[Q&A] Bank of Korea: "Raising Interest Rates Once or Twice Does Not Constitute Tightening"

Bank of Korea 'Monetary and Credit Policy Report (June 2021) Briefing'
"Considering Policy Support Areas Amid Interest Rate Hikes"

Park Jong-seok, Deputy Governor of the Bank of Korea, is speaking at the Monetary and Credit Policy Report (June 2021) briefing held at the Bank of Korea in Jung-gu, Seoul, on the morning of the 10th.

[Asia Economy Reporter Kim Eunbyeol] As the pace of economic recovery accelerates and inflation rises, increasing the likelihood of the Bank of Korea raising its benchmark interest rate, the Bank of Korea stated on the 10th that "even if interest rates are raised once or twice under the current circumstances, it cannot be described as tightening." It also mentioned that the burden on vulnerable groups in the event of a rate hike can be alleviated through other policy supports such as financial intermediation support loans.

Park Jongseok, Deputy Governor of the Bank of Korea, said at the 'Monetary and Credit Policy Report (June 2021) briefing' on the 10th, "The current benchmark interest rate is 0.50% per annum, which is quite low," adding, "Even if the rate is raised once or twice in the future depending on the economic or financial stability situation, I do not think it can be considered tightening." He further added, "It should be described as a slight increase from a low level."

He responded this way when asked whether the Bank of Korea's continued simple purchase of government bonds contradicts its stance suggesting a 'tightening' policy. Deputy Governor Park said, "Simple purchases of government bonds can be conducted in the future if deemed necessary after observing market volatility due to external and supply-demand factors," adding, "This decision is made separately from benchmark interest rate operations."

Regarding concerns that raising the benchmark interest rate could increase the interest burden on household debt exceeding 1,700 trillion won, he acknowledged, "It is true that the burden on households holding debt increases when interest rates rise," but emphasized, "Decisions must weigh both the positive and negative impacts of interest rates on household debt." He noted that if the economic situation improves rapidly, failing to raise rates could lead to a significant increase in debt and a concentration in asset markets, causing side effects. Deputy Governor Park said, "I think the aspect of financial imbalance, such as the accumulation of household debt, should be considered more significantly than before."

On the burden to vulnerable groups in the event of a rate hike, he said, "I think it can be supplemented by other means," adding, "The Bank of Korea has been supporting small business owners and SMEs through financial intermediation support loans, which can help alleviate the burden on vulnerable groups."

The following is a Q&A with Deputy Governor Park and Lee Sanghyeong, Director of the Bank of Korea's Monetary Policy Department.

- Until now, the Bank of Korea has viewed inflation as temporary. Do you now see greater concerns about inflation than before?

▲ It has not been long since the May economic outlook was released. I do not think there has been a significant change in the inflation forecast; the basic outlook remains. When the May forecast was made, the Research Department raised the consumer price inflation forecast by 0.5 percentage points from 1.3% in February. The reasons include both supply-side and demand-side factors. The temporary aspect is generally attributed to supply-side factors and base effects. On the demand side, the economic recovery has been faster than expected, leading to a significant rise in personal service prices compared to last year. Both supply and demand factors have contributed to the upward revision of the inflation forecast, which remains unchanged. The rising demand-side inflationary pressure can be seen in the core inflation rate.

- Will the Bank of Korea continue simple purchases of government bonds in the second half of this year? Does this contradict the Bank's stance suggesting a tightening policy?

▲ The benchmark interest rate is quite low at 0.50% per annum. Even if it is raised once or twice later depending on economic or financial stability conditions, I do not think it should be considered tightening. It should be described as a slight increase from a low level. The simple purchase of government bonds is conducted for market stabilization. In the first half of the year, purchases were made at the level of 5 to 7 trillion won, which is different in purpose from benchmark interest rate operations. When market volatility increases and government bond yields fluctuate sharply, simple purchases can be made temporarily as a market stabilization measure. Depending on external and supply-demand factors, if deemed necessary after observing market volatility, simple purchases of government bonds can continue. This is decided separately from benchmark interest rate operations.

