Lee Chang-yong: "The Faster the Supplementary Budget, the Better... Consumer Sentiment Must Improve" [Q&A]

Lee Chang-yong, Governor of Bank of Korea, Inflation Briefing
"Consumer Sentiment Plummeted After Martial Law... Growth Rate Likely to Decline This Year"
"The Sooner the Supplementary Budget, the Better... Ruling and Opposition Parties Should Reach Quick Agreement"

Lee Chang-yong, Governor of the Bank of Korea, said on the 18th, "The supplementary budget (additional budget bill) is better the sooner it is enacted," adding, "It would be good for economic sentiment if the ruling and opposition parties reach an agreement and announce a new budget bill as soon as possible."

At a press briefing held in the afternoon at the Bank of Korea in Jung-gu, Seoul, on the status of inflation target management, Governor Lee explained, "Many institutions need to know the extent of fiscal spending to reflect it in their economic forecasts," and added, "The later the announcement, the less they can incorporate the budget, which inevitably leads to lower growth forecasts."

Governor Lee said, "Consumer sentiment has been significantly weakened, with card usage slightly declining after the martial law incident," and added, "The economic growth rate for the fourth quarter of this year is expected to drop from 0.5% to 0.4%, and the annual economic growth rate for South Korea this year may also decrease from the previous 2.2% to 2.1%."

He mentioned that next year's economic growth rate could change later but that downward pressure has increased. Governor Lee evaluated, "The budget bill currently passed by the National Assembly has about a -0.06 percentage point impact on next year's economic growth rate," and said, "Considering fiscal and psychological issues in the current state, downward pressure has increased."

He emphasized the need for economic stimulus measures to restore consumer sentiment. Governor Lee said, "The forecasted economic growth rate of 1.9% for next year is slightly below the potential growth rate (2%), and since there is downward pressure, it is undesirable for fiscal policy to act restrictively at such times," adding, "It is desirable to spend temporarily and in a targeted manner so as not to affect long-term fiscal soundness."

Below is a Q&A with Governor Lee.

- How did the impeachment political situation after the November Monetary Policy Committee meeting affect economic forecasts?

▲It is too early to judge how much the impeachment changed the November forecast because there are only about two weeks of data. However, based on data so far, exports seem to be maintained as expected, but card usage has slightly declined more than anticipated. The biggest change is in consumer and economic sentiment. Economic sentiment has dropped sharply, so stabilizing it is important. Since the impeachment outcome is not good news for the economy, it is expected to have a negative impact. The fourth-quarter economic growth rate, previously forecasted at 0.5%, is expected to fall to about 0.4%. The annual growth rate forecast of 2.2% for this year may drop to 2.1%. The possibility of 2.0% is low.

- Is there a possibility of preemptive action at the January Monetary Policy Committee meeting next year?

▲Next year's growth rate is forecasted at 1.9%. Even if other conditions do not change, the budget bill passed by the National Assembly is expected to have a tightening effect, lowering the growth rate by about -0.06 percentage points. Fiscal and monetary policies will change from now on, and after observing the economic impact of the impeachment-induced sentiment with more than a month of data, we will consider how to revise economic forecasts.

▲However, since the Monetary Policy Committee meeting is in January, we are closely monitoring how figures change for monetary policy. At present, considering fiscal and psychological issues, downward pressure has increased from the previous 1.9% forecast.

▲There are many new developments, so it is difficult to comment on January immediately. We have not officially discussed this with Monetary Policy Committee members. In principle, we need to check data such as inflation, changes in economic forecasts, whether household debt remains stable as expected, and the sequence of implementation of the new U.S. administration's policies. We will also consider the timing and pace of U.S. interest rate cuts to decide the timing and magnitude for South Korea.

- You acknowledged the need for a supplementary budget. When would be an appropriate time for its execution?

▲It is a matter for the ruling and opposition parties to agree on. From the Bank of Korea's perspective, the sooner the better. The extent of fiscal spending must be known so many institutions can reflect it in their economic forecasts. The later it is, the less impact it has on next year's economic growth rate. Secondly, the later the announcement, the more economic forecasting institutions cannot incorporate it, leading to lower growth forecasts. Since lower growth rates also affect sentiment, in a situation with high downward pressure on the economy, it would be better for the ruling and opposition parties to quickly agree and announce a new budget bill for the sake of economic sentiment. That is our view.

- The November Monetary Policy Committee minutes mentioned that the negative impact of the exchange rate was 'bearable.' After the FOMC meeting, there were concerns about further exchange rate increases. What is your view on recent exchange rate volatility?

▲South Korea is now a creditor nation, so the level of exchange rate volatility it can bear has changed from before. However, since the exchange rate affects inflation, sentiment, and financial market stability, volatility is being managed. It is not appropriate to predict or comment on the direction of future exchange rates. During the two weeks of the impeachment process, the exchange rate rose about 30 won compared to the level before the martial law announcement. This 30 won increase is unrelated to economic fundamentals, so it is expected to normalize once the political process stabilizes. How quickly normalization occurs depends on how independently economic policies are conducted, separated from politics, and on our actions.

