U.S. investment bank Morgan Stanley projects South Korea's economy may enter a recession if domestic demand continues to contract.

In a report, Morgan Stanley economists forecasted the likelihood of a sharp drop in South Korean consumer spending and the growth rate in gross domestic product, citing lackluster domestic demand.

The experts pointed out that retail sales in South Korea have been posting minus growth for two months while the service sector is on a three-month decline.

They also said the recovery from the massive household debt arrears in 2001 and 2002 is taking place more slowly than expected, while worsening job conditions and dwindling real wage are doing nothing to help the situation.

Regarding the Seoul government's pump-priming measures, Morgan Stanley officials predicted the policies would have a limited effect.