Korean Macroeconomic Situation Over the past several decades, the Republic of Korea has experienced an unprecedented period

of economic growth, modernization, and global integration, leading to the countries rise from the rubble of the Korean War to one of premier nations in the world. In the last decade South Korea has joined the trillion dollar club of world economies, and is currently the United States' seventh-largest trading partner.1 South Koreas macroeconomic indicators shed light on the countrys economic prosperity and provide a foundation for improving future performance. The last fifteen years have provided a true litmus test for the strength of South Koreas economy, as the country has endured the Asian financial crisis and the current global recession. After experiencing strong growth in global domestic product (GDP) for the first half of the 1990s, South Koreas impressive economic run came to an end by the second quarter of 2007, as the Asian financial crisis loomed. The catalyst for the crisis was attributed to South Koreas aggressive expansion policy. Encouraged and facilitated by the South Korean government, banks and large corporations borrowed heavily to finance industrialization, creating a debt that amounted to $163.5 billion in 1996, a 5-fold increase from 1990.2 Eventually many large highly leveraged conglomerates, which had been financed by government debt, had to be taken over due to their non-performing loans. As a result, South Koreas banking industry was crippled as they took over this additional heavy burden of debt. Starting in the second quarter of 1997, South Korea experienced four consecutive quarters of negative GDP growth rate with the worst damage coming at the beginning of 1997 when they saw the economy contract nearly 7 percent.3 In 1998 alone, South Koreas GDP contracted by 6.7 percent, which pushed the unemployment rate to 6.8 percent4 a significant jump compared to the unemployment rate of 2.6 percent in 1997.5 Ultimately, high debt to equity ratios and massive short-term foreign borrowing coupled with the heavy depreciation of the Korean won led to the International Monetary Funds (IMF) $21 billion bailout plan.6 Despite the sharp economic slowdown and a weakening currency, South Korea was able to contain the financial recession through actions taken by the government along with the bailout by the IMF. By the second quarter of 1999, GDP growth had risen to 4.1 percent7 and Korea officially ended the Asian financial crisis. After recovering from the financial crisis, South Koreas economy showed strong growth, highlighted by a 12.8 percent GDP growth rate in the first quarter of 2000.8 The strengthened economy pushed the unemployment rate down to 4.8 percent in 19999 followed by a decrease of 3.7 percent in May 2000.10 Concerns of a slowing global economy, failing exports, and the possibility of a second economic downturn, caused the GDP growth rate to recede to 2.8 percent in the third quarter of 2003. However, partially due to the strong emergence of the technology sector, South Korea experienced a healthy and stable GDP growth rate between 3 to 6 percent from 2003 up to the global recession in 2007.11 With the global economic downturn, South Koreas GDP growth rate fell by 3.4 percent in the fourth quarter of 2008 from the previous quarter, the first negative

quarterly growth in 10 years.12 Most sectors of the economy reported significant declines leading to a slowing of GDP annual growth rate to 2.3 percent in 2008. The recession continued into the early part of 2009 as GDP growth rate continued to decline to 0.2 percent. Despite the global financial crisis, the South Korean economy began to recover in the third quarter of 2009, largely due to export growth, low interest rates, and an expansionary fiscal policy. In 2010, South Korea made a strong economic rebound with a growth rate of 6.1 percent, signaling a return of the economy to pre-crisis levels.13 Another indication of South Koreas economic recovery is the recent report of 3.3 percent unemployment in July of 2011.14 Unemployment at this low rate is extremely impressive considering the unemployment rate in the US is 9.1 percent. Overall South Korea's Unemployment Rate averaged 3.75 percent from 1999 until 2010.15 Of the three key Industrial economic sectors, South Korea is dominated by the service sector and the manufacturing sector, typical as people move away from the primary sector to secondary and then to tertiary as the country develops. In 2008, roughly 57.6 percent16 of South Koreas GDP was contributed by the service industry, including department stores, store chains and supermarkets. The manufacturing sector is the second largest contributor, accounting for 39.7 percent17 of GDP and roughly 24 percent of the countrys labor force.18 South Koreas secondary economic sector of manufacturing is highlighted by the construction industry (detailed blow). South Koreas other key manufacturing industries produce a wide range of labor and capital-intensive products to satisfy domestic needs, but are mainly produced for export. They include light and consumer products (fabrics and clothing); electronic, telecommunication, and computer devices; and heavy industrial products (metals, automobiles, and ships South).19 Since the 1970s, South Korea has become one of the world's major steel producers. The automobile industry began growing in the 1980s for export purposes only, but has become the fifth largest automobile producer. In 2010 South Korea produced 4,271,91 automobiles20, representing roughly 5.5 percent of the global output. As of 2008, South Korea was one worlds dominant shipbuilder with a 50.6 percent share of the global shipbuilding market.21 Electronics are another highlight for South Koreas manufacturing industry especially in semiconductors industry where it is the worlds largest producer. The remaining 3 percent of the GDP is from the primary economic sector of agriculture, which is comprised of industries such as mining, fisheries, and farming. However, these industries have experienced a steady decline, along with the agricultural sector as a whole, due to industrialization and the growth of the service sector. In the 1960s and the 1970s, construction prospered as South Korea began focusing on industrialization. Construction continued to play a major role in South Koreas economic development into the 1980s before declining during the 1997 financial crisis. One of South Koreas key drivers for steady growth in the construction sector can be attributed to the housing boom in the late 1980s. In fact, the number of residences built averaged 196,000 annually from 1973 to 1982 and reached 750,000 in 1990.22 As the economy began to slow in 1997, the economy experienced a sharp drop

