[Viewpoint] Returning to Normal Interest Rates: Time to Pay Attention to Bond Investments

Seojun Sik, Professor of Economics at Soongsil University

Recently, market interest rates have risen sharply. The yield on 3-year government bonds is around 3%, and the yield on high-quality corporate bonds is about 4%. This is the first time in over eight years that we have experienced such interest rate levels. Mortgage loan rates have surpassed 6% and are approaching 7%. The first group to suffer direct losses from rising interest rates are investors holding many long-term bonds. For example, a bond investor holding 100 million KRW worth of a 5-year National Housing Bond, a type of government bond, would lose about 5% of the investment amount, or approximately 5 million KRW, if the bond’s yield rises by 1%, which corresponds to five years of the 1% increase. The second group to incur losses are borrowers with large amounts of variable-rate loans. If loan interest rates rise by 2%, those with 100 million KRW in loans must pay an additional 2 million KRW annually in interest, which is 2% of the loan amount.

Besides those who suffer definite monetary losses, many others holding various investment assets should understand that they effectively incur losses due to rising interest rates. Small buildings generating about 5% annual rental income, orchards yielding an average return of around 7%, and high-quality companies consistently producing net profits equivalent to 10% of invested capital all see their investment attractiveness and intrinsic asset values significantly decline if market interest rates rise from 2% to 5%. In such cases, businesses with profitability around 3% might have to shut down.

Because the value of investment assets is highly sensitive to market interest rate levels, I refer to interest rates as the "scale that measures the value of investment assets." Looking back, since South Korea’s base interest rate entered the 1% range in 2015, market interest rates have been excessively low and have failed to function properly as a scale. Although the historically low base rates were maintained under the pretext of low potential growth rates, my analysis suggests that this distorted interest rate level actually suppressed South Korea’s potential growth rate.

Critics of Japan’s and Europe’s low-interest economic policies found it puzzling that South Korea seemed to be emulating their interest rate policies. In 2018, the interest rates in South Korea and the United States even reversed, and at the same time, South Korea’s real estate prices skyrocketed, ignoring the scale of this broken "interest rate scale." This is why I strongly argue that the Bank of Korea’s top priority of price stability should also include real estate price stability. Prolonged ultra-low interest rates also have significant side effects, such as households and governments becoming insensitive to interest costs and wanting to increase debt continuously.

Although somewhat delayed, I believe the base interest rate is finally normalizing. It is unfortunate that those holding relatively large bond assets or those with excessive variable-rate loans are suffering greatly, but thinking about the future, the correct answer is to break free from the "morphine" effect of ultra-low interest rates as soon as possible. Having a proper scale allows investment assets to be properly evaluated, and as funds move to properly valued assets, the economy will grow efficiently.

In my past writings, I revealed that I sold all bonds from my personal assets when the 3-year government bond yield fell below 2%, then incorporated dividend stocks yielding over 4-5%. However, a few days ago, I began purchasing bond assets for the first time in about seven years. Boldly judging the current appropriate interest rates as a base rate of 2%, 3-year government bonds at 2.5%, and 10-year government bonds at 3.2%, I have started to take an interest in 3-year bond ETFs and 5-year National Housing Bonds. Although Korean dividend stocks yielding over 7-8% remain much more attractive, it now seems like a good time to gradually include bond assets in portfolios again.

Seo Junsik, Professor of Economics, Soongsil University

This content was produced with the assistance of AI translation services.