KDI cuts 2022 growth outlook to 2.8%, ups inflation estimate to 4.2%

Jung Kyu-chul, a senior economist at the KDI, speaks at Central Government Complex in Sejong, May 16. Yonhap

The Korea Development Institute (KDI) lowered its 2022 growth forecast for the Korean economy to the 2 percent range, Wednesday, while sharply raising its inflation outlook to over 4 percent amid heightened economic uncertainty.

The state-run think tank cut its growth estimate for Asia's fourth-largest economy to 2.8 percent this year from its November estimate of 3 percent.

The KDI raised its inflation outlook to 4.2 percent from 1.7 percent, as energy and food prices remain high amid the protracted war between Russia and Ukraine.

The KDI's latest forecast is higher than the 2.5 percent estimate by the International Monetary Fund. In its latest projection in February, the Bank of Korea (BOK) forecast 3 percent economic growth.

The think tank forecast economic growth to slow to 2.3 percent next year. It expected inflation to be at 2.2 percent in 2023, close to the central bank's 2 percent target.

The revised outlooks came as concerns about stagflation, a mix of slowing growth and high inflation, have mounted amid the Ukraine crisis and the Federal Reserve's aggressive rate hikes.

The KDI said the downward revision took into account lackluster private spending in the first quarter amid a spike in COVID-19 cases and a hike in import prices spurred by soaring fuel prices.

"Rate hike moves by Korea and the United States serve as downside economic risks, and exports could be negatively affected due to worsening external economic conditions," Jung Kyu-chul, a senior economist at the KDI, told reporters.

Exports, which account for half of the economy, are forecast to grow 5.1 percent this year, sharply slowing from 9.9 percent last year, as external demand will likely ease amid the global economic uncertainty, the KDI said.

Private spending is projected to increase 3.7 percent this year, similar to a 3.6 percent year-on-year gain last year.

Consumer spending fell 0.5 percent quarter-on-quarter in the first three months due to the fast spread of the Omicron variant of COVID-19. But private spending is expected to rebound this year, as the lifting of almost all virus curbs will likely spur consumption, the KDI noted.

Facility investment will likely contract 4 percent in 2022 due largely to scaled-back investments by the semiconductor industry.

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The KDI said despite external economic risks, the Korean economy is expected to extend its mild recovery momentum.

"Consumer spending is expected to be the main driver for Korea's economic growth down the road as exports growth will likely slow down," it added.

The KDI said major economic downside risks include the prolongation of global supply chain snarls and China's economic slowdown caused by its tight COVID-19 lockdowns of major cities.

High inflation has been a major bugbear for Korean policymakers, as consumer prices have been under upward pressure amid high energy costs and a rebound in demand from the pandemic.

Korea's consumer inflation spiked 4.8 percent year-on-year in April, the fastest gain in more than 13 years, following a 4.1 percent gain in March.

ATMs in Seoul / Yonhap

The KDI said the BOK needs to "gradually" hike the key interest rate to curb rising inflation expectations.

In April, the central bank raised the policy rate by a quarter-percentage point to 1.5 percent, the fourth rate hike since August last year, in a bid to tame inflation and curb household debt. The BOK is widely expected to further increase the rate at its May 26 policy meeting.

The interest rate gap between Korea and the U.S. has sharply narrowed due to the Fed's aggressive rate hikes. The Fed raised its federal funds rate twice this year, including a 50-basis-point hike in May, to tame inflation. Additional "big step" hikes are expected in the coming months.

"It is desirable for the BOK to run monetary policy by taking into account domestic inflation and economic conditions, rather than by tracking the Fed's aggressive rate hikes," the KDI said.

"In light of Korea's economic fundamentals, the possibility of acute capital outflow is not high even if major economies raise borrowing costs," it noted.

The KDI also recommended the government focus on narrowing the fiscal deficit and slowing the pace of the growing national debt, citing the need to normalize pandemic-era stimuli.

Last week, the government proposed a record extra budget of 59.4 trillion won ($46.6 billion) in a bid to compensate pandemic-hit merchants for losses caused by stricter virus curbs.

"For the time being, the need to prop up the economy with fiscal spending seems low. The government needs to be cautious about creating additional fiscal burdens, given rising inflation and its fiscal status," the KDI said. (Yonhap)

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