in construction-industry revenues from US $32.4 billion in 1997 to US $9.9 billion in 1998.23 Another force behind South Koreas construction growth is the rapid expansion of overseas projects beginning in the early 1980s. Taking advantage of cheap labor, South Korean construction companies won contracts in the Middle East for roadbuilding projects, accounting for 60 percent of the work undertaken by South Korean construction companies.24 Recently, South Koreas construction industry experienced two years of continuous decline, as the country housing market struggled during the global recession. However, by 2009 the industry underwent a period of gradual recovery, as government stimulus packages and measures to improve the liquidity position of builders25 as well as cuts in property taxes have gradually began to take effect on the industry. This period of economic recovery coupled with government measures and significant construction opportunities including a film and entertainment complex hub by 2014, the 2012 World Exposition, and the 2018 Winter Olympic Games have the led to a positive outlook for the South Korean construction industry over the foreseeable future. South Koreas economic prosperity, relative to other countries, can largely be attributed to its fiscal policy and tax structure. After emerging from WWII, South Korea initiated an economic revival program promoting industrialization, constituting sweeping economic policy changes emphasizing exports and labor-intensive light industries26 that could be produced more cheaply than in North America and Western Europe. In addition, the government instituted a currency reform, strengthened financial institutions, and introduced flexible economic planning,27 as well as offering strong incentives to businesses, regulating foreign exchange, and implementing highly centralized fiscal policies.28 The results were impressive as South Koreas economy experienced a period of sustained expansion between the mid-1980s and the mid1990s, leading up to the Asian financial crisis. South Koreas fiscal structure prior to the crisis was considered growth friendly, with a low tax burden and a small government budget.29 Overall, South Koreas fiscal expansion policy was impressively successful as industrial production from 1976 until 2010 (comprised of manufacturing, mining, and utilities) averaged 10.35 percent reaching a historical high of 38.82 percent in July of 1976 and a record low of -25.73 percent in January of 2009.30 Furthermore, as of February 2010, South Korea's industrial production experienced twenty straight months of growth on an annualized basis,31 and at the time industrial production growth rate was projected to be 12.1 percent for 2010.32 After the Asian economic crisis of 1997, South Koreas fiscal policy changed as certain structural weaknesses in the economy had been exposed. In particular, foreign reserves were insufficient, foreign borrowing was extensive, and corporate debt to equity ratios were extremely high.33 To avoid a complete collapse of the economy, the Korean government secured a significantly large loan from the IMF for $21 billion in 1997. Furthermore, an extensive restructuring of the corporate and banking sector took place after the crisis. As a result, the government was able to re-pay all the emergency

