In a bid to tighten the flow of money and rein in runaway inflation, the Bank of Korea raised the interest rate on Friday. But on the very same day, the Ministry of Economy and Finance unveiled a plan to draw up another supplementary budget to support COVID-hit merchants.
The mix of the two potentially conflicting measures could send a wrong message to the market and increase the risk of weakening the purported effects.
In an ideal world, when the central bank moves to raise the benchmark rate to lower the excess liquidity and fight inflation, there should be no headwinds like additional government spending.
But in the real world of South Korea’s economy hit by the prolonged COVID-19 pandemic, a strong headwind is blowing from the Moon Jae-in administration that could offset the central bank’s endeavor. The extra budget plan, which was announced with fairly unusual and controversial timing, is feared to unleash a fresh wave of liquidity into the market.
The Bank of Korea, as widely expected, raised its base rate by 25 basis points to 1.25 percent Friday, hinting at additional hikes in the coming months. The latest move returned the rate to the level of March 2020. There were two 25 basis point rate hikes in August and November, respectively.
BOK Gov. Lee Ju-yeol did not hide the possibility of additional rate hikes. “Even if the rate will be raised to 1.5 percent later, it would be difficult to view it as enough tightening,” he said Friday, stressing the inflation risks as a reason for favoring more rate increases to cut down on excess liquidity.
Lee’s stance is based on warning signs that cannot be ignored. The country’s inflation grew 2.5 percent last year and is likely to hit 3 percent this year, with consumer prices gaining at a record pace.
The rate hikes are also needed to keep foreign capital from leaving the country, as the US Federal Reserve is winding down its aggressive pandemic-era stimulus measures, with its Chairman Jerome Power hinting at a series of interest rate hikes this year.
But this precarious situation seems to be a minor concern for the administration, which is keen on spending about 10 trillion won ($8.4 billion) in excess tax revenue from last year in the name of supporting small businesses struggling with plunging revenue due to the COVID-19 resurgences led by the omicron variant.
Of course, small business owners and self-employed people deserve proper compensation for the losses they swallowed as a result of the government’s somewhat inconsistent social distancing policies. But questions are being raised about whether the country needs another extra budget plan in January worth 14 trillion won.
If the Finance Ministry’s supplementary budget plan goes ahead, it will be only the second time one has been submitted to the National Assembly in January since 1948. The COVID-19 challenges facing the nation certainly require extraordinary measures, but critics are quick to point out the problems with the extra budget.
In fact, a set of support measures should have been fully reflected when the administration finalized the budget in December. Instead, the Finance Ministry announced the extra budget plan ahead of the forthcoming presidential election in March, sparking disputes about its political impact on voters.
The administration’s failure to forecast tax revenue is also under attack, as the extra budget is largely based on the 10 trillion won in excess tax revenue.
More worrisome are the conflicting policies between the central bank and the administration, which could complicate the already mounting economic issues this year. It is time for the administration to readjust its controversial plans carefully to resolve the policy mismatch and dispel concerns about political calculations.
By Korea Herald (email@example.com