Seoul shifting fiscal policy to neutral to cap debt-to-GDP ratio at 3% next five yrs

[Photo by Lee Seung-hwan]

The new conservative government under President Yoon Suk-yeol is formally ending the ultra-loose fiscal policy to contain debt ratio against the gross domestic product at mid-50 percent range and fiscal deficit at 3 percent of the GDP.

The first fiscal strategy meeting under Yoon on Thursday unveiled the goal of containing the debt ratio versus the GDP at mid-50 percent level during his presidential term through 2027.

Fiscal policy over the next five years would be more or less neutral as debt ratio after two supplementary budgets is expected to hit 49.7 percent by the end of this year.

“An absolute increase in national debt itself is inevitable,” said Choi Sang-dae, deputy economy and finance minister, in a briefing. “It is all a matter of managing debt-to-GDP ratio in a sustainable level.”

The government will aim to reduce the fiscal deficit to less than 3 percent of GDP from next year, which would be down by more than 2 percentage points from 5.1 percent estimate this year.

The government will be reducing about 43.6 trillion won ($33.6 billion) in fiscal deficit under its goal from next year based on 2,180 trillion won GDP estimate for this year.

The government will refer to managed fiscal balance instead of total fiscal balance for stricter fiscal management.

In general, total fiscal balance that includes social security fund including assets under the National Pension Fund brings better results than managed fiscal balance which can lead to an illusion in the public finance account. For example, the deficit against managed fiscal account is projected at 5.1 percent for this year and 3.3 percent against total fiscal account

The government will also simplify fiscal rule calculation and enforce law regulation instead of an ordinance for enforce binding force on upholding fiscal integrity. Debt ceiling would be lowered if the national debt-to-GDP ratio exceeds 60 percent.

A fiscal mandate is a system being managed by 90 countries across the world. Korea and Turkey are the only two governments among the Organization of Economic Cooperation and Development countries that are not subject to statutory guidelines on fiscal management.

Germany regulates fiscal management in its Constitution and limits new debts by maintaining fiscal deficit to less than 0.35 percent of GDP. France also regulates fiscal rule in its law which stipulates fiscal deficit to be under 0.5 percent of GDP.

But capping fiscal deficit at 3 percent can be challenging for the government, given the worsening economic conditions in the short term and demographic challenges from fast aging in the longer run.

“The target presented by the government is very high and it will not be easy to reach the goal,” said Kim Woo-chul, professor at University of Seoul. “It will have to put out efforts to restructure spending and in the end reform its budget structure to comply with the rule.”

As a starter, the presidential office announced it would be streamlining 13 out of 20 presidential commissions which could save annual budgetary spending of minimum 25 billion won.

Korea’s fiscal deficit has snowballed over the last five years on cheap-liquidity-backed expansion to enhance social benefits and also to fight Covid-19 pandemic.

According to the Ministry of Economy and Finance, national debt stretched 408 trillion won in five years to 1,068 trillion won in 2022 from 660 trillion won in 2017, which is more than double the growth during the previous five years.

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