Bank of Korea calls for fiscal measures to stimulate economy

South Korea's central bank governor has called on the government to take fiscal measures to stimulate the economy, citing weak public spending as a drag on growth as he revealed a downgrade in the bank's economic forecasts.

The Bank of Korea on Thursday lowered its full-year economic growth prediction from 3.4 per cent to 3.1 per cent, having previously cut it from 3.9 per cent in January.

Lee Ju-yeol, the bank's governor, said that the downgrade was prompted in part by slow public spending in the first quarter of this year, after tax revenues fell short of government expectations.

The value of work carried out on public construction projects fell 13.9 per cent year on year in January and 6 per cent in February.

"We saw big tax revenue shortfalls last year, which was a big factor dragging down the growth rate," Mr Lee said. "We expect tax revenue shortfalls for this year too. For economic recovery, some fiscal measures are needed."

Mr Lee's call follows widely perceived pressure from the government in recent months for easing by the BoK, with Choi Kyung-hwan, finance minister, saying that monetary policy should be "in harmony" with growth-focused fiscal policy.

In spite of the downgrade, Mr Lee said there would be no change to the base interest rate of 1.75 per cent, which was "accommodative enough to support economic recovery". The bank's 25 basis point cut last month was its third in eight months.

The governor previously raised concerns about the impact of weak tax revenue in January, but the finance ministry said that last year's shortfall of at least Won11.7tn ($10.7bn) was not the reason for slow infrastructure spending.

On March 20, the finance ministry said that spending in the first half of this year would be increased by Won3tn from estimates in the budget, although most of this consisted of spending being moved forward from the second half of the year.

However, more significant intervention could follow in line with Mr Lee's plea, said Wai Ho Leong, an economist at Barclays. "If growth remains soft, the government could relax its constraints on fiscal targets" and take on more debt to fund public spending, he said.

A further headwind, Mr Lee said, came from the slowing Chinese economy, which helped drag down exports by 4.2 per cent in March from a year before. Another reason for that contraction was the falling oil price - broadly seen as a positive development for resource-poor South Korea, but which has reduced the value of its refined petrochemical exports.

The falling value of imported oil has weighed heavily on inflation, which is being dragged below the BoK's target range of 2.5 to 3.5 per cent. Consumer price inflation last month fell to 0.4 per cent - the weakest figure since 1999 - and would have slipped below zero without the impact of a recent tobacco tax increase.

This prompted the BoK on Thursday to lower its inflation forecast for this year from 1.9 per cent to 0.9 per cent, a move that will reinforce widespread market expectations that another interest rate cut could follow in the coming months.

Another driver of such anticipation will be the fact that one of the monetary policy committee's seven members voted for a second consecutive rate cut at this month's meeting, said Raymond Yeung, an economist at ANZ. "That surprised the market, [which] may think that the easing bias remains," he said.

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