The International Monetary Fund said Friday that the South Korean economy faces numerous downside risks to growth, forecasting a weaker-than-anticipated outlook for this year.

Korea’s aging population, unsustainable reliance on manufacturing for growth, vulnerable household debt levels especially among low-income earners and weak consumer expectations are some of its domestic challenges.

A prolonged weak Japanese yen, rising global deflation on the back of falling oil prices and weak growth outlooks for China, Japan and Europe, Korea’s major export destinations, pose a “self-reinforcing downside” risk to Asia’s fourth-largest economy.

“Korea’s growth momentum stalled somewhat during 2014 and the outlook remains challenging from both a cyclical and structural standpoint. Domestic demand remains sluggish, inflation low, and external uncertainties have increased,” the IMF said in a report.

The economic report came as the IMF, led by Asia-Pacific chief Brian Aitken, held a consultation meeting with Korean financial policymakers over the past two weeks.

Although Korean financial authorities have sound fiscal and monetary policy tools to counter uncertainties should the country not see “clear signs of a recovery,” it needs to imminently pursue structural reforms to tackle weak internal and external prospects. Otherwise, it may have to pay a significant cost in the near future.

“The authorities have monetary and fiscal policy space to take action if clear signs of a recovery do not emerge soon,” the IMF said.

“Progress toward bringing about the desired changes will require steady consensus-building among the stakeholders, and while this may take time, if successful the ultimate impact could be profound.”

Korea’s relatively low public debt allows the government to flexibly implement reforms, which will have a long-term “fiscal payoff.”

Aitken said Korea can the IMF’s 3.7 percent growth forecast, despite a weaker outlook. The IMF outlook for the Korean economy is 0.3 percentage points higher than the Bank of Korea’s 3.4 percent, but lower than the Finance Ministry’s 3.8 percent.

Given the country’s stable financial market system, it has the capability to develop buffers against external shocks and volatility.

The IMF noted that Korea would preemptively use its won-dollar exchange policy to counter external risks.

“Allowing the won to respond flexibly would be the first policy line of defense if risks materialize, and provides a key buffer,” it said.

It continued to say that although Korea’s household debt has been rising and that its structure needs to be strengthened, it does not pose a near-term threat to the economy.

“Unlike the experience of many other advanced countries leading up to the global financial crisis, this has been matched by a corresponding increase in household financial assets rather than reflecting an increase in borrowing to finance consumption,” the IMF said.

“One key challenge will be to facilitate the transition of the mortgage market toward a more stable, long-term structure, in line with the government’s objective of increasing the share of fixed-rate, longer-maturity amortizing mortgages.”

By Park Hyong-ki (hkp@heraldcorp.com)