- The report mentioned side effects of household debt and the possibility of capital outflows. Can this be seen as building justification for raising the benchmark interest rate?

▲ In Korea's case, the risk of capital outflows is currently not significant. Considering the economic fundamentals and foreign exchange soundness, as well as Korea's credit rating, it is differentiated from other emerging countries. At present, capital outflows are not a major concern in interest rate operations. However, it is difficult to conclude how changes in monetary policies of other countries like the U.S. Federal Reserve will affect capital flows, so monitoring is necessary. Interest rates should be decided by considering economic, inflation, and financial stability conditions.

- What are your thoughts on concerns that raising interest rates could increase the burden of household debt?

▲ I believe you are referring to the burden on households with significant debt. If interest rates are raised, it is true that the burden on indebted households will increase. When adjusting interest rates, positive and negative impacts must be weighed together in decision-making. While the burden increases, if economic and inflation conditions improve rapidly, financial imbalances such as the accumulation of household debt and increased asset market investment should be considered more than before. For vulnerable sectors where the burden may increase, I think it can be supplemented by other means. For example, the Bank of Korea has been supporting small business owners and SMEs through financial intermediation support loans, which have significantly increased in scale since COVID-19 last year. These can help reduce interest burdens and ease financing difficulties for vulnerable groups. Considering the necessity and extent of support for vulnerable sectors together would be beneficial.

On the morning of the 10th, a briefing session for the Monetary and Credit Policy Report (June 2021) was held at the Bank of Korea in Jung-gu, Seoul. From the left in the photo: Lee Jeong-ik, Head of the Price Trends Team; Park Jong-seok, Deputy Governor; Lee Sang-hyung, Director of the Monetary Policy Bureau; Bong Gwan-su, Head of the Policy Cooperation Team. Photo by Lee Jeong-ik

- The preliminary GDP growth rate for Q1 was revised upward. Is achieving the optimistic scenario growth rate (4.8%) possible?

▲ The Q1 growth rate was revised upward, and factors such as the supplementary budget are upward factors for the growth forecast. However, the optimistic scenario assumes rapid progress in economic stimulus measures and vaccination rates in various countries, so we need to observe changes in the situation further.

- International oil prices have far exceeded this year's forecast of $65. Should the 1.8% inflation forecast for this year be revised upward?

▲ The recent inflation environment has changed, leading to questions about whether the inflation forecast should be revised. It is true that international oil prices have risen to around $70. Our forecast assumes an average price in the mid-$60s. If prices remain above $70 for a prolonged period, it could act as an upward inflation factor. However, from the second half of the year, supply-side factors are expected to support a gradual stabilization of oil prices. We need to observe whether this trend changes.

- The corporate bond market is booming. Is there a possibility of extending the Special Purpose Vehicle (SPV) for corporate bond and commercial paper purchases?

▲ We are currently reviewing the operation direction of the SPV and have been conducting internal reviews. Since the government and the Korea Development Bank jointly operate it, consultations are ongoing. The Monetary Policy Committee is also discussing it. No decision has been made yet, but preparations are underway. The SPV is scheduled to end on July 13, and the Monetary Policy Committee plans to make a decision before then. The corporate bond market has indeed improved, stabilizing significantly thanks to economic recovery and improved corporate performance. The SPV has played a major role in market stabilization.

- Do you think the phenomenon of 'debt investment' (Bitt) is a side effect of ultra-low interest rates?

▲ The recent expansion of asset investment cannot be attributed solely to low interest rates; various factors have contributed. The stock market has been influenced by improved economic and corporate performance outlooks. However, there has been a recent tendency toward increased leverage, which I believe is rooted in low interest rates, accommodative monetary policy, and increased risk appetite. After COVID-19 last year, interest rates were lowered significantly, and liquidity was supplied as an unavoidable response. Going forward, attention should be paid to the accumulation of financial imbalances.