Governor Lee Changyong: "Exchange Rate Far Exceeds Fundamentals and Korea-US Rate Gap" [Q&A]

January Monetary Policy Committee Press Conference
Assessing the Impact of Two Consecutive Rate Cuts
Need to Operate the Ruling-Opposition-Government Consultative Body in Two Tiers
Supplementary Budget Should Be Implemented as Soon as Possible

Lee Changyong, Governor of the Bank of Korea, stated on the 16th, "The current exchange rate level is much higher than what can be explained by South Korea's economic fundamentals or the interest rate gap with the United States."

Lee Changyong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee plenary meeting held at the Bank of Korea in Jung-gu, Seoul, on the morning of the 16th. 2025.01.16 Photo by Joint Press Corps

After the decision to keep the base rate unchanged at 3.00% per annum, Governor Lee explained at a press conference, "Given the significant political and external uncertainties, it is more important to observe the external balance a bit more and act with greater confidence. I also thought it would be more prudent and desirable to take a breather, observe the situation, and assess the impact of the two previous rate cuts, rather than moving hastily."

Regarding the recent political situation, including the execution of an arrest warrant for President Yoon Sukyeol, Governor Lee said, "Our process will return to normal, and when speaking abroad, I will continue to emphasize that, as in the past, issues will be resolved in an orderly manner and that, in the meantime, the economic control tower remains solid and economic policy will be implemented as usual." He added, "We need to demonstrate, by dividing the ruling-opposition-government consultative body into two tiers, that our economy can continue to operate even under political shocks."

He stressed that the supplementary budget should be executed as soon as possible. Governor Lee said, "Currently, the growth rate has fallen below the potential growth rate, and the GDP gap is widening due to political influences," suggesting, "To raise the growth rate by about 0.2%, a supplementary budget of around 15 to 20 trillion won would be desirable."

The following is a Q&A with Governor Lee Changyong.

-After last year's reduced budget passed, discussions on a supplementary budget have been delayed, and with fiscal policy failing to function amid recession risks, there were considerable expectations that the Bank of Korea would preemptively cut rates to warm up the market. Was the burden that a third consecutive rate cut could be read as a recession signal a factor?

▲The reason for keeping the rate unchanged this time, despite only one member expressing a minority opinion, is that, in substance, there were actually many more diverse views than the 5:1 vote suggests. All members agreed that, based solely on economic conditions, it would be natural to lower the rate now. However, since interest rates affect not only the economy but also many other variables, we needed to consider these impacts together. This time, external balance, particularly the exchange rate, was heavily influenced not by economic factors but by domestic political reasons and shifting expectations regarding the new U.S. administration, creating significant uncertainty. In particular, the political changes that began with the state of emergency have greatly affected the exchange rate, which is now at a much higher level than can be explained by our economic fundamentals or the interest rate gap with the U.S. Given the significant political and external uncertainties, I believed it was more important to observe the external balance a bit more and act with greater confidence. I also thought it would be more prudent and desirable to take a breather, observe the situation, and assess the impact of the two previous rate cuts, rather than moving hastily.

-What are the Monetary Policy Committee members' outlooks for the policy rate over the next three months?

▲All six members, excluding myself, thought that the possibility of lowering the rate from the current 3% within the next three months should remain open. This is because, given the domestic economy is performing worse than expected, it would be appropriate to respond with monetary policy after confirming changes in domestic political uncertainty and external economic conditions. I want to emphasize again that these forecasts are conditional on all economic circumstances. The reason why Shin Sunghwan presented a minority opinion is that, while concerns about the exchange rate and other external factors are valid, he believes the direction of rate cuts is already reflected in the foreign exchange market. Although a rising exchange rate could exert upward pressure on inflation, he expects demand-side inflationary pressures to ease due to the economic slowdown, so he believes that focusing on the economy and cutting rates is appropriate even now. While other members agreed with this, they concluded that, given the extreme uncertainty of external factors at this time, it would be better to pause and focus on external rather than domestic factors for now.

-Previously, you said that since the U.S. began its rate-cutting cycle, Korea could conduct monetary policy more independently of the U.S. Now that expectations for U.S. rate cuts have diminished, does this still hold? If the U.S. reduces the number of cuts, do you think Korea's opportunities to cut rates will also decrease?

▲Fundamentally, U.S. monetary policy has a significant impact, but globally, there is more room to make independent decisions based on domestic economic conditions during a rate-cutting cycle than during a rate-hiking cycle. Since we are now in a rate-cutting cycle, the influence of U.S. economic policy has lessened, and we have more room to focus on domestic factors. However, if political shocks create uncertainty in our foreign exchange market, we cannot avoid its impact. Once political conflicts stabilize to some extent, I believe we can pursue rate cuts more independently of U.S. monetary policy. We have expected the U.S. to cut rates about three times. If the Trump administration begins, much of the uncertainty will subside, so after reassessing this uncertainty, we will decide the pace and extent of future rate cuts.

-As the political deadlock drags on, there are concerns that fiscal policy is insufficient to counter the recession and that, apart from monetary policy, it is difficult to implement measures to respond to the downturn.

