[Weekly Review] Raising Social Distancing to Level 4 in the Seoul Metropolitan Area, Economic Recovery Unavoidably Slowed

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eun-byeol] As COVID-19 resurges and the government raises the social distancing level in the Seoul metropolitan area to Level 4, the recovering momentum of our economy is likely to be halted. The government had planned to focus economic policies not only on the rapidly recovering exports and manufacturing sectors since early this year but also on revitalizing consumption and the domestic economy in the second half. However, if the spread of COVID-19 is not contained, consumption stimulation measures will inevitably be postponed as they would conflict with quarantine policies. It was revealed that national tax revenues collected by the government until May this year increased by nearly 44 trillion won compared to last year. However, the government remains cautious about the tax revenue outlook for the second half of the year, as real estate and stock transactions have slowed compared to last year, and the base effect of last year's deferred payments, which were counted as additional tax revenue this year, has disappeared.

Government's Economic Stimulus Strategy Revision Inevitable Due to Level 4 Social Distancing Upgrade

The government’s decision to raise the social distancing level due to the fourth wave of COVID-19 is expected to have a significant impact on the economy. The government had previously identified consumption promotion as the core of economic recovery in its economic policy direction for the second half of the year. The Bank of Korea forecasted in its December monetary and credit policy report that if social distancing is raised to the highest level, private consumption could decrease by more than 16%.

According to the Ministry of Economy and Finance on the 10th, the government announced in the recently released ‘Second Half Economic Policy Direction’ that it would inject vitality into the domestic economy through additional issuance of consumption coupons. Once the first-dose vaccination rate reaches 50%, the use of coupons for dining out, sports, movies, exhibitions, and performances will resume, and new coupons for professional sports event tickets will be issued. Disaster relief funds will also focus on expanding consumption, with about one-third (approximately 12 trillion won) of the 33 trillion won second supplementary budget bill submitted to the National Assembly allocated for consumption activation.

However, with Level 4?the highest social distancing level?applied in the metropolitan area, gatherings and events other than briefings, commemorations, and one-person protests are banned, and businesses such as nightclubs, hunting pubs, and emotional bars must suspend operations. Businesses that violate core COVID-19 quarantine rules even once will face a 10-day business suspension.

[Image source=Yonhap News]

Ultimately, as the COVID-19 situation worsens and social distancing levels rise, the government’s economic strategy aiming for a ‘V-shaped rebound’ through consumption activation is bound to face setbacks. According to the Bank of Korea’s communication report, applying the previous highest social distancing level of Level 3 would result in an estimated 16.6% annual decrease in private consumption and an 8% reduction in gross domestic product (GDP). A Bank of Korea official stated, "At that time, Level 3 was the highest social distancing level, but since then, the system has been revised to include Level 4."

Bank of Korea’s Base Interest Rate Hike Schedule May Be Affected

There are forecasts that the Bank of Korea’s schedule for raising the base interest rate could be affected. Since the government decided to raise the social distancing level in the metropolitan area to Level 4 for two weeks, the possibility of a contraction in the recovering private consumption cannot be ignored.

According to market experts, if the strengthening of social distancing delays economic recovery, the Bank of Korea may adjust the pace of monetary policy normalization. Initially, the market widely expected the Bank of Korea to raise interest rates as early as August or as late as October. If two or more minority opinions for a rate hike emerge at the Monetary Policy Committee meeting scheduled for the 15th, an interest rate hike as soon as August would be possible.

Hong Nam-ki, Deputy Prime Minister and Minister of Economy and Finance (left), and Lee Ju-yeol, Governor of the Bank of Korea [Image source=Yonhap News]

However, given the upgraded social distancing level, it is more likely that minority opinions for a rate hike will appear after observing the impact on economic indicators such as private consumption. The Bank of Korea will release a revised economic outlook on the 26th of next month, and since this outlook is expected to reflect the recent COVID-19 resurgence and government consumption stimulus policies, the Bank may decide after monitoring the situation. This means an interest rate hike in August could be difficult, and at most, one rate hike may occur within this year. Assuming the summer COVID-19 resurgence is contained, the scenario is for a rate hike in October or November.

Gong Dong-rak, an economist at Daishin Securities, said, "The upgrade to Level 4 social distancing will have some impact on the interest rate hike schedule. If it becomes clear through data that economic activity has contracted due to Level 4, and various indicators worsen, it will be very burdensome for the Bank of Korea to proceed with the next steps." After a crisis, central banks raising interest rates signal a shift toward tightening, but with significant shocks to self-employed businesses and increased debt, changing policy direction could be burdensome.

Government Collected 44 Trillion Won More in National Taxes from January to May... Fourth Wave Is a Variable

It was revealed that the government collected nearly 44 trillion won more in national tax revenues by May this year compared to last year. This was largely due to significant increases in capital gains tax, securities transaction tax, and corporate tax amid rising housing prices and economic recovery. Although government spending increased during the COVID-19 response, resulting in a fiscal deficit of 48.5 trillion won, the deficit narrowed.

According to the Ministry of Economy and Finance’s ‘Monthly Fiscal Trends July Issue’ published on the 8th, national tax revenues reached 161.8 trillion won by May this year, an increase of 43.6 trillion won compared to the same period last year. The increase in national tax revenues was due to recovery in the three main pillars of national taxes: income tax, corporate tax, and value-added tax. The fiscal balance, which represents the state of public finances, naturally improved. The integrated fiscal balance deficit, which is income minus expenditure, was 20.5 trillion won as of May, a reduction of 40.8 trillion won compared to the same period last year. The managed fiscal balance deficit, which excludes social security funds such as the National Pension from the integrated fiscal balance to show the actual state of public finances, also decreased by 29.4 trillion won to 48.5 trillion won compared to last year.

Although the deficit narrowed, the national total debt continued to increase. The government issued 87.7 trillion won in treasury bonds this year, bringing the total national debt balance as of May to 899.8 trillion won, approaching the 900 trillion won mark. Based on the first supplementary budget bill this year, the national debt is expected to rise to 938.4 trillion won. The government is closely monitoring the potential impact of the fourth wave of COVID-19 on tax revenues.