Fiscal Deficit Capped Within 3% of GDP... Exception Applied When Drafting Supplementary Budget

Ministry of Economy and Finance Announces 'Fiscal Rules Implementation Plan'

[Image source=Yonhap News]

[Asia Economy Sejong=Reporter Kwon Haeyoung] The government plans to manage the fiscal deficit ratio relative to Gross Domestic Product (GDP) within 3%, aiming to keep the national debt ratio in the mid-50% range by 2027. If the national debt exceeds 60% of GDP, the deficit ratio will be capped at 2%. Unlike the previous administration’s fiscal rules, which were criticized as ineffective due to loose standards and low binding force, the new policy clarifies the criteria and specifies the legal basis to tighten fiscal soundness. However, the fiscal rules will not be applied during the preparation of supplementary budgets.

On the 13th, the government held an emergency economic ministers’ meeting at the Government Seoul Office, chaired by Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho, where it announced the 'Fiscal Rules Introduction Plan' centered on these points. The main points were previously disclosed at the '2022 National Fiscal Strategy Meeting' in July.

The new fiscal rules strengthen compliance standards and impose binding force compared to the government proposal announced in October 2020. First, the fiscal deficit will be managed within 3% of GDP, the level before the COVID-19 outbreak, and if debt exceeds 60%, the deficit ratio will be limited to 2%. While the previous government created complex limit formulas and included relaxation provisions during economic slowdowns, leaving many loopholes, the new fiscal rules simplify the criteria.

In particular, the government decided to use the management fiscal balance instead of the integrated fiscal balance (total government revenue minus total expenditure). The management fiscal balance excludes the currently surplus social security funds from the integrated fiscal balance, reflecting the actual state of national finances. When using the management fiscal balance, the fiscal deficit ratio relative to GDP was 5.8% in 2020, 4.4% in 2021, and 5.1% based on the second supplementary budget in 2022, higher than when using the integrated fiscal balance (3.7%, 1.5%, and 3.3%, respectively). The previous government’s use of the integrated fiscal balance created an optical illusion that the fiscal deficit was smaller than its actual size, but the new fiscal rules plan to manage national debt using a stricter indicator. However, for the national debt indicator, only 'D1'?which sums central and local government debt excluding public institutions and public enterprises’ liabilities?will be used.

Through this, the government aims to slow the increase in national debt and cap the national debt ratio relative to GDP at the mid-50% range during the current administration, up from the current 50%. The national debt ratio rose by about 6 percentage points during the Lee Myung-bak administration (2008?2013), about 3 percentage points during the Park Geun-hye administration (2013?2017), but surged by a staggering 14.1 percentage points during the Moon Jae-in administration (2017?2022).

The Ministry of Economy and Finance stated, "Considering the structural rise in the debt ratio due to aging, the system is designed to manage the speed of debt increase rather than the debt ceiling," adding, "We will develop additional fiscal-related indicators such as the ratio of mandatory expenditures to total expenditures and the ratio of deficit-financed debt to ensure compliance with fiscal rules."

Additionally, as with the previous plan, the deficit ratio limit will be reviewed every five years, and if a global surplus occurs, the national debt repayment ratio will be raised from the current 30% to 50%.

The government plans to establish the legal basis for the new fiscal rules in law and apply them immediately from the 2024 budget, which will be prepared after the law is amended next year. This shows a stronger commitment to implementation compared to the previous government, which planned to establish the basis in enforcement ordinances, allow a grace period, and apply the rules from 2025.

However, concerns have been raised because the exceptions to applying the fiscal rules are aligned with the supplementary budget preparation conditions. The National Finance Act stipulates conditions for supplementary budgets such as war, large-scale disasters, economic recessions, mass unemployment, changes in inter-Korean relations, and significant changes in domestic and international circumstances. The new fiscal rules’ exception provisions are the same. Considering that past governments have prepared supplementary budgets for eight consecutive years since 2015 and were criticized for not strictly interpreting the conditions, there are concerns that even if the fiscal rules are legalized under the new administration, exceptions may frequently occur.