How Demographic Aging Shapes Fiscal Sustainability and Sovereign Risk in Korea

South Korea is undergoing one of the fastest demographic transitions in the world, with declining fertility and a rapidly expanding retired population. This trend threatens fiscal sustainability by raising age-related transfer expenditures and straining existing fiscal frameworks. To analyze these dynamics, the study develops a forward-looking macro-fiscal model that embeds demographic aging into a fiscal limit framework with endogenous sovereign risk premia. The model links transfer spending, debt issuance, taxation, and default probability, allowing sovereign borrowing costs to evolve as a function of fiscal stress. The analysis is calibrated to Korean economic data using median values from recent studies, providing a realistic baseline for projections. The results show that in the steady state, Korea sustains moderate debt (29% of output) with zero default risk. However, even a modest 1% demographic shock significantly disrupts this balance: transfers expand, labor taxes rise, consumption declines, and debt accumulates persistently. Importantly, default probabilities shift from zero to positive values, producing nonlinear increases in risk premia and higher borrowing costs. The study concludes that demographic aging, though predictable, destabilizes fiscal dynamics as strongly as stochastic shocks. Existing fiscal rules are inadequate, underscoring the need for stronger rules, entitlement reforms, and proactive debt management to prevent rising sovereign risk.