▲An unfortunate event that should not have happened has led to political deadlock. Such events have a significant impact on the economy, and as seen in the past two impeachment cases, it is difficult to separate politics and the economy. However, it is crucial to demonstrate that the economy operates normally regardless of the political process. Since we are in a rate-cutting cycle, I believe this is naturally supporting the economy. However, unlike fiscal policy, monetary policy affects not only the economy but also variables like the exchange rate. Therefore, it is not desirable to rely solely on monetary policy to stimulate the economy or to shift the entire burden onto monetary policy.

-If the Bank of Korea lowers the base rate, could the interest rate gap with the U.S. widen again?

▲If you are concerned that an interest rate reversal with the U.S. of more than 200 basis points (1bp=0.01 percentage point) is risky, you should not just look at the number but also at the reasons for the gap. We need to consider how this affects capital outflows and make decisions accordingly. There is no specific number we are targeting.

-Please explain the impact of the political situation on the economy. Has the political situation also contributed to the downward revision of the economic growth outlook?

▲It is still very difficult to judge the impact of political shocks on the economy. The effects will vary greatly depending on how long the uncertainty persists. However, compared to the outlook in November, economic sentiment has deteriorated significantly. At that time, we projected fourth-quarter growth at 0.5%, but if actual growth is around 0.4%, last year's annual growth rate would be about 2.2%. Now, consumption, domestic demand, and especially the construction sector are declining more than expected. At this Monetary Policy Committee meeting, we considered the possibility that fourth-quarter growth could be 0.2% or even lower, rather than 0.4%. If so, last year's growth rate could be lower than I previously mentioned, and this base effect could impact this year's growth as well. Therefore, we plan to release data up to now by next week or before February.

-Recently, you have delivered various messages regarding the political situation. Some say the economy is encroaching on the political sphere. What is your view?

▲Some say my messages are political, but I consider them to be very economic in nature. At that time, the Prime Minister was impeached, and then Choi, who was the acting official, became the acting acting official. If he were also impeached and removed, what would happen to our external credibility? How would the command tower for the Korean economy be maintained? I was aware that foreign investors and credit rating agencies were viewing the situation very negatively, so to stabilize the economy, it was more important to maintain the fundamentals than to lower the interest rate by a few percentage points. I believe that was the most important message for economic stability. As someone responsible for the economy, I felt compelled to speak out.

-It seems you are more concerned about increased volatility than the absolute level of the exchange rate. Many interpret that the National Pension Service's foreign exchange hedging is one of the reasons for the recent decline in the exchange rate. Do you think that, if the exchange rate rises further, such hedging will help stabilize the rate?

▲This decision was clearly focused on external balance rather than domestic balance, considering various uncertainties such as external credibility. Especially regarding the exchange rate, rather than focusing on the level, we have been carefully analyzing the reasons for its rise. Of the 70-won increase from 1,400 to 1,470 won, we attribute about 50 won to the global strong dollar trend. If you ask whether the remaining 20 won is due to political factors, I believe it is actually greater than that. The National Pension Service's foreign exchange hedging volume is significant, and we have implemented market stabilization policies, so I estimate that about 30 won of the increase is due to political reasons. Especially after the Prime Minister's impeachment, the exchange rate once surged by as much as 60%. Currently, the overall changes are due to the slowdown in U.S. CPI and yesterday's execution of the presidential arrest warrant. Predicting whether this will continue is akin to asking how the policy process will unfold.

-What impact will the execution of the arrest warrant have on external credibility? Could there be any positive effects?

▲I believe that, following yesterday's events, our process will return to normal, and when speaking abroad, I will continue to emphasize that, as in the past, issues will be resolved in an orderly manner and that, in the meantime, the economic control tower remains solid and economic policy will be implemented as usual. If this is well received abroad, there will be no problem, but if it is not and there is another shock, it will be difficult to say it is the same as before, so there is a risk. In fact, in this situation, the National Assembly continues to discuss the ruling-opposition-government consultative body, and someone told me not to say foolish things like how politics and the economy can be separated. Of course, it is difficult to separate politics and the economy. However, we must strive to ensure that the economy operates normally, independently of politics, as much as possible, even if it is difficult. This is essential for our economic normalization and minimizing shocks. To ensure that economic matters proceed quickly, I believe it is important to divide the ruling-opposition-government consultative body into two tiers: one dealing with political issues and another where working-level officials focus on economic issues, so that economic policy can function normally. This will demonstrate that our economy can continue to operate even under political shocks.

-Last month, you said that if fiscal expansion is needed and a supplementary budget is implemented, it would be desirable to target spending on specific items temporarily. Has your view changed now that monetary policy is pausing? If a supplementary budget is needed, what scale and timing would you consider appropriate?

▲I now believe a supplementary budget is necessary. Last year, I was not very positive about a supplementary budget because the economic growth rate was above the potential GDP, so refraining from supplementary spending and maintaining fiscal soundness would help stabilize prices. Now, the growth rate has fallen below the potential growth rate, and the GDP gap is widening due to political influences. In terms of scale, if the growth rate has dropped by about 0.2%, it would be good to estimate a supplementary budget that compensates for that amount. Previously, I suggested that to raise the growth rate by about 0.2%, a supplementary budget of around 15 to 20 trillion won would be desirable. Of course, the fiscal authorities will decide, but I hope the scale will be sufficient to raise the level to potential GDP or reduce the GDP gap.