🚨 Real GDP Contraction and Economic Stimulus Measures: First Quarter Economy Goes Negative, Dilemma Between Government's Fiscal Policy and Bank of Korea's Interest Rate Policy
Today Korean Economic News | 2025.04.25
📌 Both Domestic Demand and Exports 'Step Backward'... Korean Economy Finally Goes Negative in Q1
💬 South Korea's real gross domestic product (GDP) decreased by 0.2% in the first quarter of this year compared to the previous quarter, recording negative growth for the first time in 2 years and 3 months. Private consumption, construction investment, equipment investment, and exports all declined, and imports also decreased. The Bank of Korea expects a recovery in domestic demand in the second quarter but stated that it may not meet the overall growth forecast. The government and the Bank of Korea are caught in a dilemma between fiscal policy and monetary policy for economic stimulus.
1️⃣ Easy Understanding
The Korean economy recorded negative growth in the first quarter of this year. I'll explain what this means and what concerns the government and the Bank of Korea are facing.
Negative economic growth means that economic activity has decreased compared to the previous period. During the first quarter (January to March), our country's economic size shrank by 0.2% compared to the fourth quarter of last year (October to December). This phenomenon, occurring for the first time in 2 years and 3 months, shows that a complete recovery from the COVID-19 pandemic has not yet been achieved.
The particularly concerning point is that both domestic demand and exports decreased simultaneously. General citizens' consumption (private consumption) decreased, and companies' equipment investment and construction investment also declined. The reduction in exports, which had been a reliable support for our economy, is due to global economic uncertainty and the strengthening of U.S. protectionist trade policies.
In this situation, the government has prepared a supplementary budget of about 12 trillion won to revive the economy. This money will be used to support small business owners and vulnerable groups experiencing difficulties, as well as export companies. However, many experts point out that this scale will only raise the economic growth rate by 0.1 percentage points, making it less effective.
The Bank of Korea could also stimulate the economy by lowering the base interest rate, but this is also a difficult choice. The current base rate is 3.25%, and lowering it would reduce loan interest rates, potentially increasing consumption and investment. However, if the interest rate gap with the United States widens further, foreign investment funds may flow out, causing the exchange rate to rise, which could lead to increased import prices and inflation.
Ultimately, the government and the Bank of Korea are struggling to find a balance between economic stimulus, financial stability, and fiscal soundness. Any policy choice has side effects, requiring a cautious approach in the current situation.
2️⃣ Economic Terms
📕 Real GDP
Real GDP is gross domestic product excluding the effects of price changes, a measure of the real growth or contraction of an economy.
- Unlike nominal GDP, it excludes the effects of inflation to show actual changes in economic activity.
- It is expressed as the rate of change compared to the previous quarter or year and is used as a key indicator for economic judgment.
📕 Supplementary Budget
A supplementary budget is an additional budget prepared beyond the already established and confirmed budget.
- It is prepared in cases of economic crisis, natural disasters, or urgent fiscal needs and is confirmed through the deliberation and approval of the National Assembly.
- It is used as a tool for expansionary fiscal policy during economic downturns to promote economic recovery.
📕 Base Interest Rate
The base interest rate is the standard rate applied by the Bank of Korea when lending funds to financial institutions.
- It directly affects deposit and loan interest rates of commercial banks.
- It is generally raised during economic overheating and lowered during economic downturns.
📕 Protectionism
Protectionism is a policy that imposes tariffs or non-tariff barriers on imported goods to protect domestic industries.
- It appears in various forms such as tariff imposition, import quotas, and technical regulations.
- It may have short-term protective effects for domestic industries but can lead to reduced global trade and economic growth slowdown in the long term.
3️⃣ Principles and Economic Outlook
💡 Causes and Implications of First Quarter Economic Contraction
Let's examine the detailed factors and meaning of the first quarter GDP contraction.
First, a 'double dip' phenomenon occurred where domestic demand and exports decreased simultaneously. According to the Bank of Korea, private consumption decreased by 0.4% compared to the previous quarter in the first quarter. This is a result of consumer sentiment not fully recovering after COVID-19, increased household burden due to high interest rates, and economic uncertainty leading to reduced consumption. Additionally, equipment investment decreased by 1.9%, construction investment by 0.7%, and exports by 0.2%. The decrease in exports is mainly due to the strengthening of U.S. protectionist policies and the intensification of U.S.-China trade conflicts. In particular, high tariffs (25%) by the United States on Korea's main industries such as automobiles, semiconductors, and steel acted as factors weakening export competitiveness. This simultaneous decrease in domestic demand and exports indicates a weakening of both engines of economic recovery, suggesting a decline in the overall resilience of the economy.
