[Q&A] Lee Changyong: "Economy Faces Challenges but Liquidity Is Sufficient... We Must Be Cautious About Cutting Rates Too Much, Too Quickly"

Q&A with Governor Lee:
Unanimous Rate Cut Decision by the Monetary Policy Committee
Four Out of Six Members Open to Additional Rate Cuts Within Three Months
Growth Forecast for This Year Set at 0.8%
Unlike the 2008 Financial Crisis
"Further Rate Cuts Will Consider Both Growth and Financial Stability"

On the 25th, Lee Changyong, Governor of the Bank of Korea, stated, "The main reason for the significant downward revision of the growth forecast over the past three months was the impact of the construction sector." He added, "We also reflected the fact that private consumption has been slower than initially expected, and the decline in exports has been significantly amplified due to the effects of tariffs."

Lee Changyong, Governor of the Bank of Korea, is speaking at a press conference on the interest rate decision by the Monetary Policy Committee held on the 29th at the Bank of Korea in Jung-gu, Seoul. Photo by Bank of Korea.

At a press conference held after the decision to cut the base interest rate by 0.25 percentage points, Governor Lee explained, "Given that the growth rate is expected to decline significantly, it is appropriate to ease downward pressure on the economy, and the Monetary Policy Committee unanimously decided to further lower the base rate."

Regarding the possibility of additional rate cuts, Governor Lee said, "Since the growth momentum has weakened much more than initially anticipated, there is a possibility that the extent of future rate cuts could be larger." However, he also noted, "There are both upside and downside risks to the economic outlook, and we must also pay attention to financial stability risks." The forward guidance reflecting the Monetary Policy Committee members' rate outlook for the next three months was split: four members favored a cut, while two preferred to hold the rate steady.

Explaining the background behind the sharp downward revision of this year's economic growth forecast to 0.8%, Governor Lee stated that the reduction was due to a 0.4 percentage point decrease in construction investment, a 0.15 percentage point drop in private consumption, and a 0.2 percentage point decline in exports. He emphasized, "Uncertainty about the future growth path remains high, and there are risk factors in both directions. The possibility of swift and smooth trade negotiations with major economies and the implementation of additional stimulus measures by the new government are upside factors, while prolonged trade conflicts and the imposition of additional tariffs on specific items could act as downside risks."

The following is a Q&A with Governor Lee.

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

▲First, the decision to cut the base rate this time was unanimous among all committee members. Looking three months ahead, of the six committee members excluding myself, four said that we should keep open the possibility of lowering the rate below the current 2.5%. The remaining two members expressed the view that it is more likely the rate will be kept at its current level. The four who favored further cuts argued that, given the economy has deteriorated more than expected, it would be desirable to stimulate the economy with additional rate cuts while still monitoring financial stability risks. The two who leaned toward holding the rate said that it would be better to make a rate cut decision after the direction of economic conditions becomes clearer, considering the effects of the previous rate cut, the Korea-US rate differential, changes in US tariff policy, changes in real estate prices in the Seoul metropolitan area, and the new government's economic policies. I want to emphasize again that all these are conditional opinions based on economic circumstances.

-Is there a possibility of further rate cuts this year? The market expects up to two more cuts in the second half.

▲Given the significant downward revision of the growth forecast, the possibility of additional rate cuts has indeed increased. However, please understand that I cannot provide a clear guideline on the direction of rates after three months, as doing so could be misinterpreted as policy.

-The growth forecast for this year was sharply lowered to 0.8%. Was the supplementary budget (extra budget) reflected in this?

▲The currently finalized supplementary budget has been reflected, but the rest has not been included.

▲The current economic situation has dropped below 1%, and it is indeed a difficult situation. However, the 0.8% figure from the Bank of Korea includes both upside and downside risks. In particular, under the baseline scenario, we expect a recovery to 1.6% next year. It is true that, depending on tariff policy, exports could deteriorate further, but as we saw today (with a US court ruling President Trump's reciprocal tariffs invalid in the first trial), there is also a significant possibility that tariff policy could be eased, which would be an upside factor. We also need to consider the effects of the new government's fiscal policy and the impact of the rate cut cycle. Political uncertainty, which has tightened conditions for the past six months, is also expected to ease considerably, so it is fair to say that there are both upside and downside risks to growth at this time.

-What is the contribution of domestic demand and exports to the 0.8% forecast?

