[Q&A] Hong Nam-ki: "Korea Has Fiscal Capacity... Advanced Countries Also Strengthening Fiscal Roles"

'Fiscal Rules Reinforced for Flexibility' to be Announced in September... Considering Extreme Crisis Situations like COVID-19
"Significant Tax Increase Requires Public Consensus"

Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki is conducting a detailed pre-briefing on the '2021 Budget Proposal' at the Government Complex Sejong on the 27th of last month.

[Asia Economy Reporter Jang Sehee] The Deputy Prime Minister and Minister of Economy and Finance stated, "Most advanced countries, including the Group of Twenty (G20), are strengthening the role of fiscal policy."

Deputy Prime Minister Hong said at the '2021 Budget Pre-Briefing' held at the Government Complex Sejong on the 27th of last month, "The expansionary fiscal budget reflects the fact that we have more fiscal capacity than other countries." He emphasized, "We have suppressed the total expenditure growth rate as much as possible, considering future fiscal demand."

The following is a Q&A with Deputy Prime Minister Hong.

▲ Next year’s total expenditure growth rate is 8.5%, marking the third consecutive year of expansionary fiscal policy. Is there a concern that the national debt ratio might increase excessively?

= The growth rate has slightly decreased from 9.1% this year to 8.5% next year, but both show a fiscal expenditure growth rate above 8%. Last year, there was a global economic downturn, and this year, we faced the crisis of COVID-19. The government had two choices: to proceed with low growth by relying less on fiscal policy, or to actively use fiscal policy despite increased debt and deficits to raise growth rates and establish a virtuous cycle that restores fiscal soundness. The government judged that it is more desirable for fiscal policy to play its role even if national debt and fiscal balance weaken slightly. I would like to point out that almost all advanced countries, including the G20, have pursued similar measures. Also, Korea’s fiscal capacity is greater than that of other countries. Efforts were made to suppress the total expenditure growth rate as much as possible, considering fiscal soundness and future fiscal demand.

▲ How do you view the economic impact of implementing the third stage of social distancing?

= If social distancing moves to stage 3, the economic damage is expected to be very severe. Stage 3 social distancing is very strict, including prohibiting gatherings of more than 10 people, so its impact on the economy is expected to be significant. In that sense, the transition to stage 3 should be deeply reviewed before a decision is made. However, since moving to stage 3 is closely linked to both the economy and quarantine measures?two sides of the same coin?it is not possible to oppose it outright. When the Central Disaster and Safety Countermeasure Headquarters (CDSCH) discusses this, we will ensure that the necessity of quarantine and the economic impact are balanced carefully in the decision-making process. If I may express hope, moving to stage 3 would be the most burdensome factor for economic recovery.

▲ Is positive growth possible this year?

= The Bank of Korea has revised this year’s growth rate down to -1.3%. This seems to reflect the global economic trend and recent fluctuations in COVID-19 cases. The government announced a target growth rate of 0.2% in the second half economic policy direction in June, aiming to avoid negative growth. If the COVID-19 crisis is controlled quickly, we believe we can make our best efforts to rebound in the third quarter and prevent negative growth this year, and we expect positive results. However, if the recent increase in COVID-19 cases continues until the end of the year or new situations arise, it will be very difficult to prevent negative growth this year. The government does not adjust growth rates as frequently as the Bank of Korea or research institutes. The government’s maximum measure is to mobilize all means to achieve the target set in the second half economic policy direction. There will be no further adjustments to the growth rate.

▲ What are the specific plans for introducing fiscal rules?

= Due to recent economic crises and the COVID-19 crisis, the fiscal growth rate has been very high. Fiscal capacity regarding national debt and fiscal balance has weakened considerably, so we believe fiscal rules are necessary. Research shows that about 100 countries worldwide, precisely 92, have introduced and operate fiscal rules. We are reviewing the introduction of fiscal rules in Korea as well. Looking at advanced countries, there are four types of fiscal rules: tax rules, balance rules, expenditure rules, and revenue rules. In addition, qualitative, non-quantitative rules are combined and operated. Along with fiscal rules, we plan to propose fiscal rules that include flexibility, such as exceptions for extreme crises like the COVID-19 crisis where fiscal policy must play a role. We plan to complete the review and announce it in September.

▲ What is the criterion for expansionary fiscal policy?

= We use three criteria to determine whether fiscal policy is expansionary. These are the difference between total revenue growth rate and total expenditure growth rate (difference between revenue and expenditure growth), the extent to which total expenditure growth exceeds the potential growth rate, and the Fiscal Impulse Indicator. The total revenue growth rate is 0.3%, while the total expenditure growth rate is 8.5%, so the difference is 8.2%. It was 7.9% this year. The increase from 7.9% to 8.3% can be one indicator of expansionary fiscal policy. The second criterion is how much the total expenditure growth rate exceeds the potential growth rate. This year, total expenditure growth was 9.1%, and potential growth was 3.8%, so the difference was 5.3%. Next year, total expenditure growth is 8.5%, and potential growth is 4.8%, so the difference is 3.7%. According to this criterion, it is slightly lower than this year but still significantly exceeds the potential growth rate. The third criterion is the Fiscal Impulse Indicator, created by the International Monetary Fund (IMF). If the FI index is greater than 0, it is expansionary fiscal policy; if less than 0, it is contractionary. The FI index was 1.7 this year and will be 2.0 next year. In that sense, it can be considered expansionary fiscal policy.

▲ What are the plans for tax increases to secure reduced tax revenue?

= The debt growth rate next year will be in the mid-40% range. It was 43.5% based on the third supplementary budget this year, so it will increase by more than 3 percentage points. The national debt ratio inevitably increased due to three supplementary budgets this year. If the revenue growth rate were higher than the expenditure growth rate, this burden could be reduced, but that is not the case. The deficit bond issuance this year will affect next year as well, so the national debt ratio will inevitably reach the mid-40% range next year. The government did not consider tax increases when preparing next year’s budget. Significant tax increases require public consensus, so it is a separate issue that needs to be considered. The government will restructure expenditure to reduce spending and implement measures such as reducing tax exemptions and discovering new tax bases.

▲ The national debt will exceed 50% of GDP by 2022.

= We have a scheduled consultation with the international credit rating agency Fitch in September. Credit rating agencies, including Fitch, evaluate national credit ratings based on various factors such as the country’s economic situation, fundamentals, debt, and fiscal balance. The level of national debt is also considered. Fitch is one of the agencies that closely monitors the national debt-to-GDP ratio. Therefore, the government has repeatedly expressed caution about the speed at which the national debt-to-GDP ratio is increasing. We will prepare countermeasures to prevent rapid increases in national debt and to secure fiscal soundness proportionally. During the COVID-19 crisis, about 190 credit rating downgrades occurred globally. Korea’s national credit rating has not changed according to the three rating agencies. The government will explain the inevitability of fiscal policy’s role and the government’s efforts to maintain fiscal soundness while responding accordingly.