A continued slump in South Korean exports remains a drag on the economy, though its domestic demand is improving gradually, a state-run think tank said Tuesday.

In its latest report on the economy, the Korea Development Institute said the country's exports to all major economies stayed weak in September, with most flagship goods, except wireless communication devices and vehicle parts, losing ground in overseas markets.

South Korea's outbound shipments plunged 8.3 percent on-year in September, with exports down 6.6 percent in the first nine months of this year. Such a development bodes ill for the heavily export-dependent economy.

"The on-year fall last month marks an improvement over the 14.9 percent drop reported for August, yet outbound shipments, which have long been the country's growth engine, are actually weighing down economic recovery," the KDI said.

Sluggish exports were attributed to the overall slowdown in the global economy and financial market turmoil, brought on in part by troubles facing China and other major emerging markets.

The think tank said the fall in exports and its effects on production are causing a rise in inventory and a drop in manufacturing shipments.

The manufacturing sector's capacity utilization rate fell to a low of 74.3 percent, down from 74.7 percent tallied for the month before.

According to the report, South Korea experienced a relatively sharp increase in investment amid improvements in private sector spending in August.

"Such developments represent a trend toward recovery in domestic demand," the KDI claimed.

Retail sales increased while services production sustained growth levels of previous years, it said, adding that this is a sign that the country is overcoming the fallout from the Middle East Respiratory Syndrome scare, it said.

First confirmed in late May, MERS infected 186 people, with 36 of them succumbing to the disease. No new cases have been reported since July 4, with the last person to have contracted the illness testing negative for the virus Thursday.

The think tank said service-sector output and retail numbers were up 2.1 percent and 1.8 percent, respectively, on-year in August. The country's equipment investment index also jumped 17.1 percent compared to the previous year.

Strong local demand and investment helped nudge up industrial output by 1.3 percent in August from a month earlier.

On the labor market, the KDI said employment rose by 256,000 in August, down from a gain of 326,000 reported for the month before. (Yonhap)