▲With the caveat that uncertainty is so high that it is difficult to predict, based on the situation as of yesterday, the 0.8% growth forecast for this year assumes that all of the contribution comes from domestic demand, while net exports are assumed to contribute zero. Next year, even if current tariffs are maintained, their impact will be felt more in the second half of this year, so the contribution of net exports is expected to deteriorate to -0.3%. However, domestic demand is expected to pick up from the first quarter low, and the construction sector is also expected to recover from a bottom in the second half, so the contribution from domestic demand is assumed to be 1.9%. We need to continue monitoring how these baseline assumptions may change.

-A 0.8% growth forecast is said to be at the level of the 2008 financial crisis. Why was the base rate only cut by the standard 0.25 percentage points?

▲Since 2000, the growth rate has fallen below 1% only twice: 0.8% during the 2008 global financial crisis and -0.7% during the COVID-19 pandemic. While it is true that the economy has become extremely difficult, it is hard to directly compare the current situation with 2008. Back then, Korea's potential growth rate was around 3%, and economic fluctuations occurred around that level, but since then, due to structural factors like aging, the potential growth rate has been trending below 2%. Meanwhile, the amplitude of economic fluctuations has not decreased much, sometimes rebounding even as the potential growth rate has fallen. Therefore, the average growth rate has dropped from 3% to below 2%, but because the volatility remains high, the likelihood of growth falling below 1% or even turning negative has mechanically increased.

▲According to our analysis, if the probability of negative growth during the global financial crisis was about 5%, it is now, on average, about 14%. While 0.8% growth feels very difficult both subjectively and historically, it is hard to equate this situation to the global financial crisis based on numbers alone.

▲Looking only at the financial markets, during the global financial crisis, there was a credit crunch and money did not circulate, whereas now, three-year and other mid- to long-term rates have already fallen significantly, and market liquidity is ample. In such circumstances, lowering rates too much or too quickly could lead to excess liquidity flowing into housing prices and similar areas, rather than boosting the economy, which means there is a high risk of repeating the mistakes made during the COVID-19 period.

-You forecast that the recovery in growth this year and next will be driven by domestic demand. What signs of recovery do you see?

▲To explain the process of lowering this year's growth forecast from 1.5% in February to 0.8% now, private consumption fell by about -0.15%, construction by -0.4%, and exports by -0.2%. Of the 0.7 percentage point reduction, exports accounted for 0.2% and domestic demand for 0.5%. The downward revision of the growth forecast this time was not only due to the impact of tariffs, but also significantly affected by the decline in domestic demand.

▲This year, private consumption is expected to grow by 1.2%. Although this is much lower than the potential growth rate of 2%, due to structural factors such as household debt, lowering interest rates and increasing fiscal spending may help private consumption recover somewhat next year, but the recovery will likely be limited.

-What is the biggest drag on growth?

▲The biggest factor is the decline in construction investment. Even with 0.8% growth this year, construction investment is expected to fall by about 6.1%. In terms of contribution, this accounts for 0.9%. For example, if construction investment were 0% instead of -6.1%, this year's growth rate would increase by 0.9 percentage points to 1.7%. This shows just how much impact construction alone is having right now.

-What is the reason construction investment is constraining growth?

▲One might think it is due to a weak economy, but in reality, there was excessive investment during the past few years when the real estate market was strong, especially with a significant oversupply of housing in regional areas. As project financing (PF) is being adjusted, the construction sector appears to have weakened.

▲As for when this will improve, I hope that as the oversupply of houses built in the past is resolved and the market is gradually adjusted, this process will be completed around the second half of this year. I expect that the excess investment, mainly in regional areas during the real estate boom, will bottom out in the second half after two consecutive years of decline and then begin to recover.

-Paradoxically, does the recovery of growth require an increase in construction investment?

▲This is a major dilemma. While it is necessary to support struggling construction companies by boosting construction through fiscal and interest rate policies, on the other hand, simply repeating the past real estate boom without adjustment would be problematic. Therefore, the key challenge for the new government will be how to stimulate the economy, where and to what extent, and how to avoid repeating past mistakes.

-With the sharp economic downturn, there are expectations that the new government may respond with rapid rate cuts. However, there are also concerns that this could lead to a repeat of the asset price surge seen during the Moon Jae-in administration due to excessive liquidity in the market.

▲Since liquidity conditions are not tight, I am sufficiently concerned that (rate cuts) could further boost asset prices. Especially when uncertainty is high, liquidity supply is more likely to flow into asset prices rather than real economic recovery or corporate investment, as we already experienced during the COVID-19 period. This is why, even if rates are cut further, we will consider not only growth but also financial stability. The Monetary Policy Committee members also agree that we need to carefully consider the impact on real estate prices in Seoul and household debt before making a decision.

