[Yoo Choon-sik] Fiscal expansion vs. BOK tightening

With the South Korean government expected to submit its 2027 budget proposal to the National Assembly within days, recent comments by senior policymakers, both in official settings and elsewhere, suggest that next year’s budget could contain features not seen in the country for decades.

The circumstances alone make the plan unusual. South Korea’s economy is expected to record its strongest growth in about a decade, excluding periods distorted by major shocks, thanks largely to the accelerating global artificial intelligence boom and the resulting surge in exports of semiconductors.

Government tax revenue, particularly corporate tax receipts, is also expected to increase sharply as companies like Samsung Electronics and SK hynix are set to pay massive amounts in taxes after posting surges in profits.

The government has already indicated that total spending next year will increase by more than 10 percent from this year. Given that the ruling Democratic Party of Korea commands an overwhelming majority in the National Assembly, the government’s plan is unlikely to be significantly revised.

Governments typically increase spending during downturns to support demand and employment, while exercising greater restraint during booms to contain inflationary pressures and preserve fiscal capacity for future shocks. That is precisely why the direction of the 2027 budget deserves closer scrutiny.

South Korea now appears to be preparing to move in the opposite direction, as the government is planning what could be one of its most expansionary budgets in roughly a decade outside periods of economic crisis despite unusually favorable economic growth conditions.

Recent remarks by President Lee Jae Myung provide perhaps the clearest indication of the thinking behind this approach, as he said last week: “This is no time to make the mistake of becoming fixated on managing near-term fiscal figures. We need the wisdom to invest precious future financial resources in more efficient and productive areas so as to turn 10,000 won today into 100,000 won tomorrow and then into 1 million won.”

Political leaders everywhere occasionally use expressions that are difficult to interpret literally, but these remarks were made while government ministries were preparing their budget requests and appeared intended to encourage more aggressive fiscal spending.

Viewed against conventional economic policy principles and South Korea’s current economic conditions, they reveal a way of thinking that deserves examination. The most troubling phrase is Lee’s warning against becoming “fixated on managing near-term fiscal figures.”

Presumably, this means that fiscal soundness should not be the government’s overriding priority at present, a position that may be defensible under certain circumstances. What is missing, however, is a convincing explanation of why this is such a moment and why taxpayers should accept the risks involved.

Nor did Lee specify which “fiscal figures” he had in mind. By describing excessive attention to such figures as a mistake, he risks portraying concern about fiscal discipline itself as something backward or misguided.

Spending against the economic cycle

Meanwhile, the administration has announced plans to enact special legislation and create special accounts to support its three megaprojects, which were announced in late June despite controversy over the selection of specific regions for political considerations at the expense of economic feasibility.

The government has also proposed separating so-called excess tax revenue and unusually large revenue surpluses from the general government account, placing the money in the tentatively named Future Fund and investing it in areas the government considers strategically important.

There is nothing inherently wrong with creating mechanisms to finance long-term investment. If public money can generate substantially greater economic value in the future, refusing to invest merely to improve short-term fiscal indicators would itself be irresponsible.

The more difficult question is who determines which investments qualify and through what process. The ruling party currently controls roughly three-fifths of the National Assembly, while recent experience offers relatively few examples of meaningful consultation with the opposition on major policy initiatives.

Under such circumstances, it is difficult to be confident that views substantially different from those of the Lee administration will be fully incorporated when these new fiscal mechanisms are designed and implemented.

An additional concern is that the government’s fiscal stance appears increasingly inconsistent with other major areas of economic policy. The Bank of Korea raised its benchmark interest rate in a rare back-to-back move, citing strong economic growth and intensifying inflationary pressure.

The government, meanwhile, has made equally clear that it wants to cool the housing market. It has announced tighter tax measures and stronger restrictions affecting homebuyers, owners of multiple homes, owners of expensive properties and owners of homes in which they do not reside.

When the central bank adopts a tightening stance in monetary policy amid economic growth overshooting its underlying trend and inflation staying above the target, the most rational course for fiscal authorities is traditionally to restrain spending growth as much as possible to avoid adding excessive liquidity.

Preparing the 2027 budget with the most expansionary stance in roughly a decade outside crisis periods, just as the central bank is raising interest rates and the government is trying to suppress excess demand in housing, raises fundamental questions about policy consistency.

If fiscal policy continues stimulating demand when tighter economic conditions are needed, it can crowd out private investment, weaken fiscal credibility and force sharper tax increases or spending cuts. Recent developments in the United States also provide a useful reminder that even the world’s largest economy cannot ignore such risks indefinitely.

Long-term US Treasury yields recently climbed to their highest levels in 19 years amid concerns over fiscal deficits and government debt. The Treasury Department took measures but failed to eliminate concerns about structural fiscal weakness, and yields rose again.

The repercussions have spread across global asset markets, contributing to dollar weakness and higher prices for assets such as gold and bitcoin. The broader lesson is difficult to dismiss, as even the United States cannot escape the risk premium investors demand when fiscal policy loses credibility.

South Korea is fortunately in a much better position, with government debt relative to gross domestic product remaining below that of the United States, while its fiscal deficit is not yet at a level that signals an immediate crisis. That should be treated as an asset to preserve rather than an invitation to spend.

The preference for expansionary fiscal policy under both the Moon Jae-in and Lee Jae Myung administrations warrants concern, but mechanical austerity is hardly the answer. The Yoon Suk Yeol administration’s rigid approach to fiscal restraint also created problems, underscoring the need for fiscal policy to respond flexibly.

The choice is not between indiscriminate austerity and indiscriminate expansion. Governments should be willing to spend aggressively when circumstances require it, but that principle also implies exercising restraint when conditions provide an opportunity to rebuild fiscal room.

History contains more extreme warnings of what can happen when that discipline disappears.

In Greece, successive governments borrowed heavily to finance generous public programs and a large state sector. When its fiscal problems became clear, investors retreated, borrowing costs surged and Greece was eventually forced into severe spending cuts amid recession.

South Korea today is nowhere close to such circumstances, and suggesting otherwise would be needlessly alarmist. The value of the example lies elsewhere.

Fiscal problems rarely become serious on the day a government decides to spend more money. They accumulate gradually, often during periods when borrowing appears manageable and political leaders can plausibly argue that additional spending will generate greater prosperity later.

South Korea is entering 2027 with strong economic growth, booming semiconductor exports and rapidly increasing tax revenue. Precisely because of this, the government needs to explain convincingly why this is the right time to pursue an unusually aggressive expansion of fiscal spending.

The issue is not whether the government can spend more. With tax revenue rising and a commanding parliamentary majority behind it, it almost certainly can.

The more important question is whether it should and whether the process for answering that question is rigorous enough to justify drawing so heavily on the fiscal room that previous generations have left behind.

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Yoo Choon-sik

Yoo Choon-sik is a senior AI correspondent covering Korea for MLex Market Insight. He has worked for international media organizations for about 30 years, including as Reuters’ chief economics correspondent in Korea. The views expressed here are the writer’s own. — Ed.