Economic Analysis - 2018 Budget: Focus On Job Creation - JAN 2018

BMI View: South Korea ' s proposed 2018 expansionary budget aims to fulfil President Moon Jae-in ' s campaign pledges by focusing on the welfare of the people and job creation. However, we expect the government to struggle to achieve its operating headline budget deficit of 1.6% of GDP as we expect revenue collection efforts to fall short.

South Korea's proposed 2018 budget of KRW429trn (USD381bn) marks the steepest annual rise in nine years (10.4% y-o-y in 2009), expanding by 7.1% y-o-y. The expansionary budget is aimed at fulfilling President Moon Jae-in's campaign promises of jobs creation as well as ensuring the welfare of the people. The budget appears to be building on the government's supplementary jobs creation budget that was approved in July as Moon seeks to address South Korea's persistently high youth unemployment (see ' Fiscal Discipline No More, More Government Spending To Come ' , May 23; and ' Moon's First 100 Days Point To Increasing Policy Challenges ' , August 23). However, we expect the government to struggle to tackle unemployment as efforts to create jobs fail to address structural issues that contribute to high unemployment. In addition, we believe that the government will face difficulties in hitting its revenue collection target, with revenue collection being predicated on the successful passage of a tax revision bill through parliament, which we believe is unlikely to happen (see ' Revised Tax Bill Could Undermine Business Environment ' , August 8). As such, we believe that the South Korean government is unlikely to achieve its operating headline budget deficit of 1.6% of GDP.

Significant Increase In Welfare Spending
South Korea - Budget Balance, % chg y-o-y
Source: BMI, Ministry of Strategy and Finance

Jobs And Welfare Take Centre Stage

In keeping with Moon's emphasis on improving the welfare of Korean citizens, the budget saw the biggest increase in the health, welfare, and employment component, which rose by 12.9% y-o-y (compared to 5.3% y-o-y in 2017) as well as education, which expanded by 11.0% y-o-y (6.1% y-o-y in 2017). According to the government, welfare is also set to receive the largest allocation (34%) to provide subsidies for companies creating jobs and fund the Moon administration's plans to increase social service jobs including workers at nursing homes and childcare centres. The government plans to spend KRW19.2trn on jobs alone, including KRW400bn that will be used to hire 15,000 employees of the central government. The government has set a goal of hiring 174,000 public servants in the next five years, with plans to hire 3,500 police officers this year and 6,800 workers in fields related to public safety, including quarantine and border patrol.

While these efforts reflect the government's commitment to job creation, we believe that they will not be able to fully address South Korea's high youth unemployment rate (9.3% in July). As we have mentioned previously, South Korea's relatively rigid labour market and seniority wage-based employment system are key reasons for high levels of youth unemployment, and the government's measures are unlikely to change the country's labour market environment.

Key Welfare Initiatives
Source: Ministry of Strategy and Finance, BMI
Strengthen childcare support Provide a childcare support of KRW100,000 per month for a child aged between 0 and five
Increase public daycare centers from 180 to 450
Pay 100% of daycare charges for children aged between three and five
Provide young adults with employment support Provide SMEs with an annual support of KRW20,000mn per newly hired young adult employee for three years
Give a jobseeker benefit of KRW300,000 per month for three months
Improve housing support for the newly married Increase the supply of public rental housing for the newly married from 20,000 units to 30,000
Introduce low interest rate mortgages for the newly married, which lend up to KRW30,000mn with the interest rates 0.3 percentage points lower than other mortgages
Increase the income of the elderly Raise the basic pension from KRW206,000 per month to KRW250,000
Increase jobs for the elderly from 437,000 to 514,000
Improve welfare for the low income class Expand housing support to cover more households, and supply 170,000 public rental homes
Increase the energy voucher from KRW95,000 to KRW102,000
Increase support for small merchants Launch a KRW20bn small merchant fund

Defence Increases To Meet North Korea Threat

The defence budget also saw a large increase, expanding by 6.9% y-o-y (4.0% y-o-y in 2017) in response to rising threats from North Korea. We expect Moon to come under increasing pressure to adopt a tougher stance towards Pyongyang following the North's hydrogen bomb test on September 3 and the missile overflight of Japan on August 29. Indeed, Moon has called for the deployment of additional Terminal High Altitude Area Defense (THAAD) Missile System batteries and has had talks with the US in a bid to improve South Korea's defence capabilities. The larger budget is thus unsurprising and could see South Korea increase its defence capabilities rapidly following the 'conceptual' approval by US President Donald Trump to allow Seoul to purchase billions of dollars of US military hardware (see ' Regional Tensions To Remain Elevated Following H-Bomb Test ' , September 4).

Revenue Collection To Fall Short

We believe that the government is unlikely to be able to obtain its revenue collection target of KRW268.2trn (or an increase of 6.8% y-o-y) as this target is dependent on the successful passage of the tax revision bill through parliament. According to the Ministry of Strategy and Finance, the government expects tax receipts to be 'backed by strong corporate performance and the 2017 tax revision bill' (for more information on the tax revision bill, see ' Revised Tax Bill Could Undermine Business Environment ' , August 8). However, we believe that the tax revision bill is unlikely to pass parliament in its existing form due to strong opposition from the second largest party, the conservative Liberty Korea Party (LKP), and the smaller Bareun party as both have close ties to big businesses.

Furthermore, while the government has pledged to 'tightly control spending increases over the next few years', we believe that the Moon administration will struggle to do so due to its welfare platform and the government's preference for expansionary fiscal policy to improve the lives of its citizens. However, we believe that government debt is unlikely to breach the 40% of GDP debt ceiling as the government will seek to remain under its legally mandated debt ceiling to ensure continued investor confidence.