South Korea Faces `Moderating' Growth, Inflation Risk, IMF Says

By Shamim Adam

Sept. 12 (Bloomberg) -- South Korea's economic growth is ``moderating'' and a weakening currency is adding to inflationary pressures, the International Monetary Fund said.

South Korea's $970 billion economy grew 4.8 percent in the second quarter from a year earlier, the slowest pace in more than a year. Household spending fell for the first time in four years as rising living costs prompted consumers to cut discretionary purchases.

``Growth has softened, equity prices and the won have weakened, and high oil prices have contributed to higher inflation,'' the fund said. ``While projections point to only a modest slowing of growth and a return of inflation to the Bank of Korea's target band during 2009, risks are skewed to the downside.''

The won has declined as investors sold the nation's stocks and bonds because of the dimming outlook for economic growth and signs of increased overseas debt. The currency is Asia's worst performer this year and its 16 percent slump has driven up the cost of imported goods.

Gross domestic product will advance 4.1 percent this year, and climb 4.3 percent in 2009, the IMF predicts.

``This outlook is subject to substantial uncertainty, with the possibility remaining of a deeper global slowdown, further volatility in global financial conditions or still higher oil prices,'' the fund said in a report today.

The won's slump has ignited concern the nation may face a financial crisis like that of 1997, when the currency lost half its value and the government was forced to turn to the IMF for a $57 billion bailout to help businesses repay overseas debt.

`Appropriately Valued'

``Despite the recent sharp depreciation, the exchange rate remains broadly in line with fundamentals,'' the fund said in the report, known as an Article IV Consultation. ``The won remains broadly appropriately valued.''

While the central bank's inflation-targeting framework remains the ``most effective policy tool'' to contain inflation, some IMF directors said management of the exchange rate may also help to keep prices in check, according to the report.

Consumer prices increased 5.6 percent in August from a year earlier, moderating from July's 10-year high of 5.9 percent. Price gains have breached the central bank's 2.5 percent-to-3.5 percent inflation target for 10 consecutive months.

The Bank of Korea left the benchmark interest rate at an eight-year high of 5.25 percent yesterday, after raising borrowing costs in August for the first time in 12 months. IMF directors were divided on future rate moves, the statement said.

``Some directors suggested that the balance of risks may call for further tightening, while some others saw merit in proceeding cautiously,'' the IMF said. ``A more accommodative monetary policy could be envisaged if inflation eases and growth remains soft.''

The IMF expects South Korea's inflation rate to reach 5.6 percent at the end of the year, and ease to 3.3 percent at the end of 2009, it said.

``Slowing domestic demand and moderating food and fuel- price inflation should help bring headline inflation down early next year,'' the statement said. ``Keeping expectations well- anchored is crucial to avoid more forceful and more damaging tightening later.''

To contact the reporter on this story: Shamim Adam in Singapore at sadam2@bloomberg.net