Budget Cuts and Worsening Fiscal Soundness... Next Year's Growth Rate of '2.2%' Also Uncertain

Next Year's Budget Proposal Reduced by 13 Trillion Won from Initial Plan
Belt-Tightening Efforts Yet Fiscal Soundness Expected to Worsen
Bank of Korea's 2.2% Growth Forecast for Next Year Also Uncertain

As the government has reduced next year's budget to 656.9 trillion won from the initially planned amount, there is an analysis that achieving the 2.2% growth rate forecasted by the Bank of Korea for next year has become more difficult. While it could have been positive if the government had tightened its belt and improved fiscal soundness, concerns are being raised that despite the budget cut, the next year's management fiscal balance is expected to worsen compared to this year, potentially increasing downward pressure on medium- to long-term growth rates.

President Yoon Suk-yeol is presiding over a Cabinet meeting at the Presidential Office building in Yongsan, Seoul on the 29th.
[Image source=Yonhap News]

According to the Bank of Korea and the Ministry of Economy and Finance on the 30th, next year's government budget was finalized at 656.9 trillion won, an increase of 18 trillion won (2.8%) from this year's 638.7 trillion won. Although the expenditure budget itself increased compared to this year, it decreased from the original plan. Earlier, the Ministry of Economy and Finance presented the total expenditure for 2024 as 669.7 trillion won (4.8%) through the '2022?2026 National Fiscal Management Plan' last August. Compared to this, next year's budget will be reduced by about 12.8 trillion won.

Accordingly, it is expected to have some impact on achieving the growth rate forecast for next year. On the 24th, the Bank of Korea presented a revised economic outlook, lowering next year's growth rate by 0.1 percentage points from the May forecast to 2.2%, which reflected the government expenditure scale before the cuts. Amid already significant uncertainties surrounding next year's growth rate due to factors such as the Chinese economy, semiconductor exports, and international oil prices, the government's reduction in spending has shaken even the early 2% growth rate.

A Bank of Korea official explained, "The impact of the government's next year's budget on the growth rate needs further analysis," adding, "The expenditure growth rate is lower than the amount stated in last year's medium-term fiscal plan." The reduction in government spending next year indicates that the economic outlook and tax revenue base are unstable. According to the Ministry of Economy and Finance, due to poor corporate performance and a slowdown in consumption, national tax revenue is expected to decrease by 13.6 trillion won compared to this year.

The problem is that despite the reduction in next year's government budget, fiscal soundness is expected to worsen. The Bank of Korea initially anticipated that, as the government maintains a sound fiscal stance, the management fiscal balance deficit ratio relative to GDP would remain in the mid-2% range until next year. However, when the figures were revealed yesterday, it showed 3.9%, a significant difference from expectations. This is not only higher than this year's 2.6% but also exceeds the fiscal rule standard (within 3%) that the government is pushing to introduce.

The management fiscal balance is an indicator used to assess the government's fiscal soundness; a higher deficit ratio relative to GDP means a worse fiscal situation. Although fiscal soundness is not directly linked to the growth rate, it affects the overall economy both directly and indirectly. A Bank of Korea official said, "Recently, the United States had its credit rating downgraded due to fiscal issues," and explained, "(Fiscal soundness) is an important indicator for evaluating the government's fiscal capacity, so it is reviewed and assessed when making forecasts."

This weakening of the government's fiscal capacity could become an obstacle to domestic economic recovery in the future. Looking at the recent case of China, decades of accumulated massive local government and corporate debt have acted as a key factor in economic slowdown. As China's real estate and domestic demand markets have stagnated, local tax revenues have significantly decreased, restricting the government's active stimulus measures and further deepening the recession. This context is broadly similar to Korea, where tax revenues are faltering due to economic sluggishness and poor corporate performance.

Typically, when the economy is weak, the government increases spending and strengthens public works or infrastructure investment to prevent a decline in growth rates, but such responses will be difficult to expect going forward. This is not only due to a lack of capacity but also because it does not align with the government's policy stance. Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho said, "I am aware that some demand the government to lead growth," but added, "However, what cannot be abandoned is fiscal normalization and a sound fiscal stance."

However, since Korea's decrease in government spending and deterioration in fiscal soundness next year are both due to economic slowdown, the situation could change depending on the extent of export recovery next year. Another Bank of Korea official explained, "It seems the government reduced next year's expenditure considering this year's tax revenue shortfall," adding, "However, semiconductor demand might improve next year, and tax revenue could exceed expectations. It is difficult to predict a slowdown in next year's growth rate based solely on the budget."

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