[Bank of Korea on the Hot Seat] Inflation Surges Amid 'Recession and Interest Burden' Challenges [Expert Discussion]

Expert Discussion Ahead of the Monetary Policy Committee Meeting on the 13th
Professor Kim Young-ik: "Negative Growth Expected in Early Next Year... Interest Rates Should Be Lowered"
Director Park Seok-gil: "Inflation Peak in October... Downward Pressure on Companies Will Increase"
Chief Jo Kyung-yeop: "Interest Rates May Need to Rise to 4%... Opportunity for Corporate Restructuring"

[Image source=Yonhap News]

The Financial Monetary Policy Committee of the Bank of Korea is expected to implement a 'big step' (a 0.5 percentage point increase in the base interest rate) for the first time in history on the 13th, amid coexistence of concerns and expectations regarding the impact of the rate hike on the market and the future economic outlook.

Last month, the domestic consumer price inflation rate reached the 6% range for the first time since the foreign exchange crisis, and with the U.S. Federal Reserve (Fed) likely to implement another 'giant step' (a 0.75 percentage point increase in the base interest rate) this month, the Bank of Korea also faces the necessity to raise rates to respond to inflation and capital outflows. However, there is analysis that such a move could excessively increase interest burdens on households and companies, potentially harming the overall economy.

Opinions on the future economic outlook also differ somewhat. The Bank of Korea and the government maintain that the focus should still be on price stability rather than the economy, but concerns have been raised that economic recessions could hit sooner than expected, especially in the U.S. and Europe. Accordingly, Asia Economy conducted a special discussion with three economic experts to diagnose the recent inflation situation and the economy, and to hear their opinions on the Bank of Korea's monetary policy.

Park Seok-gil, Head of JP Morgan's Financial Market Operations Department, analyzed the Bank of Korea's monetary tightening policy by saying, "Because household debt has increased significantly, the rate hike could affect purchasing power," and "For companies, reduced investment demand will act as downward pressure." Cho Kyung-yeop, Head of the Economic Research Office at the Korea Economic Research Institute, evaluated, "It could be an opportunity for restructuring where marginal companies are eliminated and competitive companies enter."

On the other hand, Kim Young-ik, Professor at Sogang University Graduate School of Economics, predicted, "Although the government is currently prioritizing price stability policies, the policy direction could completely change by the first half of next year due to concerns such as economic recession." 'Bank of Korea on the Test Bench'

Below is the Q&A with Professor Kim, Head Park, and Head Cho.

[Image source=Yonhap News]

-Will the big step be taken at the Monetary Policy Committee meeting on the 13th? How do you view the inflation peak and the appropriate year-end interest rate level?

▶Kim Young-ik: It seems the big step will be taken at this Monetary Policy Committee meeting. However, after one more 0.25 percentage point increase, the rate hike cycle will conclude. I believe the inflation rate peaked in July. In the second half of the year, as raw material prices fall and demand contracts, the inflation rate will decrease, eliminating the need for further rate hikes.

▶Park Seok-gil: I agree with the forecast of a big step. Subsequently, I expect the base interest rate to be raised by 0.25 percentage points in August, October, and November, reaching 3.0% by year-end. The inflation peak could be around October.

▶Cho Kyung-yeop: Since Bank of Korea Governor Lee Chang-yong emphasized the importance of preemptively controlling inflation over the economy, the possibility of a big step is high. Because a lot of money has been loosened due to low interest rates, rate hikes are inevitable. To reduce concerns about capital outflows, Korea's base interest rate needs to be 0.75 to 1 percentage point higher than the U.S. If the U.S. raises its base rate above 3% as the market expects, Korea may need to raise it to at least 4%.

-Do you think inflation will be controlled in the second half of the year if interest rates are raised?

▶Park Seok-gil: Even if rates are raised, inflation may appear to remain high for some time on the surface, but without the rate hikes, inflation would have worsened further. Current inflation is largely driven by supply-side factors and the sharp rise in international oil prices beyond monetary policy, but rate hikes are unavoidable to respond to inflation.

▶Cho Kyung-yeop: Raising rates generally helps stabilize prices. However, there are uncertainties due to the Ukraine war and China's zero-COVID lockdown measures. If inflation prolongs, rate hikes alone may be insufficient to stabilize prices. For now, rising rates will help stabilize prices, but the extent of the effect depends on future external conditions.

On the afternoon of May 23rd, export and import cargo was piled up at Busan Port Sinsundae Pier. [Image source=Yonhap News]

-Raising interest rates could increase concerns about economic recession. How do you assess the current state of our economy?

▶Kim Young-ik: Signs of economic slowdown will become apparent toward year-end. Especially in the first half of next year, I expect our economy to experience negative growth. The global economy, centered on the U.S., is likely to enter a recession. Our economy has maintained growth mainly through exports, but exports will turn negative, consumption will increase slightly, and investment will decline.

▶Cho Kyung-yeop: The economic situation is unstable. Concerns about stagflation are increasing. Even if inflation stops rising, recession symptoms could fully manifest. The exchange rate is also rising, but unlike before, the government lacks the capacity for significant intervention. Generally, a rising exchange rate helps exports, but import prices also rise sharply, increasing production costs, so it is not necessarily positive for exports.

-Raising interest rates increases household interest burdens and corporate cost burdens.

▶Park Seok-gil: There will definitely be concerns about household debt due to rate hikes. Since household debt has increased considerably, rapid rate hikes could have a greater-than-expected impact on household purchasing power. Companies are more influenced by the global economic cycle, but rate hikes could reduce investment demand, acting as downward pressure.

▶Cho Kyung-yeop: Raising rates could cause loan defaults among households and companies. However, many marginal companies with very low productivity have survived thanks to low interest rates. These companies need to be eliminated during the rate hike period, and competitive new companies should enter, making this an opportunity for restructuring. Although there will be some difficulties, this opportunity can serve as a foundation for renewed growth.

Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho is heading to his seat after a commemorative photo at the Financial Authorities Breakfast Meeting chaired by the Deputy Prime Minister, held on the morning of the 4th at the Bankers' Hall in Jung-gu, Seoul. From the left: Kim So-young, Vice Chairman of the Financial Services Commission; Choi Sang-mok, Senior Secretary for Economic Affairs to the President; Deputy Prime Minister Choo; Lee Chang-yong, Governor of the Bank of Korea; Lee Bok-hyun, Governor of the Financial Supervisory Service.
[Photo by Yonhap News]

-Besides monetary policy such as rate hikes, what measures can the government take to control inflation?

▶Kim Young-ik: Since prices have risen sharply recently, the government has no choice but to prioritize price stabilization policies now, but the policy direction will completely change around the first half of next year. The Bank of Korea will need to lower rates, and the government will need to increase fiscal spending. Our economy has already entered a structurally low-growth phase.

▶Cho Kyung-yeop: Although public enterprises have become insolvent due to policies like nuclear phase-out under the previous government, the government must take measures to prevent further increases in public utility fees through self-help efforts. Also, since gasoline prices have risen significantly, policies such as expanding income tax deductions for transportation cards are needed to reduce private car use and gasoline demand. For agricultural products, stockpiled rice should be released properly and tariffs lowered to ensure stable supply and demand.