The Organisation for Economic Co-operation and Development (OECD) raised its growth forecast for Korea's economy this year by 0.9 percentage point in just three months. While the OECD lowered its global outlook on the back of war in the Middle East and a blockade of the Strait of Hormuz, Korea saw the largest upward revision among major economies, lifted by strong semiconductor exports. Nominal growth this year could also exceed 10% for the first time since 2002.
In its Economic Outlook released Tuesday, the OECD projected Korea's real gross domestic product (GDP) growth at 2.6% for this year, up 0.9 percentage point from the 1.7% it forecast in its interim outlook in March. Growth next year is projected at 1.9%.
In March, the OECD had cut Korea's growth forecast to 1.7% from 2.1%. The organization judged that the war in Iran and energy supply disruptions would weigh on production and exports in countries heavily dependent on Middle East energy, such as Korea. However, the outlook flipped within just three months as the semiconductor cycle recovered more strongly than expected.
"Demand for advanced semiconductors has been stronger than expected, with export expansion driving growth and private investment, while consumption is expected to recover gradually," the OECD said. The organization noted that exports surged from early this year, with both prices and volumes rising notably in the technology export segment. Shipbuilding was also cited as a pillar supporting the manufacturing sector.
At the same time, the OECD said the recovery has yet to spread across the broader economy. Sentiment in manufacturing outside semiconductors and shipbuilding remains weak, and consumer confidence deteriorated significantly in April, the organization noted. That suggests the export-led recovery may take more time to filter through to domestic demand and the wider manufacturing sector.
The global outlook moved in the opposite direction. The OECD lowered its world growth forecast for this year to 2.8% from 2.9%, a cut of 0.1 percentage point. The organization judged that the Middle East war, rising energy prices and trade disruptions from the Strait of Hormuz blockade are weighing on the global economy. If the energy price shock is prolonged, production disruptions could widen, particularly in some Asian economies, the OECD said.
Korea's nominal growth this year is estimated at 10.4%. The figure was back-calculated by the Ministry of Economy and Finance based on the GDP deflator of 7.6% presented by the OECD. If realized, it would mark the first time Korea's nominal growth has surpassed 10% since the 11.0% recorded in 2002.
A jump in nominal growth also affects fiscal indicators. As nominal GDP expands, the debt-to-GDP ratio falls even when the level of public debt is unchanged. Based on the OECD outlook, the Ministry of Economy and Finance lowered its projection for the general government debt ratio to 48.2% this year and 50.2% next year. Even so, the debt ratio is still expected to exceed 50% next year despite the high nominal growth.
The inflation outlook improved slightly. The OECD lowered its forecast for Korea's consumer price inflation this year to 2.6% from 2.7%, a cut of 0.1 percentage point. Inflation is expected to ease to 2.2% next year, near the price stability target. Price ceilings and fuel tax cuts are having some effect in slowing the inflation pressure from the energy supply shock, the organization assessed.
The OECD warned, however, that prolonged price stabilization measures could amplify side effects. While they reduce the burden of energy prices in the short term, they distort market prices, delay the normalization of inflation and increase the fiscal burden, the organization said. The OECD recommended prioritizing targeted support for vulnerable households and firms, while phasing out energy price support, price controls, fuel tax cuts and export restrictions.
On monetary policy, the OECD assumed a path in which the Bank of Korea raises its base rate by 0.25 percentage point in the third quarter of this year, then cuts it back to 2.5% next year as inflation returns to target. The OECD said that for energy supply shocks, it is more important to keep inflation expectations anchored than for monetary policy to react excessively. Still, additional rate hikes may be needed to keep long-term inflation expectations in check, the organization added.
On fiscal management, the OECD called for strengthening the long-term sustainability framework. Fiscal deficits are accumulating while spending pressures from population aging are rising. The OECD proposed building a fiscal framework that aligns the annual budget with a long-term fiscal path, and suggested considering the introduction of a cyclically adjusted fiscal balance ceiling and an independent fiscal institution.
