Korea’s base rate is now lower than the Federal Reserve’s for the first time in 10 years and seven months. The Fed raised a range of its base rates by a quarter percentage point as expected to 1.5 to 1.75 percent Wednesday.
The upper end of the band is 0.25 percentage points higher than the current Korean central bank’s benchmark rate of 1.5 percent.
The Fed will likely accelerate its rate hike. It is expected to raise its key interest rates three or four times this year.
The Fed’s decisions have a huge influence on the monetary policies of many countries, including Korea, and capital movement across the world.
However, Korea’s domestic economy is not performing well enough for the Bank of Korea to raise its benchmark rate accordingly. Recovery is slow due to sluggish sales. A looming trade war started by the US makes it hard to guarantee the continued growth of Korea’s exports. Youth unemployment has not bottomed out. Household debt totaling 1,450 trillion won ($1.34 trillion) is a time bomb for the Korean economy.
Despite the gap in base rates, concern of foreign capital outflow is not great.
About 90 percent of foreign funds are invested in stocks, so they tend to move depending on business conditions and corporate earnings prospects rather than a small rate differential.
Furthermore, macroeconomic conditions are sound at the moment. Korea recorded a current account surplus for 71 straight months. Its foreign exchange reserves amounted to $394.8 billion late last month.
But if the rate gap widens, capital outflow will be inevitable, and pressure on the BOK to hike rates will mount. The central bank is reportedly considering raising its benchmark rate once or twice this year. This may be of some help in preventing capital outflow, but pressure will increase next year and beyond, as the Fed is expected to step up its rate hike.
Another problem is household debt.
If the US keeps raising its base rates. Korea cannot but follow suit. However, considering massive household debt and the effects of higher rates on exports and investments, it would be difficult to follow the Fed at the same pace. And yet the central bank must prevent the gap from becoming too wide.
At any rate, loan interest rates will rise inevitably. According to the BOK, household debt borrowed from three or more financial institutions and borrowed by the bottom 30 percent income group totaled 81 trillion won as of September last year. About 70 percent of household debts carry interest rates adjustable to the base rate.
If a lot of real estate is put up for quick sale due to unbearable interest burden, financial institutions, not to mention borrowers, will be put at risk due to the falling value of mortgages.
About 20 percent of domestic companies fail to pay interests on time. To make matters worse, the raised minimum wage and shortened working hours are weighing on small businesses.
Financial authorities must take into account the situation of economically vulnerable households and businesses before speeding up rate hikes. They should also check social safety nets for the low-income bracket.
The government ought to take steps to strengthen the fundamentals of the national economy through industrial restructuring and regulatory reform. Industries need be streamlined to withstand external impact.
The BOK must find the right time and pace at which to raise rates based on a thorough analysis of economic conditions and risks.
The government and the central bank should work out an elaborate mix of fiscal, monetary and foreign exchange policies to minimize the impact of negative variables including the looming US-China trade war.
As expected, Korea’s base rate has become lower than the US’ and more rate hikes are expected to follow. Pre-emptive responses are needed to prevent risks from becoming reality.