Second, the uncertainty in the global economic environment directly affected the Korean economy. The strengthening of U.S. protectionist policies is a factor worsening the global trade environment, not just for Korea. Under the Trump administration's 'America First' stance, discriminatory tariffs on major trading partners such as Korea, Japan, and the EU are shrinking global trade. Additionally, the reignition of the U.S.-China trade war is adding confusion to global supply chains. The IMF has warned that if the U.S.-China trade war intensifies, the global economic growth rate could fall by more than 0.5 percentage points. Furthermore, China's economic slowdown is leading to a decrease in Korea's exports to China. As China is Korea's largest export market, China's economic downturn inevitably has a direct impact on the Korean economy. The deterioration of the global economic environment is an important factor weakening the growth momentum of the Korean economy, which has high external dependence.
Third, differentiated impacts are appearing by industry. The automobile industry is directly hit by high U.S. tariffs (25%). Hyundai and Kia's exports to the U.S. are expected to decrease by up to 300,000 units from about 900,000 units last year. The semiconductor industry is at the frontline of U.S.-China conflicts, suffering doubly from U.S. semiconductor export restrictions to China and tariffs on Korea. However, due to the nature of the product having few substitutes, the decrease in demand due to tariffs may be relatively limited. The oil refining and petrochemical industries are suffering from global demand depression and margin pressure. The refining margin is below $1 per barrel, far below the break-even point (4-5 dollars), worsening profitability. While the intensity and pattern of impacts vary by industry, overall, the deterioration of the external environment and domestic demand depression are acting in combination.
The first quarter economic contraction is a result of domestic and international adversities coinciding in a situation where complete recovery after COVID-19 has not been achieved. In particular, the phenomenon of simultaneous decrease in domestic demand and exports suggests that the path to economic recovery may become more difficult. A customized policy response considering differentiated impacts by industry and strengthening economic resilience against external uncertainties are needed at this point.
💡 Dilemma of Fiscal Policy and Monetary Policy
Let's analyze the dilemma and limitations of fiscal policy and monetary policy for economic stimulus.
First, the effectiveness of the supplementary budget is likely to be limited. The government is trying to stimulate the economy with a 12.2 trillion won supplementary budget, but the Korea Development Institute (KDI) and the Bank of Korea expect this to raise the economic growth rate by only 0.1 percentage points. The effectiveness of the supplementary budget varies not only by size but also by timing and composition. The current supplementary budget focuses mainly on supporting small business owners, vulnerable groups, and export companies, which may help alleviate short-term difficulties but has limitations in expanding growth engines. Due to the time lag between supplementary budget preparation and execution, it takes time for its effects to be reflected in the actual economy. Some argue that "a supplementary budget of at least 20 trillion won is needed," but this could cause another problem of deteriorating fiscal soundness.
Second, interest rate policy is also constrained by external conditions. The Bank of Korea may consider lowering the base rate (currently 3.25%) for economic stimulus, but there is a risk from widening interest rate differences with the United States. Currently, the U.S. base rate is 5.0-5.25%, about 2 percentage points higher than Korea's, and if Korea unilaterally lowers rates, the widened interest rate difference could lead to foreign capital outflow and won depreciation. Additionally, Korea's household debt is about 104% of GDP, far exceeding the OECD average, with the risk of interest rate cuts leading to additional debt increases. Above all, the effectiveness of interest rate policy may be limited given that the current economic downturn is not a short-term phenomenon that can be solved by interest rates alone but stems from structural problems.
Third, both fiscal policy and monetary policy need balance. Fiscal expansion through supplementary budgets has short-term economic stimulus effects but comes with the cost of increased national debt and long-term deterioration of fiscal soundness. Korea's national debt is about 55% of GDP in 2025, lower than the OECD average (about 110%) but rapidly increasing. Considering increased welfare spending due to aging, low-growth trends, etc., fiscal capacity is gradually decreasing. Similarly, monetary easing through interest rate cuts has the effect of stimulating investment and consumption but has side effects such as exchange rate instability, inflation risk, and increased household debt. Therefore, both policies need a balanced approach rather than an extreme direction, and it is important to pursue short-term economic response and long-term structural reform in parallel.
Both fiscal policy and monetary policy show clear limitations in the current situation. The supplementary budget is limited in size and effect, and interest rate cuts are constrained by external conditions and household debt. Therefore, a balanced combination of the two policies and fundamental quality improvement through structural reform are needed.
