Standard Life Investments

Weekly Economic Briefing

Japan & Developed Asia

Not another bill


After ten years out of office, President Moon and his Liberal Party came to power in Korea earlier this year promising to focus on inequality and job creation, while cracking down on corruption and improving governance. His first budget, which was submitted to the Diet on September 1, represents a shift towards a more proactive fiscal policy. Budget spending is expected to rise to KRW 429.0 trillion (tn), a 7.1% year-on-year (y/y) increase versus the initial 2017 budget plan. Furthermore, the medium-term framework calls for an average annual rise in spending in 2017-2021 of 5.8% y/y. The stronger spending growth does not reflect an abandonment of Korea's notoriously austere fiscal management. It is backed by bumper tax receipts in recent years. Tax revenue rose 11.3% y/y in 2016 and 6.0% y/y in 2015, versus an average in 2012-2014 of 2.3%. Furthermore, the government has tabled a tax revision bill that is aimed at raising revenue by KRW5.5tn annually, primarily through raising the highest marginal income and corporate tax rates.

Keep calm, carry on Another bill to pay

Given this base line, the government expects debt-to-GDP to increase marginally to 40.4% and the budget surplus to fall to 0.6% of GDP by 2021. In a benign environment where export growth continues to lift corporate earnings and the housing market has a soft landing, forecasts for strong tax receipts are perfectly palpable. However, any external shock or escalating geopolitical tensions in the peninsula, even in our central scenario where military confrontation is avoided, may undermine these fiscal plans. While consumer sentiment and PMI readings have proven resilient of late (see Chart 7), more immediate barometers, including the stock market and President Moon's popularity ratings, have fallen significantly in the aftermath of the North Korean nuclear tests. Weaker tax receipts on moderating growth may be accompanied by higher spending in areas such as national defence, which is set to jump 6.9% y/y in 2018, compared to 4% y/y and 3.6% y/y growth in 2017 and 2016 respectively. Anything but a benign muddle-through scenario is likely to test South Korea's desire to keep its position as one of the least indebted nations in the OECD.

Higher military spending is also on the cards for other regional powers. In Japan, national defence spending has been rising in recent years (see Chart 8) and the Ministry of Defence has requested a record high ¥5.02tn in spending in the fiscal year 2018 budget, up 2.5%y/y. Financing this requirement presents another headache for Ministry of Finance bureaucrats who are already struggling with the rising burden of the nation's ageing population (see Chart 8). Throw in the government's pledge to make pre-school education free and additional resource requirements from the Ministry of Health, Labour & Welfare to support the government's 'workstyle reforms' programme and it is easy to see why there are concerns about the prospect of helicopter financing. However, spending cuts are being found elsewhere and the fiscal year 2018 budget request actually represented a fall on the previous year. Unfortunately, the decision-making process around allocation of these funds prevents them having a meaningful impact on the supply-side of Japan's economy.

Govinda Finn, Japan and Developed Asia Economist