Korea Should Guard Against Debt Exploding on Aging, IMF Says
(Bloomberg) -- South Korea can handle a rise in debt spurred by current pandemic spending, but it needs to closely consider its future spending plans to ensure its debt burden doesn’t “explode” as its population quickly grays, according to the International Monetary Fund.
Korea’s government debt load is projected to jump from 53.2% of gross domestic product this year to 69.7% by 2026, according to the IMF Fiscal Monitor released earlier this month. That compares with a decline in the euro area and Japan over the same five years, though their debt levels stand significantly higher.
Korea’s strong fundamentals, including a robust manufacturing sector and a quality labor force, will keep the debt manageable for now, but health care costs and other liabilities associated with aging pose a concern going ahead, said Andreas Bauer, Korea mission chief for the IMF.
“You have to plan forward,” he said in an interview on Tuesday. While it makes sense to use fiscal space to respond to the Covid shock, “you should put fiscal policy into a longer term framework that will make sure the debt will not explode later on when additional liabilities from population aging will arise.”
Korea recorded more deaths than births in 2020 for the first time in modern history, accelerating a demographic shift that will mean around 40% of the population are 65 or older by 2050, the highest share in the world according to the United Nations.
President Moon Jae-in has been more active in fiscal spending than his predecessors, implementing five extra budgets to cushion the pandemic shock. While that has helped limit the economy’s scarring and set the stage for a strong rebound this year, the spending has pushed debt levels well beyond 40% of GDP, a long-held goal by previous administrations to prepare against future needs.
Aware of the weight of aging and pandemic spending on government coffers, the finance ministry proposed a fiscal rule in October that still awaits parliamentary approval. The proposal aims to cap government debt at 60% of GDP from 2025. The government uses a narrower definition of debt compared to the IMF, excluding borrowing by non-profit public organizations.
Bauer said the fiscal support provided in the past year has been effective in blunting the impact of the pandemic. The fund recently raised its growth forecast for Korea to 3.6% from 3.1%, higher than the central bank and the government’s projections.
Still, the mission chief pointed out there are structural reforms that need to be made to improve the labor market as aging takes hold, including a stronger safety net for workers, more training and greater flexibility.
There are also a “bucket of policy measures” the government can implement to create jobs and stimulate innovation in an economy dominated by large firms, Bauer said.
“Korea’s economy is highly regulated,” he said. “We know a lot of growth comes from young firms. Some of them start small but they grow quickly. That is what has been maybe missing a little bit in Korea.”
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