Korean government spending slows at the fastest pace in 26 years in Q2

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South Korea’s government spending slowed at the fastest pace in 26 years in the second quarter, raising concerns about a fiscal vacuum amid forecasts that the current tax revenue shortage and modest spending will persist in the remaining months of this year.

According to the government and Bank of Korea on Monday, government spending fell 1.9 percent in the second quarter from the previous quarter, mainly due to decreased healthcare spending in the wake of fewer Covid-19 and influenza patients.

It was the steepest decline in 26 years since 2.3 percent in the first quarter of 1997.

The BOK sees the recent decline in government spending as a one-off event but market insiders believe that the slowdown in spending will continue throughout the year.

Data from the BOK and Korea Development Institute (KDI) obtained by Representative Oh Gi-hyoung of the Democratic Party showed that the two entities each projected government spending to go down by 1.7 percentage points and 1.2 percentage points in the second half of this year from the first half.

They cited the recent record-low tax revenue as grounds to their forecasts. By June, tax revenue declined by 39.7 trillion won ($29.8 billion) this year compared to the previous year, while the managed fiscal balance, an indicator of the government‘s financial standing, showed a deficit of 83 trillion won.

The Yoon Suk Yeol administration aims to recover fiscal soundness and boost the economy with support for consumption and private investment.

The government unveiled its economic roadmap for the latter half of this year, which focused on bolstering the private sector through an emphasis on exports and investment, along with tax cut incentives.

The problem facing the government, however, is the lack of recovery momentum in the economy, amid unaddressed concerns regarding inflation, experts noted, due to extreme weather events, rising international oil prices, and delayed recovery in manufacturing and construction sectors.

Youth employment has been on a decline over the past 6 months, with a downward trend in job additions in the manufacturing sector for 7 straight months. The series of sluggish data has sparked concerns that the gains in overall employment, driven mainly by seniors and women, have been incomplete. Fears of a slow recovery in China, the biggest trading partner of Korea, also contributed to the forecast.

The developments have led to growing calls on the government to implement fiscal responses to the uncertainty in the private sector.

The government, however, has limited options, as it has adhered to a policy of fiscal soundness.

“In cases where tax revenues are not fully collected, the government must devise strategies. In the absence of strategies, however, the only available option is to reduce spending,” said Ha Joon-kyung, an economics professor at Hanyang University. “Should the allocated budget remain unutilized, it could potentially lead to a contraction in domestic demand, thereby exerting adverse repercussions on the overall economy.”

Ha’s concerns were echoed in the KDI‘s recent economic forecast Thursday, which maintained this year’s forecast growth while citing the unused budget scenario as a risk factor.

“If fiscal spending diminishes below the initially projected level owing to worsening revenue collection, there is a possibility of a transient contraction in domestic demand,” the KDI stated.

“The government so far doesn’t consider such a scenario of unutilized budgets,” said an unnamed official from the government.