IMF loans by the end of 2001. A period of rapid expansion followed, continuing up to the global economic crisis in 2007 In the aftermath of the global economic crises, South Korea implemented an expansionary fiscal policy on a massive scale, amounting to five percent of the nations GDP in 2007, 3.6 percent in 2009, and 1.1 percent in 2010.34 By making prompt and decisive policy decisions and through an aggressive implementation of expansionary fiscal policy, Korea was able to mitigate the effects of the crisis. The government enacted a massive $120 billion bailout package in November 2008, followed with another $11 billion infusion in the form of tax cuts and other stimulus.35 In January 2009, South Korea launched its $38 billion economic stimulus package, with over 80 percent of the total earmarked for green investment.36 This, together with another $21.6 supplementary budget announced in March 2009, enabled the South Korean economy to narrowly avoid recession in the last quarter of 2008 when it grew just 0.1 percent.37 However, the effects of the crisis were felt, as South Korea's economy grew only 2.2 percent in 2008, easily its worst performance since the Asian financial crisis when the country contracted 6.95 percent for the year in 1998.38 Since then, South Koreas economy had remained resilient, aided by heavy government spending and increases in domestic consumption. Moreover, compared to other advanced nations, South Korea is maintaining a very sound fiscal balance with surplus relative to GDP projected at 1.0 percent, putting Korea in a select group as one of only two OECD countries with a fiscal surplus.39 Koreas government debt ratio stands at 36.2 percent, which is the third smallest among OECD countries,40 indicating their ability pay back debts and withstand unforeseen shocks from the global economy. South Koreas relatively low debt ratio is a good indicator of Koreas healthy economic recovery, especially when compared to the US, which currently operates at a 53.5 percent debt ratio.41 In a recent report released in October 2010 by the International Monetary Funds World Economic Outlook, Koreas fiscal balance is expected to remain sound, ranking second among the G20 countries as of 2010, while its government debt ratio is projected to stay low, ranking sixth.42 In recent years, Korea's economy has moved away from the centrally planned, government-directed investment model toward a more market-oriented one.43 This liberalization of South Korea's economy is aimed at minimizing the role of the public sector, while governing the private sector with less regulation. Currently, South Korea continues to operate a fiscal policy focused on expansion in order to keep the economic recovery going. The current fiscal structure is driven by the philosophy instilled by the current President Lee Myung-bak, who vowed to liberalize the economy further through freer trade, deregulation, and the privatization of major industries.44 Specifically the government has stated it will continue carrying out aggressive fiscal policies including front-loading 60 percent of the planned fiscal spending during the first half of the year and gradually reducing fiscal deficit with an aim to reach a balance by 2013 or 2014.45 In 2010 total government expenditures represent 30 percent of GDP.46 A very favorable number when you consider Japans total government spending is 37.1 percent of GDP.47 One of the measures targeted by the current fiscal policy will include helping domestic companies through debt restructuring programs. According to a government

official Small and medium-sized companies will be given further government support and trade infrastructure will be strengthened to help the country's export-dependent economy lead its way out of the economic downturn.48 Furthermore, the government said it will also seek to stem inflationary pressure and stabilize the country's real estate market by stepping up regulation on price-fixing and easing entry barrier for everyday necessity products while increasing stockpiles of raw materials.49 Another focus for South Koreas modern financial sector is to be more open and competitive, allowing for improved transparency and efficiency. Recently, the government has been largely successful in recapitalizing banks and non-bank financial institutions. Through competition weak institutions have been closed or merged, and non-performing loans have decreased considerably. Another component to South Koreas fiscal policy is the nations tax structure. The Korean tax system is comprised of both national and local taxes, the latter of which are imposed by provinces, countries and municipalities. Examples of local taxes include property tax, automobile tax, license tax and registration tax. National taxes can be broken down into direct and indirect taxes. According to the Korean National Tax Service, Direct taxes include Income Tax (9% - 36%), Corporation Tax (13% - 25%), Inheritance & Gift Tax (10% - 50%), Comprehensive Real Estate Holding Tax (10% surcharge).50 In addition to direct taxes, South Korea's tax system relies heavily on indirect taxes, which account for about 50 percent of tax revenue.51 Indirect taxes include sales tax, value added tax (VAT), goods and services tax (GST) and use tax. According to the Organization for Economic Co-operation and Development (OECD), 2007 figures show that 26.5 percent of the fiscal burden was financed by the public, which was the third lowest figure among the 30 member states.52 In particular, South Korea ranks as the sixth lowest OECD nation, in terms of revenue generated from income taxes, relative to GDP.53 Overall, 14.69 percent of the $975 trillion GDP generated by South Korea in 2007 was consumed by the government.54 At the same time, by moderating government expenditures, the Korean economy has been able to maintain a very sound fiscal balance, with a surplus of 0.4 percent and a government debt ratio of 29.7 percent.55 Overall in 2010, tax revenue as a percentage of GDP was 26.6 percent.56 South Koreas dynamic economy has successfully weathered the global economic slowdown and demonstrated a considerable level of resilience. The nations economic success is buttressed by the sentiments of the IMF, who stated in September 2010, that among the advanced economies, Australia, Denmark, South Korea, New Zealand, and Norway generally have the most fiscal space to deal with unexpected shocks.57 However, despite these circumstances, the Korean government remains cautious and plans to continue focusing on maintaining a sound fiscal balance that will serve to protect the Korean economy. As a result, the Korean government will introduce an expenditure rule, into the national finance management plan for 2011-2014, which mandates the ratio of expenditure growth be kept two to three percent lower than that of revenue growth.58