💡 Mid-to-Long-Term Strategy for Overcoming the Economic Crisis
Let's explore mid-to-long-term strategies to overcome the current economic crisis and ensure sustainable growth.
First, strengthening industrial competitiveness and technological innovation are key. Trade barriers like tariffs must ultimately be overcome through technological competitiveness. The automobile industry is responding through accelerating electric vehicle transition, strengthening software capabilities, and expanding local production in the U.S. The semiconductor industry is strengthening competitiveness by securing advanced process technology, developing AI semiconductors, and expanding investment in the U.S. The oil refining and petrochemical industries are pursuing expansion of high-value-added product production and business diversification into eco-friendly energy. In this way, each industry must turn crisis into opportunity through key technology development and business structure innovation. The government should support industrial competitiveness strengthening through regulatory innovation, R&D support, and talent cultivation. Strategic investment in securing future growth engines such as AI, bio, and eco-friendly energy is particularly important.
Second, risk diversification through market and supply chain diversification is necessary. The dependence on specific markets such as the U.S. and China should be reduced, and export markets diversified. Exploration of emerging markets such as India, ASEAN, Middle East, Africa needs to be strengthened, and export items also need to be diversified. Global production networks should be reorganized to respond to geopolitical risks. Resilience against supply chain shocks should be enhanced through expanding local production, diversifying procurement sources for key components and raw materials, and securing strategic inventory. Especially amid intensifying U.S.-China trade conflicts, a flexible strategy to utilize both markets is needed. Some companies are already expanding production bases to Southeast Asia, India, Mexico, etc., through a 'China Plus One' strategy.
Third, domestic market activation and structural reform must be pursued simultaneously. To improve the constitution of the Korean economy, which has high external dependence, it is important to enhance the vitality of the domestic market. Regulatory reform to foster the service industry, strengthening the ecosystem of small and medium enterprises and startups, and expanding consumption base through income growth are needed. Fostering new industries such as healthcare, digital content, and eco-friendly consumer goods in response to the aging society is particularly important. Additionally, the fundamental quality of the economy should be improved through structural reforms such as labor market reform, education innovation, and strengthening social safety nets. Such structural reforms may entail pain in the short term but enable increased growth potential and sustainable development in the long term.
The crisis facing the Korean economy cannot be overcome by short-term response alone. Industrial competitiveness strengthening and technological innovation, market and supply chain diversification, domestic market activation, and structural reform must be pursued in a balanced manner. This requires consistent policy support from the government, innovative efforts from businesses, and social consensus.
4️⃣ In Conclusion
In the first quarter of 2025, the Korean economy contracted by 0.2% compared to the previous quarter, recording negative growth for the first time in 2 years and 3 months. The particularly concerning point is the occurrence of a 'double dip' phenomenon where domestic demand and exports decreased simultaneously. Private consumption decreased by 0.4%, equipment investment by 1.9%, construction investment by 0.7%, and exports by 0.2%. This is a result of external adversities such as strengthening U.S. protectionist policies, intensifying U.S.-China trade conflicts, and China's economic slowdown coinciding in a situation where complete recovery after COVID-19 has not been achieved.
The government has prepared a 12 trillion won supplementary budget to stimulate the economy, but this is expected to raise the economic growth rate by only 0.1 percentage points, raising concerns about its effectiveness. On the other hand, issuing larger national bonds for a bigger supplementary budget could cause side effects such as market interest rate rises and deterioration of fiscal soundness, creating a dilemma.
The Bank of Korea could also consider economic stimulus through lowering the base rate, but there are risks of foreign capital outflow and exchange rate instability due to widened interest rate differences with the U.S., and potential inflation. In particular, Korea's high household debt level (about 104% of GDP) is a factor limiting the effectiveness of interest rate policy.
In this situation, for the Korean economy to overcome the crisis, not only short-term economic stimulus measures but also mid-to-long-term quality improvement is needed. Global competitiveness should be enhanced through technological competitiveness strengthening and business structure innovation by industry, and dependence on specific countries should be reduced through market and supply chain diversification. Additionally, an economic constitution strong against external shocks should be created by pursuing domestic market activation and structural reform in parallel.
Ultimately, the current economic crisis reveals the structural vulnerabilities of the Korean economy while also providing an opportunity for quality improvement. It is time to build a sustainable growth foundation through balanced operation of fiscal and monetary policies, strengthening industrial competitiveness, market diversification, domestic base expansion, and structural reform.