[Q&A] Lee Changyong: "If the Current Outlook Holds, Rate-Cut Stance Likely to Continue Through First Half of Next Year"

Q&A with Governor Lee Changyong:
Only Shin Sunghwan Dissented on Rate Freeze
Five Out of Six Members Open to Further Cuts Within Three Months
Unusual Political Uncertainty and Shifting External Conditions
"Sub-Potential Growth This Year

Lee Changyong, Governor of the Bank of Korea, stated on the 28th, "Given the current economic growth outlook, it is highly likely that the trend of interest rate cuts will be maintained until the first half of next year."

Lee Changyong, Governor of the Bank of Korea, is speaking at a press conference on the interest rate decision of the Monetary Policy Committee held on the 28th at the Bank of Korea in Jung-gu, Seoul. Courtesy of the Bank of Korea.

At a press conference on monetary policy held that day, Governor Lee explained, "We are projecting next year's growth rate at 1.6%. On a quarterly basis, we expect low growth to continue until the first half of next year, with growth rising closer to the potential rate in the second half. Since low growth is likely to persist until the first half of next year, there is a high possibility that the policy of interest rate cuts will be maintained until then."

On this day, the Monetary Policy Committee of the Bank of Korea decided to keep the base interest rate unchanged at 2.5% per annum. The projected growth rate for this year was revised to 0.9%, up 0.1 percentage point from the 0.8% forecast in May.

Regarding the background of the outlook, Governor Lee said, "The second supplementary budget and improved economic sentiment have led to a stronger-than-expected recovery in consumption, which contributed to raising this year's growth rate by about 0.2 percentage points. In terms of exports, the semiconductor market has remained strong longer than expected, and automobile exports have also been robust, which added another 0.2 percentage points." On the other hand, he added, "The construction sector has been weaker than initially expected, which lowered this year's growth outlook by about 0.3 percentage points."

He further stated, "The main reason for the low growth outlook this year was political factors in the first half. Although tariffs have been lowered, they are still quite high compared to before. Considering these external conditions, it is natural for this year's growth rate to fall below the potential growth rate, and to some extent, we should accept this. While we will use fiscal, financial, and interest rate policies to prevent growth from falling too low, if we try to boost growth excessively to reach the potential rate despite unfavorable external conditions, it could lead to various side effects."

The following is a Q&A with Governor Lee.

-Was there a dissenting opinion in this Monetary Policy Committee decision?

▲Shin Sungwhan, a committee member, expressed the view that it would be desirable to lower the base interest rate to 2.25%. The five committee members who supported keeping the rate unchanged believed that, although the government's June 27 measures have had significant policy effects, it is still difficult to say that housing prices and household debt in the Seoul metropolitan area have stabilized sufficiently. They also considered the need for policy coordination if the government introduces additional real estate measures, as well as the interest rate gap with the United States, and thus preferred to keep the rate unchanged this time and monitor domestic and international policy conditions further. In contrast, the dissenting member acknowledged the risk that a rate cut could stimulate expectations of rising home prices, but argued that the upward trend in real estate prices has slowed considerably and, given the high likelihood of a Federal Reserve rate cut in September, it would be appropriate to preemptively lower rates to support the economy.

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

▲Of the six committee members excluding myself, five believe that the possibility of a rate cut to a level lower than the current rate should be kept open, while one member believes it is highly likely that the rate will remain at 2.5% even after three months. The five members who favor keeping the option open expect growth to remain below the potential rate and suggest that further cuts should be considered while monitoring upside and downside risks and financial stability. The remaining member said that while future data will be reviewed, more time is needed to resolve financial stability risks, so it would be appropriate to keep the rate unchanged for the next three months while assessing economic conditions.

-The Bank of Korea's projected growth rate is below the potential rate for both this year and next year. Does this mean the trend of rate cuts will continue into next year as well? Should we consider the possibility of a base rate in the 1% range next year?

▲We are projecting next year's economic growth rate at 1.6%. On a quarterly basis, growth is expected to remain below the potential rate until the first half of next year and then approach the potential rate in the second half. Therefore, at least until the first half of next year, the trend of rate cuts is likely to continue. In the first half of next year, we will reassess the economic outlook for the second half and decide whether to maintain the rate cut trend. However, this is based on the current economic outlook (1.6% growth next year).

▲A base rate in the 1% range ultimately depends on what the final rate will be, but I do not think it is appropriate to discuss the final rate at this stage. The timing and extent will be determined according to economic conditions.

-Could you give a brief assessment of the Korea-US tariff negotiations and the Korea-US summit, which influenced growth projections and rate decisions?