South Koreas foreign exchange activities are governed by four distinct entities: the Ministry of Finance and Economy (MOFE), the Bank of Korea (BOK), the Financial Supervisory Service (FSS), and the Korea Customs Service (KSS). Each entity operates with the common goal of achieving price stability to contribute to the positive development of the national economy. The MOFE is responsible for the establishing the overall foreign exchange policy.59 The role of the BOK is to hold and manage the foreign reserves, while managing all transactions pertaining to foreign trade and capital movement. In addition, the BOK also supervises money-changers and foreignexchange brokers, and provides foreign-exchange banks with foreign currency loans.60 The FSS supervises financial institutions that are involved in foreign exchange activities.61 International trade regulatory responsibilities fall on the shoulders of the KSS.62 Although these four entities share the lions share of responsibility in regard to foreign exchange activities, certain banks do have some authority. In particular, foreign exchange banks can engage in foreign financial transactions, including international banking South Koreas exchange rate is determined by supply and demand and is commonly known as a free-floating exchange rate. After a stable run against the US dollar in the first half of the 1990s, the won gradually depreciated form $771.27 in 1995 to $951.29 in 1997.63 It was not until the financial crisis in 1997 that these relatively small fluctuations had a major impact on the pace of economic activities and purchasing power of the population.64 In December 1997, South Koreas exchange rate, compared to the US dollar, had jumped 122 percent to $2,000.65 The sharp and sudden increase in the exchange rate had a major negative impact on the South Korean economy, which is heavily dependent on large imports of capital goods and energy.66 By 1999 the exchange rate began to decrease as the economy gained traction during the recovery. As a result, the cost of imported goods and fuel began to decrease, adding to the gradual economic recovery in 1999 and 2000. Over the next seven years, South Korea experienced a gradual appreciation of the won in comparison to the US dollar, reaching its strongest point of $907 in December of 2007.67 This period of appreciation continued up to the global recession, before steadily depreciating beginning in 2008. After a major deflationary spike in February 2009, the South Korean won has steadily appreciated, and is currently trading near the 2007 lows relative to the dollar. According to Subir Lall, an IMF analyst, officials should continue to let the won appreciate.68 Lall reasons that the won has gained since the depths of the recent financial crisis, but said it still remains undervalued.69 Since the 1960s, there have been various restrictions and regulations on foreignexchange operations designed to ensure the availability of foreign currencies to South Korean enterprises and to prevent the flight of capital from South Korea. Under foreign pressure, the South Korean government began to liberalize the foreign exchange market in mid-1992.70 However in reality, the system has yet to become fully liberalized and many new direct and indirect regulations in various forms have been put in place, including restrictions on certain transactions, tax rules, and monitoring regulations, to ensure its control over the financial system.71

As previously mentioned, the BOK plays a central role in determining South Koreas foreign exchange activities. However, holding and managing foreign reserves is only one of the banks many tasks. The BOK with a capital of 1.5 billion won was established on June 12, 1950 under the Bank of Korea Act.72 The key competencies and responsibilities of the BOK include monitoring and standardizing monetary and financial policy, bank supervision, and foreign exchange policy. Under Article 1 of the Bank of Korea Act, the primary purpose of the Bank is pursuing price stability so as to contribute to the sound development of the national economy.73 In pursuing price stability, the Central Banks key instrument to safeguard the value of the money by keeping inflation low is their ability to adjust the quantity of money in circulation. One of the major concerns of the BOK is how to contain inflation. Since the Asian financial crisis, South Koreas inflation rate has ranged from 2 to 6 percent.74 Currently, South Koreas outlook remains favorable following the recent global financial economic crisis. However, with potential global weaknesses and current inflation projections at 4.5 percent for 2011 and 4.2 percent in 2012, inflation remains a concern. According to the IMF the The immediate policy priority is to ensure a soft landing and safeguard financial stability--through proactive monetary tightening, greater exchange rate flexibility and ongoing fiscal consolidation.75 As a result, South Korean central bank officials need to adjust the country's monetary policy to reflect the fact the economy has moved beyond recovery and into expansion.76 The BOK has many tools at its disposal to counter against inflationary and deflationary pressures. For example, the BOK can cap prices on key raw materials and/or regulate prices in certain sectors, including agriculture, telecommunications, other utilities, pharmaceuticals and medical services.77 Since 1998, the BOK has applied inflation targeting, where the target inflation rate is set through consultation with the government. According to the BOK, the inflation target for 2010 onward is 3 percent, with a tolerance range of plus/minus 1 percentage point around this target.78 The inflation target price is derived from the 12-month rate of change in the consumer price index.79 South Koreas consumer price index is the bench mark for inflation and tracks the changes in prices of a standard package of goods and services which South Korean households purchase for consumption. Over the past two decades South Koreas dynamic economy has successfully weathered two global economic slowdowns and demonstrated a considerable level of resilience. South Korea remains one of Asias strongest democracies, currently holding the worlds 14th largest economy.80 However, challenges remain in ensuring South Koreas long-term economic success. The rigidity of the labor market and lingering corruption continue to hold back overall economic freedom. Korea must continue to reform and improve the efficiency of the tax system and make tax rates more competitive. In wake of low birthrate and aging population, Korea must balance a growth-friendly financial structure with financial soundness. To remain an economic leader in the 21st century, the Korean government must continue to evolve and maintain a proactive financial policy.

