What Explains Current Account Surplus in Korea?

Abstract

Since the currency crisis in 1998, Korea has experienced continuous current account surpluses. Recently the current account surplus increased more rapidly amounting to 7.7% of GDP in 2015. In this paper, we investigate the underlying reasons as to why Korea’s current account surpluses are widening. We find that the upward trend in Korea’s current account surpluses is essentially explained by its demographical changes. Demographical changes are so powerful that they explain, quite successfully, the current account balance trends of other economies with highly aged populations such as Japan, Germany, Italy, Finland and Greece as well. When we add the real exchange rate as an additional explanatory variable, it is statistically significant with the right sign, but the magnitude explained by it is quite limited. For example, in order to reduce current account surplus by 1 percentage point, a whopping 12% depreciation is needed. If Korea’s current exchange rate is undervalued 4 to 12 percent than the level consistent with fundamentals, it is impossible to reduce Korea’s current account surplus to a reasonable level by adjusting the exchange rate alone. Another way to reduce current account surplus is to expand fiscal policies. We find, however, that the impact of fiscal adjustments in reducing current account surplus is even more limited. If we allow endogenous movements of exchange rate and fiscal policy, the impact of exchange rate adjustment increases by 1.6 times but that of fiscal policy decreases that it is no longer statistically significant.