An International Monetary Fund (IMF) mission, led by Brian Aitken, visited Seoul during February 2–13 to conduct the 2015 Article IV consultation discussions. At the conclusion of the mission, Mr. Aitken issued the following statement:

“Korea’s growth momentum has stalled somewhat during 2014 and the outlook remains challenging from both a cyclical and structural standpoint. Domestic demand remains sluggish, inflation low, and external uncertainties have increased. From a longer run perspective, relatively weak non-manufacturing productivity has been accompanied by a heavy, and likely unsustainable, reliance on manufacturing exports for growth while also leaving the economy more exposed to external shocks, and the demographic headwinds from a rapidly aging population are beginning to build.

“The government’s focus on boosting Korea’s future growth potential is welcome and recent initiatives to begin addressing labor market and other rigidities and strengthening financial market efficiency and stability are steps forward on a long road of policy actions that will be needed. At the same time efforts should remain focused on shoring up economic momentum where the currently weak outlook could have a lasting impact on Korea’s growth well beyond the near term. The authorities recently put in place a number of measures to spur economic recovery, although it is still too early to gauge their full impact.

“Growth outlook for 2015 is weaker than what we had anticipated at the time of our last assessment and is subject to a great deal of uncertainties. However, what matters more than the precise year-on-year growth and inflation rates is whether they begin showing upward momentum in the coming months. With a highly open economy, Korea faces global cross-currents and the outlook will depend on a number of uncertain factors. As one of the world’s largest importers of oil products, Korea will clearly benefit from lower oil prices, but it may take some time before this translates into growth through higher investment and consumption. Although growth momentum in the U.S. may be building, the outlook for China, the EU, and Japan remain a concern, and globally deflation risks are rising. The prolonged weakness of the yen has been a challenge to some Korean export industries although the strong dollar could provide some buffer. From this standpoint, the exchange rate should continue to be flexible and market determined.

“There is the risk, however, that a self-reinforcing downside dynamic could take hold. Households’ expectations about future inflation could fail to rebound and consumer spending may remain suppressed, particularly with the possible impact of an aging population on future house prices. This could in turn lead firms to withhold investments, and if reinforced by perceived weak external prospects, result in slower growth relative to the steady recovery assumed in the baseline scenario. The likelihood of this scenario may not be high but the costs could be significant. The authorities have monetary and fiscal policy space to take action if clear signs of a recovery do not emerge soon.

“Korea continues to build external buffers which enhance the economy’s resilience to shocks, and would help limit the impact of any renewed global financial volatility. These buffers include a reduced and now modest level of short-term external debt, a positive and growing net foreign asset position, and a sizeable stock of international reserves. Allowing the won to respond flexibly would be the first policy line of defense if risks materialize, and provides a key buffer.

“Financial system is broadly stable with solid capital buffers. Overall household debt has been rising, but unlike the experience of many other advanced countries leading up to the global financial crisis, this has been matched by a corresponding increase in household financial assets rather than reflecting an increase in borrowing to finance consumption. Therefore, we do not see debt levels as a near term threat to the macroeconomy, although there are pockets of vulnerabilities particularly for some lower-income households. The structure of household debt could also be strengthened. One key challenge will be to facilitate the transition of mortgage market towards a more stable, long-term structure, in line with the government’s objective of increasing the share of fixed rate, longer-maturity amortizing mortgages.

“As the government’s growth strategy recognizes, tackling fundamental challenges to long run growth will require far-reaching reforms which should begin now as they may take some time to bear fruit. Progress toward bringing about the desired changes will require steady consensus-building among the stakeholders, and while this may take time, if successful the ultimate impact could be profound. Korea’s relatively low public debt affords it the flexibility—unlike in many other countries—to undertake needed structural reforms that may have short-run fiscal costs, particularly since achieving higher growth potential will have a lasting fiscal payoff down the road.”