▲Ahead of the Monetary Policy Committee meeting, there were many concerns about the outcome of the Korea-US summit. However, the results were in our view very positive and the negotiations went smoothly, so fortunately there was no need to make significant changes to our forecasts. If the summit outcome had been very different from the early August negotiations, especially if it had been negative, the trade-off between growth and financial stability would have become more severe, making it much more difficult for us to decide to keep the rate unchanged.

-Fiscal policy is driving a recovery in consumption through supplementary budgets, but there is a view that monetary policy is lagging in supporting growth. Should the recent decision to keep rates unchanged be seen as simply delaying a rate cut, or does it signal a general shortening of the rate cut cycle?

▲There is a concern that we may have missed the timing for a rate cut by keeping rates unchanged this time, but I do not see it that way. So far, we have lowered rates by 100 basis points (1bp = 0.01 percentage points), which is faster and more preemptive than other countries. Internationally, our real interest rate level is actually lower than others. Various liquidity indicators also do not show a shortage of liquidity at present.

▲Some argue that the growth rate should be raised above 0.9%, but due to political uncertainty in the first half, the growth rate was actually in the 0% range. Considering the unusual political situation, economic conditions, and structural factors, economic stimulus is indeed needed. However, there are differing views on how much and how quickly growth would rise if rates were cut further. We believe that further and faster rate cuts would have more negative side effects, such as rising real estate prices and increased household debt, than positive effects on growth. Therefore, we are only adjusting the rate and timing, not missing the opportunity. Especially since the government is expected to introduce additional macroprudential policies, policy coordination with monetary policy is necessary for effectiveness. In this respect, we are not shortening the cycle but adjusting the timing.

-In the United States, there are calls for the resignation of Federal Reserve officials, raising concerns about the erosion of independence. Do you see any threats to the independence of the Bank of Korea?

▲In theory, central bank independence does not apply to everything. Everyone agrees that it is essential to maintain central bank neutrality for monetary policy aimed at price stability. Governments tend to prioritize economic growth over price stability, so central banks must give slightly more weight to price stability for balance. On the other hand, macroprudential policies or financial stability measures in times of crisis cannot be handled by the central bank alone and naturally require policy coordination, so in that respect, the central bank cannot act independently. Independence is necessary for monetary and interest rate policy, and in Korea, the central bank has not been influenced by the government in this regard, so I believe our independence in monetary policy is well maintained compared to other countries.

-Since entering the rate cut cycle, the base rate has been lowered by 1 percentage point. How effective has this been in boosting growth?

▲Statistically, a 25bp drop in the base rate raises the growth rate by about 0.06 percentage points. Since the rate has been lowered by about 100bp, the cumulative effect on growth is estimated at about 0.24 percentage points. However, this varies over time, so we will review the statistics again after this rate cut cycle. Further rate cuts should also boost growth, but under current conditions, we cannot rule out the possibility that it may raise real estate prices more than growth, so we are researching this.

-Previously, you emphasized managing household debt over specific regional housing prices, but since the July committee meeting, you have mentioned the need to stabilize Seoul housing prices. Does this mean that even if household debt growth slows, rate cuts could be constrained if home prices are not stable? Does "stabilizing Seoul housing prices" mean a gradual decline or just a slowdown in the upward trend?

▲In principle, financial stability is assessed by household debt rather than specific regional housing prices. Although household debt declined in July, it is uncertain whether transaction volumes will decrease in August, and based on past trends, unless Seoul home prices fall significantly, it is unlikely that transaction volumes will drop sharply. Therefore, we cannot be confident that household debt has stabilized.

▲It is true that the Bank of Korea is often criticized for focusing on housing prices and real estate in terms of financial stability. However, over 50% of Korea's population lives in the Seoul metropolitan area, and changes in real estate prices and rents in this region significantly affect inflation. Some claim that the Bank of Korea is trying to control home prices, but I do not agree. I do not believe home prices can be controlled by interest rates. The Bank of Korea's position is not to fuel expectations of rising home prices by oversupplying liquidity. We are being cautious with rate cuts to prevent a surge in home prices, and allowing some time for real estate measures to take effect, not to control home prices through monetary policy.

▲As for the criteria, we mainly look at whether the rate of increase in Seoul real estate prices is high compared to the past and whether there is further upside potential. We also monitor whether rising Seoul home prices are spreading to other regions. If only home prices in Gangnam, Seoul, were rising and not elsewhere, and household debt was not increasing, we would not be overly concerned. But since that is not the case, we are making judgments based on these developments.

-Is it realistically difficult to achieve 1% growth this year?

▲This should be assessed from both short- and long-term perspectives. The main reason for growth falling below the potential rate this year was political factors. Tariff policy uncertainty is high, and even the currently agreed tariff levels are quite high compared to before. Therefore, it is natural for this year's growth to fall below the potential rate. While we will use fiscal, financial, and interest rate policies to prevent growth from falling too low, if we try to boost growth excessively to the potential rate despite unfavorable external conditions, it could lead to various side effects. We should accept to some extent that growth will be below the potential rate this year.

