance management mechanisms within Climate-Responsive Budget Proposals. Further, in the financial sector, a policy direction that supports the voluntary formation of ESG investment and a climate finance ecosystem is needed.