"Rapid Aging and Debt Increase Concerns" Fitch Downgrades South Korea's Potential Growth Rate

Credit rating maintained on condition of fiscal soundness improvement efforts,
but fiscal soundness shaken if 2nd supplementary budget increases
Ministry of Economy and Finance distributes reference materials omitting downward revision of potential growth rate and other contents
Only self-praise of "maintaining the highest-ever rating"

[Sejong=Asia Economy Reporter Kim Hyunjung] The international credit rating agency Fitch lowered South Korea's potential growth rate due to unprecedentedly rapid aging and structural debt increase globally. The Korean government's claim of maintaining the credit rating at AA- is also based on the government's efforts to improve fiscal soundness, such as partial repayment of government bonds using additional tax revenue, raising concerns about the repercussions of discussions led by the ruling party on increasing the 2nd supplementary budget.

On the 21st (local time), Fitch maintained South Korea's sovereign credit rating and outlook at AA- "Stable" while lowering the potential growth rate from 2.5% to 2.3%. It forecasted that the general government's fiscal deficit (central government, local governments, and non-profit public institutions) will expand from 3.7% of GDP last year to 4.4% this year, still below the AA median of 5.3%.

◆ "Aging and debt increase as risk factors" = Fitch cited aging and debt increase as threats to South Korea's economic situation. In particular, it explained, "With expenditure pressure due to aging, the increase in national debt can be a risk factor in fiscal management," adding, "The future development of risks will depend on the productivity and potential growth rate improvement effects of fiscal spending."

Fitch also predicted that South Korea's national debt will rise to 47.1% of GDP within this year. This is about 4 percentage points higher than the 43.8% national debt-to-GDP ratio recorded at the end of last year.

On the other hand, Fitch cited effective pandemic management and strong economic recovery due to export growth as reasons supporting South Korea's creditworthiness. Although there is a fiscal burden from the 2nd supplementary budget due to COVID-19, it expressed trust in the history of sound fiscal management so far.

Additionally, it evaluated, "Despite rising real estate prices due to low interest rates and housing supply shortages and continued household debt increase, threats have been relatively well contained through household and corporate soundness and policy responses," and "Relations with North Korea are deadlocked but tensions remain stable." It also added, "Robust external soundness, including net external creditor status, sustained current account surplus, and sufficient foreign exchange reserves, has played a buffering role against international financial market volatility even during the COVID-19 situation."

◆ Fitch’s trust in ‘soundness improvement’ may be broken by ruling party claims = One of the key factors for Fitch’s positive evaluation of South Korea compared to the downgrade of ratings or outlooks of 18 advanced countries after COVID-19 is ‘improvement in fiscal indicators.’

Regarding the background of maintaining the rating this time, Fitch stated, "The 2nd supplementary budget is funded by additional tax revenue, does not issue additional deficit bonds, and partially repays government bonds, so medium- to short-term fiscal indicators will improve compared to previous forecasts." It also explained, "South Korea’s history of sound fiscal management mitigates pressure from increasing national debt, and fiscal rules will provide a foundation to further strengthen fiscal management."

However, recently, the Democratic Party of Korea has strongly demanded an increase in the 33 trillion won scale 2nd supplementary budget previously announced by the government, citing the resurgence of COVID-19. The main points include significantly expanding compensation and support for small business owners and pushing for nationwide support payments. In particular, the ruling party is arguing for the cut of the 2 trillion won budget related to government bond repayment, which Fitch mentioned as part of South Korea’s fiscal soundness improvement efforts. The Ministry of Economy and Finance has expressed fundamental opposition to this, but considering previous COVID-19 response budget procedures, it is highly likely to follow the ruling party’s proposal this time as well.

Concerns also arise as the fiscal rules, which Fitch called the "foundation for strengthening fiscal management," are stalled in the National Assembly. The fiscal rules, aiming for introduction in 2025 to maintain the national debt-to-GDP ratio below a certain level, were submitted by the government to the National Assembly at the end of last year but have not progressed in discussions, leaving the introduction uncertain. A government official said, "The government bond repayment (2 trillion won) is not large compared to the actual debt size but symbolizes the government’s fiscal soundness efforts," adding, "If it is cut due to political demands and used as supplementary budget funds, repercussions are expected."

Meanwhile, the explanatory materials on Fitch’s South Korea sovereign credit rating change distributed by the Ministry of Economy and Finance omitted the downward revision of the potential growth rate and the expansion of government debt deficit ratio to GDP. Instead, only the positive evaluation of maintaining the credit rating and outlook at the highest-ever level was included, drawing criticism for omitting unfavorable content.

This content was produced with the assistance of AI translation services.