-Do you think monetary policy coordination with the new government will go smoothly?

▲I believe the new government generally agrees with this policy direction. I hope that, once the new government is formed, there will be consensus on issues such as the share of household debt in GDP and the problems of supplying liquidity to the extent that rate policy stimulates real estate prices in specific regions.

-You forecast that next year's economic growth will recover, although it will remain below potential. Does this mean there is little need for additional monetary policy?

▲Even if the economy recovers, the output gap will continue to widen as growth remains below potential. Therefore, there will likely still be a need to stimulate the economy through fiscal and monetary policy next year. However, decisions should not be based solely on the size of the output gap, but also take into account financial stability and real estate prices.

-In the past, you warned "all-in" borrowers not to expect base rates in the 1% range. What is your current position?

▲I believe I made that comment about three years ago. If you are asking whether the base rate could fall below 2% in the short term, I do not think it is very likely at this point. We need to make decisions based on economic conditions, and it will take some time for the 1% range to be maintained over the long term.

-There are concerns that it is still too early to be reassured about the exchange rate. What do you see as the main factors that will influence the exchange rate going forward?

▲I believe external factors are currently having a greater impact on the exchange rate than domestic factors. Tariff policy volatility is a major factor, and in addition, the size of the US fiscal deficit related to the budget is causing fluctuations in US long-term bonds and the exchange rate. More broadly, after years of so-called "US exceptionalism" and a significant concentration of dollar assets in the US, there is now a perception that this has become excessive, leading to some rebalancing. These external factors are currently driving exchange rate movements.

-Overall, Asian currencies have been strengthening, and in particular, the won has appreciated relatively more. What is the reason for this?

▲It is true that the US government and several Asian countries discussed tariffs, including exchange rates, at the ADB annual meeting. The significant fluctuations in exchange rates during this period were less about the content of the discussions and more about the fact that the meetings themselves caused a shift in market expectations, leading to the strengthening of Asian currencies. Since this was not accompanied by actual capital or real-sector movements, we need to monitor the progress of these discussions.

▲The appreciation of the won was due to significant depreciation driven by political uncertainty over the past six months, rather than economic conditions. The recent appreciation is a normalization process. The political uncertainty index has now returned to the level before the state of emergency last November. I do not believe political factors are currently influencing the situation. With normalization, predicting the future direction of the exchange rate has become even more difficult.

-Please summarize the Bank of Korea's position on issuing a won-denominated stablecoin.

▲In principle, we do not oppose the issuance of a won-denominated stablecoin. Considering its innovative potential, I believe the Bank of Korea may even need to actively develop a won stablecoin. However, our concerns are that a won stablecoin is a substitute for currency. If non-bank institutions, rather than banks or regulated entities, are allowed to freely issue won stablecoins, it could significantly undermine the effectiveness of monetary policy.

▲For money to function as a medium of exchange, there must be confidence that its value will not fluctuate easily and that it can be exchanged at any time. If an unregulated institution issues a currency substitute and then defaults or encounters problems, public trust in the payment and settlement system could collapse at once.

▲In particular, if a won stablecoin exists, transactions with dollar stablecoins will become much easier, making it possible to circumvent supervision and move funds easily in various ways. For a country like Korea, which has capital controls in place, this could be used as a means to evade those controls. Considering these financial stability aspects, while a won stablecoin may be necessary, our position is to start with the banking sector, where the Bank of Korea can supervise monetary policy.

▲The Han River Project, which the Bank of Korea is piloting, is labeled as a deposit coupon, but in fact, it is a won stablecoin issued within our network, and we plan to gradually develop it further. Our position is to first allow and observe its operation within the banking sector, and then gradually expand its scope if necessary.

-How do you expect US interest rates to change? If the US cuts rates, what impact will this have on Korea's base rate?

▲Given today's court decision in the US, there could be a lot of discussion. The Fed's decisions so far have been based on waiting for uncertainty from tariffs to subside, but uncertainty has actually increased, so a rate cut could be delayed beyond the September timeline expected by the market.

▲The impact of US rates on our monetary policy was such that, two years ago when the US took a "giant step" by raising rates by 0.75 percentage points, we had to follow suit unilaterally. However, now, considering the pace and the impact on the exchange rate, I believe we do not need to raise rates mechanically and can instead take financial stability into account. While we cannot completely ignore capital flows, compared to two years ago, there is now much more room for Korea to conduct monetary policy independently.