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[Editorial] Deflation looming

Policy shift, not fiscal expansion, could save the economy from risks

Official data released this week showed that the country’s inflation rate fell into negative terrain last month after staying below the 1 percent threshold for seven consecutive months.

The on-year decrease of 0.04 percent in August marked the first time that consumer prices plunged to negative growth since 1965, when the state statistics agency began compiling related data.

The fall in prices amid a slowing economy has deepened concerns that South Korea might be heading for a period of deflation soon. Price stability is nothing to worry about. But a decline in prices accompanied or caused by an economic slowdown could draw the economy into a long-term recession.

Actually, many economists here warn that the country’s economy is facing a prolonged recession akin to Japan’s “two lost decades,” which began in the early 1990s.

The government and the Bank of Korea have downplayed the possibility of structural deflation, attributing the fall in consumer prices last month mainly to a base effect from the high prices of agricultural and petroleum products a year earlier.

But many economic indicators portend rising deflationary risks.

Consumer spending fell for the second consecutive month in July. Facility investments shrank 10.8 percent in the first quarter, marking the steepest decline in more than two decades. Production capacity in the manufacturing sector decreased for 12 straight months through July.

The specter of deflation could lead consumers to further delay spending in anticipation of lower prices in the near future, pushing companies to cut production and investments.

This vicious cycle would draw the economy deeper into a low-growth rut.

Further weighing on the economy is a continuous decline in exports, which account for nearly half of the country’s gross domestic product. Korea’s outbound shipments dropped 13.6 percent in August from a year earlier, extending their downward streak to nine consecutive months amid deteriorating external conditions.

In July, the BOK revised its growth outlook for the country’s economy this year to 2.2 percent, down from the 2.5 percent it forecast three months earlier. The Ministry of Economy and Finance also recently cut its growth estimate for the year by 0.2 percentage point to a range between 2.4-2.5 percent. Such trimmed estimates, however, still seem rosy, given that most economic institutions at home and abroad have projected Asia’s fourth-largest economy will expand less than 2 percent this year.

It is undesirable to let excessive concerns about deflationary risks turn into a self-fulfilling prophecy. But it is also unwise to turn a blind eye to the risks and take inadequate measures to prevent them from devastating an economy that is already struggling.

The best and most fundamental way to ward off deflation is to revitalize the economy by implementing policies conducive to stronger corporate investment and higher consumer confidence.

But President Moon Jae-in’s administration has only adhered to policies that call for expanded fiscal expenditure, while dragging its feet on regulatory and labor reforms needed to bolster corporate activity. Its misguided income-led growth policy has imposed heavier burdens on companies and reduced the earnings of low-income households.

Last week, the government unveiled a record 513.5 trillion won ($427.2 billion) budget for 2020, focused on boosting the slowing economy. The expansionary budget represents a 9.3 percent hike from 2019.

To some degree, expanding fiscal spending is necessary to shore up the economy.

Without a policy shift, however, fiscal expansion will do little to prompt companies to increase investments and consumers to open their purses.

More than 70 percent of this year’s budget was spent in the first seven months of the year, but the economy has shown no signs of a significant rebound as domestic policy risks continue to amplify uncertainties.

The government also needs to refrain from carrying out policies designed to push down asset values, such as placing a cap on the prices of reconstructed apartments, if it is to avoid aggravating deflationary risks.

Mounting household debt in the country also risks precipitating asset devaluation. The value of assets such as real estate and stocks could tumble if households were pressed into selling assets to repay debts due to reduced income and an economic slump. Low prices would have the effect of pushing up real interest rates, increasing the debt-servicing burden for households.

Greater heed needs to be paid to ensuring that the country’s household debt, which is expected to exceed 1,500 trillion won in the coming months, is contained at an appropriate level so that marginalized households can afford to repay their debt.