▲Deputy Prime Minister Koo Yooncheol's comment ("The decline in the potential growth rate is because our economy lacks capability") raises the question of whether Korea's potential growth rate is at an appropriate level. I believe Korea's potential growth rate has fallen below 2%. Even large countries like the United States have a potential growth rate above 2%, so I do not think it is desirable for Korea to simply accept a rate below 2% due to factors like population aging. While we may not be able to achieve 3-4% growth immediately, we must prevent it from falling too low, which requires restructuring. Also, since the low birth rate cannot be resolved in 1-2 years, we need to consider how to utilize foreign labor.

-What is the main reason for sluggish growth this year?

▲It is the construction sector. Exports have held up better than expected, but the construction sector has deteriorated further since May. We expect construction investment growth to be -8.3% this year, contributing -1.2 percentage points to overall growth. If construction investment growth were zero, the growth outlook for this year would be 2.1% (0.9% + 1.2%). The dilemma is whether we should lower interest rates and provide subsidies to revive construction. I believe the construction sector is currently undergoing necessary restructuring due to excessive supply of housing, commercial properties, and unsold units in regional areas. While government support could provide temporary relief, it may hinder restructuring, so some unavoidable restructuring is likely for the time being.

-What are the upside and downside factors for the economy this year and next year?

▲The downside factor is the very fact that tariff negotiations have been reopened. If renegotiations begin, uncertainty will increase, and even if tariffs remain as they are, industries like automobiles may need to increase production in the United States to avoid tariffs, which poses a risk of hollowing out Korea's industrial base and could lead to labor-management conflicts. There is uncertainty about how much this will affect the domestic economy and how smoothly it will be resolved. Without political and economic coordination, the damage could be greater. Other downside factors include restructuring in the petrochemical sector, real estate project financing, and highly competitive industries like steel, where industrial restructuring is likely in the next few years. Whether this will proceed smoothly or trigger further conflicts is a downside risk.

▲On the upside, a positive outcome in tariff negotiations would be beneficial. The semiconductor industry could also provide an upside if it is not significantly affected by tariffs and the cycle lasts longer than expected. If government fiscal spending in next year's budget is larger than expected, there could be short-term upward pressure, though it remains to be seen whether this would be sustainable in the medium to long term.

-A new head of the financial authorities has been appointed. How much progress has been made in discussions on stablecoins?

▲We have discussed the impact of capital liberalization and regulatory direction with working-level officials at the Ministry of Economy and Finance, and discussions are ongoing at higher levels. Laws directly related to virtual assets, such as the Virtual Asset Act, fall under the jurisdiction of the Financial Services Commission, and while we have had many discussions with working-level officials, there have been no discussions at the senior level as the confirmation hearing for the Financial Services Commission chairman has not been completed. However, we have sufficiently communicated the Bank of Korea's position in consultations and hope it will be well reflected.

-The government announced plans to cooperate with the Bank of Korea on the national treasury management project in its new economic growth outlook. What role will the Bank of Korea play? There are also rumors that the previously suspended Han River Project may be revived.

▲When Deputy Prime Minister Koo visited the Bank of Korea, he suggested finding ways to efficiently distribute about 110 trillion won in government subsidies annually while increasing transparency using artificial intelligence (AI) and blockchain. For example, when the government provides subsidies to a prime contractor, we have not been able to control the flow of funds to subcontractors, but with blockchain technology, it is possible to automatically send funds to subcontractors as soon as the contract with the prime contractor is signed. It is also possible to restrict the use of subsidies. We are looking for ways to enhance transparency in this manner. The Han River Project involves embedding programmable functions into electronic money via deposit tokens, and we plan to connect this naturally with the second phase of the Han River Project.

▲Deposit tokens can serve as both complements and competitors to stablecoins and could play a major role in the government's digital currency initiatives. We had planned to start the second project as soon as the law was enacted, but a good example has emerged, so we intend to proceed. Building on the experience from the first project, the second project will focus on banks that are willing to invest actively in technology development, rather than opening it up to all banks.

-Assemblyman Jeon Yonggi of the Democratic Party of Korea has proposed an amendment to include a labor representative on the Monetary Policy Committee, arguing that the interests and opinions of the working class most affected by interest rate changes need to be represented. What is your view?

▲I believe that the Monetary Policy Committee should be composed of members who have neutral opinions on the entire financial market and macroeconomy, rather than representatives of specific interest groups. If the committee is made up of representatives from labor, management, and other specific sectors, decision-making on interest rates would become extremely difficult. Regardless of who nominates them, if committee members represent the interests of the nominating organizations, it would be difficult to manage the macroeconomy. Rather than representing group interests, members should be able to make decisions based on the overall financial system.