Figure 1: Source from Indexmundi.com

Figure 2: Source from Indexmundi.com

Figure 3: Source from Indexmundi.com

Figure 4: Source from Indexmundi.com

(Central Intelligence Agency 2011) (Encyclopedia of the Nations n.d.) 3 (Trading Economics 2011) 4 (Encyclopedia of the Nations n.d.) 5 (World Bank 2011) 6 (International Monetary Fund 2011) 7 (Trading Economics 2011) 8 (Trading Economics 2011) 9 (Encyclopedia of the Nations n.d.) 10 (Encyclopedia of the Nations n.d.) 11 (Trading Economics 2011) 12 (Wikipedia 2011) 13 (Wikipedia 2011) 14 (Trading Economics 2011) 15 (Trading Economics 2011) 16 (Central Intelligence Agency 2011) 17 (Central Intelligence Agency 2011) 18 (Central Intelligence Aency 2011) 19 (Encyclopedia of the Nations n.d.) 20 (Wikipedia 2011) 21 (Wikipedia 2011) 22 (Encyclopedia of the Nations n.d.) 23 (Encyclopedia of the Nations n.d.) 24 (Wikipedia 2011) 25 (Live-PR, Public Relations & News 2011) 26 (globalEDGE n.d.) 27 (globalEDGE n.d.) 28 (International 2010) 29 (Koreabrand n.d.) 30 (Trading Economics 2011) 31 (The China Post 2011) 32 (Central Intelligence Agency 2011) 33 (International 2010) 34 (Koreabrand n.d.) 35 (International 2010) 36 (International 2010) 37 (International 2010) 38 (International 2010) 39 (Koreabrand n.d.) 40 (Koreabrand n.d.) 41 (Trading Economics 2011) 42 (Koreabrand n.d.) 43 (Trading Economics 2011) 44 (2011 Index of Economic Freedom n.d.) 45 (China View 2010) 46 (2011 Index of Economic Freedom n.d.) 47 (2011 Index of Economic Freedom n.d.) 48 (China View 2010) 49 (China View 2010) 50 (International Business Wiki 2009) 51 (Encyclopedia of the Nations n.d.) 52 (Organization for Economic Co-operation and Development 2010) 53 (Organization for Economic Co-operation and Development 2010) 54 (Organization for Economic Co-operation and Development 2010)
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(Koreabrand n.d.) (2011 Index of Economic Freedom n.d.) 57 (Koreabrand n.d.) 58 (Koreabrand n.d.) 59 (Encyclopedia of the Nations n.d.) 60 (Encyclopedia of the Nations n.d.) 61 (Encyclopedia of the Nations n.d.) 62 (Encyclopedia of the Nations n.d.) 63 (Encyclopedia of the Nations n.d.) 64 (Encyclopedia of the Nations n.d.) 65 (Trading Economics 2011) 66 (Encyclopedia of the Nations n.d.) 67 (Trading Economics 2011) 68 (MarketWatch 2011) 69 (MarketWatch 2011) 70 (Encyclopedia of the Nations n.d.) 71 (Encyclopedia of the Nations n.d.) 72 (Bank of Korea n.d.) 73 (Bank of Korea n.d.) 74 (Trading Economics 2011) 75 (MarketWatch 2011) 76 (MarketWatch 2011) 77 (2011 Index of Economic Freedom n.d.) 78 (Bank of Korea n.d.) 79 (Bank of Korea n.d.) 80 (World Bank 2011)
56

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