Interest Rate Gap, High Inflation, and Exchange Rates
Contemplating the Necessity of Big Step
Money Flow Blocked by Legoland Incident
Household and Corporate Loans Surge
Concerns Over Financial Crisis from Corporate Debt
Economic Recession and Persistent Trade Deficit
Rapid Interest Rate Hikes Burden Growth
Lee Chang-yong, Governor of the Bank of Korea, is attending the Emergency Macroeconomic and Financial Meeting held at the Bankers' Hall in Jung-gu, Seoul, on the 3rd. Photo by Hyunmin Kim kimhyun81@
[Asia Economy reporters Seo So-jeong and Moon Je-won] The prolonged tightening stance of the U.S. Federal Reserve (Fed) is expected to inevitably lead to changes in the Bank of Korea's monetary policy. While it is certain that the Fed will continue its rate hike trend with four consecutive giant steps (0.75 percentage point increases in the benchmark interest rate), the biggest concern is the size of the rate hike at the last Monetary Policy Committee meeting of the year, scheduled for the end of this month. Considering the inflation rebound after three months and the continuing upward trend of the KRW-USD exchange rate, there is a strong justification for a big step (0.50 percentage point increase) at the MPC meeting on the 24th. However, given the short-term liquidity market tightening triggered by the 'Legoland incident' and domestic financial instability, opinions are sharply divided, with some arguing that a baby step (0.25 percentage point increase) would be more appropriate.
◆Silent on the interest rate direction, Lee Chang-yong= On the morning of the 3rd, Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho and Bank of Korea Governor Lee Chang-yong held an emergency macroeconomic and financial meeting attended by Financial Services Commission Chairman Kim Ju-hyun and Financial Supervisory Service Governor Lee Bok-hyun to discuss countermeasures in response to the Fed's reaffirmation of its high-intensity tightening stance. Although it was their first meeting in about ten days since the 23rd of last month, the meeting was held in a tense atmosphere for about an hour and a half, longer than scheduled, as market anxiety increased with the KOSPI plunging and the exchange rate surging following Chairman Powell's hawkish remarks that morning.
Immediately after the meeting, the Ministry of Economy and Finance explained in a press release that "As the Fed's rate hikes increase uncertainties for our and global financial markets, we have decided to maintain a higher level of vigilance and respond accordingly." However, Deputy Prime Minister Choo did not add any comments after the meeting. Governor Lee also only said "I'm sorry" in response to reporters' questions such as whether the Bank of Korea's terminal rate could rise above 3.5%. Governor Lee's usual earnest responses to reporters' questions were replaced by silence, which can be interpreted as reflecting the difficulty of the MPC's decision this month.
◆Three major dilemmas of monetary policy= The first reason the Bank of Korea is hesitating despite the justification for a big step is the rapidly cooling bond market. Due to the 'Legoland incident,' investment sentiment has shrunk, causing a liquidity crunch known as 'money clots.' Although the government expanded its liquidity supply program to '50 trillion won plus alpha' and the Bank of Korea introduced measures such as expanding eligible collateral securities and purchasing repurchase agreements (RPs), the situation has not been easily resolved. In the domestic bond market, there are complaints that the money flow has dried up as the Bank of Korea has continuously raised the benchmark interest rate for over a year since August last year, making an additional big step a burden for the Bank.
The second dilemma is the rapidly accumulating household and corporate debt. According to the International Institute of Finance (IIF) Global Debt Report, as of the second quarter of this year, Korea had the highest household debt-to-GDP ratio among 35 countries at 102.2%. Korea was the only country surveyed where household debt exceeded the economic size (GDP). Corporate debt is also increasing rapidly. The debt ratio of Korean non-financial corporations to GDP was 117.9% as of the second quarter, ranking fourth after Hong Kong (279.8%), Singapore (161.9%), and China (157.1%), jumping three places from seventh in the first quarter within just three months. There are concerns that if corporate bank loans increase further due to bond market liquidity tightening, a financial crisis triggered by corporate debt cannot be ruled out.
The third dilemma is that with the global economy entering a recession next year, South Korea's growth rate is inevitably expected to slow down. According to the Ministry of Trade, Industry and Energy's 'October Trade Trends,' last month's trade balance recorded a deficit of 6.7 billion dollars. The trade balance has been in deficit for seven consecutive months since April, marking the first time in about 25 years since May 1997 that a trade deficit has persisted for seven months. According to the minutes of the October MPC meeting, one MPC member said, "As the global economy enters a recession next year, our small open economy will be significantly affected," and "Considering the lag effect of monetary policy, the recent monetary policy is expected to impact the real economy, and domestic economic growth is expected to slow significantly in the mid to late next year."
Kim Jung-sik, emeritus professor at Yonsei University, said, "Considering inflation, exchange rates, and the widened interest rate gap of up to 1.00 percentage point between Korea and the U.S., a big step in November is warranted. However, given the domestic financial liquidity crunch and the growth slowdown due to the global recession, the weight inevitably leans toward a baby step." He added, "Governor Lee Chang-yong stated last month that the terminal rate would be around 3.5%, but with the Fed's terminal rate rising to about 5%, he may have to retract his previous statement."
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