▲Globally, the dollar is strengthening due to the new U.S. administration's policies. Many European countries also face political issues and economic downturns, leading them to lower interest rates faster than the U.S. The euro is weakening, and the yuan and yen face depreciation pressure, so the dollar's strength trend continues. On the other hand, if the U.S. policy rate is cut, it could benefit us. =In broad terms, the 30 won increase due to political reasons is expected to normalize, and the direction will be determined by overseas factors. Regarding volatility, it rose after the martial law announcement, and smoothing operations (market interventions for fine adjustments) were conducted. Now it has stabilized and is moving roughly in line with the dollar.

- You said foreign exchange reserves would not decrease significantly. Is that because you expect exchange rate stability? Are there other measures to stabilize the exchange rate?

▲There were many concerns that foreign exchange reserves would sharply fall below $410 billion and even below $400 billion in the medium term due to recent events. Fortunately, martial law was lifted within six hours, and market stability was quickly restored. The exchange rate volatility has decreased without large-scale interventions. If volatility increases again, smoothing operations will be conducted, but the reserves have not decreased to the extent feared. While we do not target a specific exchange rate level, we will firmly act to reduce volatility when it rises.

- You mentioned card usage has decreased. How much impact do you expect on private consumption after the martial law incident? Does this make a downward revision of next year's growth forecast (1.9%) inevitable?

▲In the short term, activities like weekend gatherings have been canceled, indicating significant contraction. Card usage has slightly declined, but the concern is that if consumer sentiment does not improve, it may continue to fall. Past cases show that if economic policies work properly, the public will be reassured, and overseas confidence will rise, so the extent of consumption decline is unpredictable. It is very important for the ruling and opposition parties to quickly agree and demonstrate that the system works well.

▲Whether the economic growth forecast is revised downward depends on future actions. What is certain now is that the current budget bill may cause tightening. However, supplementary budgets are being discussed, and consumer sentiment must be considered, so it is difficult to say how much it will decline now.

▲The message that the economy and politics should be separated is important. It is not a situation where words alone are trusted. It is crucial to show that important economic bills are quickly processed and executed through bipartisan agreement, and we continue to emphasize this.

- You acknowledged the need for a supplementary budget. When would be an appropriate time for its execution?

▲It is a matter for the ruling and opposition parties to agree on. From the Bank of Korea's perspective, the sooner the better. The extent of fiscal spending must be known so many institutions can reflect it in their economic forecasts. The later it is, the less impact it has on next year's economic growth rate. Secondly, the later the announcement, the more economic forecasting institutions cannot incorporate it, leading to lower growth forecasts. Since lower growth rates also affect sentiment, in a situation with high downward pressure on the economy, it would be better for the ruling and opposition parties to quickly agree and announce a new budget bill for the sake of economic sentiment. That is our view.

- There are talks that monetary policy should contribute more as fiscal policy capacity diminishes.

▲It does not mean that an enormous amount of fiscal spending is required. The 1.9% growth rate is slightly below the potential growth rate, and since there is downward pressure, it is undesirable for fiscal policy to act restrictively at such times. The idea is to raise the growth rate to the potential level or slightly above. It is not a situation like during COVID-19 where long-term fiscal soundness considerations are ignored. There is no need for fiscal policy to be restrictive. It is desirable to spend temporarily and in a targeted manner so as not to affect long-term fiscal soundness.

▲Monetary policy will naturally contribute as well. Since interest rates were raised to fight inflation, they must be lowered as the situation normalizes. Therefore, the timing of cuts is being adjusted considering various variables. Monetary policy will also consider the economy and adjust timing accordingly. Besides interest rates, the Bank of Korea can provide financial intermediary support loans, which are quasi-fiscal activities, so fiscal policy will be explicitly implemented first, and then we will consider how much fiscal spending increases.

- Will the Bank of Korea focus more on the economy in its monetary policy throughout next year?

▲Looking at past cases, in 2023, inflation was high while economic growth was low, but fiscal policy was inevitably sound to quickly control inflation. In that sense, fiscal and monetary policies cooperated well. Compared to other countries, inflation was controlled quickly, which was desirable. This year, although economic growth was lowered at the end, domestic demand was weak, but the growth rate was initially expected at 2.4%, later lowered due to worsening exports. Overall, the economy did not fall below potential growth. Therefore, fiscal policy does not need to expand quantitatively, but targeting spending is important.

▲Looking at 2025, domestic demand is not rising as quickly as expected, exports are falling, and unexpectedly, the impeachment situation has arisen. Therefore, there is a risk that growth will fall below potential, so fiscal policy needs to expand both qualitatively and quantitatively. Currently, fiscal policy's impact on inflation is limited amid downward economic pressure. However, it should temporarily and selectively stimulate the economy without affecting long-term fiscal soundness, and monetary policy should align accordingly.

- You said consumer sentiment has fallen more than economic conditions warrant. Is there a possibility of a big rate cut (0.5 percentage points) in January?

▲We need to look at the data. However, based on data so far, it is unlikely to be that large.