[BOK Focus] Monetary Policy Committee Also Worries About Supplementary Budget... "What About Inflation in the Second Half?"

Last Month's FOMC Also Mentioned Possibility of Supplementary Budget
Government and Ruling Party Drew the Line but Concerned About Economic Slowdown and Tax Revenue Decline
Bank of Korea Negative... Monetary Policy Also Affected if Actually Formed

As analyses suggest that this year's inflation rate will gradually stabilize, the supplementary budget (추경) formulation is emerging as a new variable. With the heating cost bomb and consecutive public utility fee hikes overlapping, demands for supplementary budgets aimed at supporting low-income households are growing stronger, especially in the National Assembly. While formulating a supplementary budget to support heating costs can partially reduce household burdens, the massive influx of funds could also exacerbate inflation concerns. The Bank of Korea, which must prioritize price stability while implementing monetary policy, is closely monitoring the National Assembly and government's discussions on the supplementary budget.

Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho (third from left), Bank of Korea Governor Lee Chang-yong (second from left), Financial Services Commission Chairman Kim Ju-hyun (far right), and Financial Supervisory Service Governor Lee Bok-hyun are posing for a commemorative photo on the morning of the 2nd at the Bankers' Hall in Myeong-dong, Jung-gu, Seoul, before holding an emergency macroeconomic and financial meeting. [Image source=Yonhap News]

The Monetary Policy Committee also says "Supplementary Budget Scenarios Must Be Considered"

According to the Bank of Korea and political circles on the 2nd, voices calling for the formulation of a supplementary budget have recently emerged from some members of the Democratic Party and the People Power Party, drawing attention to whether it will materialize. After Lee Jae-myung, the Democratic Party leader, recently demanded a supplementary budget citing the promotion of a 30 trillion won-scale 'Emergency Livelihood Project,' party-level support such as from floor leader Park Hong-geun has followed. Although Joo Ho-young, floor leader of the People Power Party, and Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho have drawn a line against the supplementary budget for now, public dissatisfaction over heating costs is growing, making it necessary to devise countermeasures.

The Bank of Korea expects fiscal tightening to continue for the time being, as the Yoon Seok-yeol administration has expressed a stance to secure fiscal soundness. However, it is also mindful of the possibility of a supplementary budget being formulated later due to tax revenue shortfalls and economic recession. The minutes of the Monetary Policy Committee meeting held on the 13th of last month show that some committee members stated, "The economic situation has worsened compared to when the government budget was formulated, and tax revenue is expected to be lower than anticipated due to tax cuts," and "It is necessary to consider the possibility of an unavoidable supplementary budget in the second half of this year as a potential forecast scenario."

On the morning of the 1st, Lee Chang-yong, Governor of the Bank of Korea, is having a discussion with Shin Hyun-song, Senior Economist and Head of the Research Department at the Bank for International Settlements (BIS), at the joint seminar between the Bank of Korea and the Korea Chamber of Commerce and Industry held at the International Conference Hall of the Korea Chamber of Commerce and Industry in Jung-gu, Seoul, on the theme of "Changes in the Economic Paradigm and Response Measures of the Korean Economy." [Image source=Yonhap News]

'No Supplementary Budget' but Burden from Economic and Tax Revenue Deterioration

Although the government and ruling party reject the formulation of a supplementary budget, analyses suggest that if the economic slowdown accelerates faster than expected, formulating a supplementary budget as a last resort will be inevitable. The International Monetary Fund (IMF) recently downgraded South Korea's economic growth forecast for this year from 2.0% to 1.7%. This figure is even lower than Japan's (1.8%), which has been experiencing a long-term recession. Despite China's reopening after abandoning its zero-COVID policy, the Korean economy is unlikely to recover from this year's slump easily due to intensified US-China conflicts, the semiconductor downturn, and high interest rates.

In this situation, formulating a supplementary budget could boost the growth rate. Bank of Korea Governor Lee Chang-yong said at a press conference after the Monetary Policy Committee meeting in May last year that the government's second supplementary budget of 59 trillion won at the time had the effect of raising the economic growth rate by 0.2 to 0.3 percentage points. The Korea Development Institute (KDI) also estimated the impact of the supplementary budget on the growth rate at 0.4 percentage points, which was used as evidence that the supplementary budget has a greater effect on economic growth than on inflation. With the general election scheduled for early next year, both the government and ruling party need economic recovery, so discussions on a supplementary budget in the second half of the year may gain momentum.

The government's lowering of corporate tax and comprehensive real estate tax has also weakened the tax revenue base, increasing the possibility of a supplementary budget. If the real estate market continues to deteriorate due to the economic recession and income and consumption decrease, tax revenues such as income tax, comprehensive real estate tax, and value-added tax will inevitably decline. On the other hand, the need for support for low-income households continues to grow due to electricity and gas price hikes, so it is expected that the government will find it difficult to reject opposition parties' demands for a supplementary budget solely on the grounds of fiscal soundness. The Bank of Korea explained, "Whether a supplementary budget is formulated depends on future tax revenue and economic trends, so it is difficult to make a judgment at this point."

Democratic Party of Korea leader Lee Jae-myung is attending the Supreme Council meeting held at the National Assembly on the 1st. [Image source=Yonhap News]

If a Supplementary Budget Is Formulated in the Second Half, It Will Also Affect Monetary Policy

The Bank of Korea is expected to take a negative stance on the supplementary budget. The Bank must consider not only inflation but also the national debt, which amounts to 1,000 trillion won. Governor Lee said at a seminar hosted by the Bank of Korea and the Korea Chamber of Commerce and Industry the day before, "The Ministry of Economy and Finance has a firm will to pursue sound fiscal management, so policy coordination is well maintained not only for inflation but also for crisis management." This can also be interpreted as meaning that if the government pursues a supplementary budget that is negative for fiscal soundness, cracks may appear in policy coordination.

Shin Hyun-song, Economic Advisor and Head of Research at the Bank for International Settlements (BIS), said, "Government debt, which was not a major concern until now, is gradually emerging as a risk factor," and "Fiscal spending will play an important role in the global economy going forward, and how governments manage finances amid high interest rates will become a new theme."

If the government undertakes a supplementary budget in the second half, it could also influence the Bank of Korea's monetary policy. The minutes of last month's Monetary Policy Committee meeting show that many members expressed caution about further raising the base interest rate, assuming that the inflation rate continues to slow as currently forecasted. In fact, some members stated that "It is important to maintain a tight policy stance until the trend of inflation converging to the target level is confirmed." Earlier, Governor Lee also explained at a press conference, "We decide interest rates considering the supplementary budget."