[Deputy Manager Column] The Crisis of Fiscal Soundness

[Asia Economy Reporter Kwangho Lee] With the announcement of the 3rd supplementary budget following the 1st and 2nd supplementary budgets, the soundness of the national finances is under threat. The government initially planned to secure the 2nd supplementary budget for emergency disaster relief payments through expenditure restructuring, but after political pressure, it expanded the payment target to the entire population and plans to issue additional deficit bonds. Furthermore, since most of the funds for the 3rd supplementary budget are planned to be covered through deficit bonds, there is a significant concern that the soundness of national finances will be severely shaken.

Even if the 2nd supplementary budget size remained at 7.6 trillion won, the deficit ratios of the integrated fiscal balance and the management fiscal balance relative to the gross domestic product (GDP) are expected to rise by 2.3% and 4.3 percentage points, respectively. National debt also increased to 815.5 trillion won after the 1st supplementary budget, with the ratio to GDP exceeding the 40% mark at 41.2%. Once the 3rd supplementary budget is finalized, the management fiscal balance deficit ratio will far exceed the 4.7% level seen in 1998, when the aftermath of the foreign exchange crisis was severe.

In a crisis, the state can issue debt to inject liquidity, but if this process damages fiscal soundness, it could trigger a red light for the country's credit rating. Given the high degree of openness of our economy, a deterioration in credit rating could escalate into crises in the financial and foreign exchange markets. S&P has maintained South Korea’s sovereign credit rating and outlook at the current level (AA, stable), but this is based on assumptions that the Korean economy will rebound next year and that the general government budget will return close to a balanced level.

Some argue that compared to the OECD average of 110%, Korea’s 40% level indicates sufficient fiscal capacity. Moreover, there are voices advocating for active stimulus measures over fiscal soundness during crises. Kenneth Rogoff, a leading austerity economist and professor of economics at Harvard University, recently emphasized in an interview with the US economic broadcaster CNBC, "This is a war situation, so we cannot look at other aspects (like fiscal soundness). We have to do this (stimulus)." Rogoff, who served as a chief economist at the International Monetary Fund (IMF) and is known for his critical stance on fiscal deficits and government debt, argues that active fiscal and monetary policies are necessary in crisis situations such as the COVID-19 pandemic.

However, there are also many counterarguments warning that if the current fiscal spending trend is not controlled, South Korea’s national debt ratio could soon exceed 60% and reach up to 80%. It is pointed out that Korea could follow the path of South American countries like Venezuela and Argentina, where populist policies led to a multiple increase in the national debt ratio relative to GDP. Above all, a fiscal crisis leaves a "tax bomb" for future generations. It amounts to moral hazard by imposing a huge debt burden on future generations. While the urgent situation requires putting out the fire, preparations for the boomerang effect should also be made.