Policy change needed to cushion impact from rate hike

Measures need to be taken quickly to prevent a possible interest rate hike next month from making a deeper dent in the country’s economic growth and employment, economists say.

Slowing growth and disappointing job figures led the Bank of Korea last week to decide to freeze its key rate at 1.5 percent for 11 consecutive months despite growing concerns that a rate increase may be overdue.

Announcing the rate freeze, the central bank revised down its growth forecast for this year to 2.7 percent from an earlier prediction of 2.9 percent made in July. It will mark the slowest growth of the Korean economy since 2012 when it expanded 2.3 percent.

The BOK expected about 90,000 jobs to be added in 2018, sharply down from an estimate of 180,000 three months earlier.

Central bank policymakers seemed to have judged it was unreasonable to raise interest rates while putting forward such downward forecasts.

But a statement released after last week’s meeting of the monetary policy board of the BOK gave a strong signal it would raise the benchmark rate at its next gathering slated for Nov. 30. Two of its seven members voted against the rate freeze, calling for a quarter-point increase.

BOK Gov. Lee Ju-yeol also hinted at the possibility of a rate hike by telling reporters that it was necessary to consider financial stability in managing monetary policy if it was judged that external risks would not have significantly negative effects on the country’s economy.

He apparently referred to the need to curb rising household debt and prevent a possible capital outflow.

Korea’s household debt has exceeded 1,500 trillion won ($1.32 trillion).

If the US Federal Reserve lifts its policy rate by a quarter point in December for a fourth time this year as expected, the rate gap between Korea and the US will reach 1 percentage point. The Fed has suggested it will make three more rate hikes next year.

A widening rate difference with the world’s largest economy, combined with the strengthening value of the US dollar against the Korean won, could spark a massive outflow of foreign capital from the country. So far this month, offshore investors have net sold about 4 trillion won worth of Korean bonds and stocks.

The BOK has also been under pressure from ruling party lawmakers and government officials to raise interest rates to help cool down the overheated housing market.

Experts see there is little room for the central bank to further tighten monetary policy after a possible rate increase next month, given that economic conditions are unlikely to improve next year. They expect next year’s growth rate to fall below this year’s level, as export growth is likely to slow amid escalating trade rows between the US and China.

“It would cause considerable controversy if (the BOK) chooses to raise rates continually,” said Gong Dong-rak, an analyst at Daeshin Securities.

There are concerns that a rate hike would further drag down economic growth, probably slashing the number of new employees into negative territory next year. Higher interest rates would also increase financial burdens on heavily-indebted households and self-employed businesses saddled with more than 600 trillion won of debt.

Experts call for the government to work out effective policies to reinvigorate the economy and create more jobs beyond expanding fiscal spending and taking stopgap measures such as cuts in fuel tax rates, which are scheduled to be announced this week.

“Not much time is left to boost economic activity (before the rate increase),” said Cho Young-moo, a researcher at the LG Economic Research Institute, a private think tank.

Economists say the government should move fast to convince businesses that it will prioritize forging the pro-corporate environment through regulatory reforms and tax incentives to help boost investment. The BOK last week predicted facility investment would contract 0.3 percent this year, down from a 1.2 percent increase forecast in July.

The decline in investment comes as President Moon Jae-in’s administration has implemented a set of labor-friendly measures that have imposed heavier costs on companies as part of its income-led growth drive. The government has also raised the maximum corporate tax rate to 25 percent, the seventh-highest among 36 member states of the Organization for Economic Cooperation and Development. The OECD average stands at 21.5 percent, according to data from the Finance Ministry.

Economists worry about the rapid weakening of Korea’s growth momentum over the past year, with its growth hovering below its potential growth rate, which is estimated by the BOK to be around 2.8 to 2.9 percent.

The country has also been sidelined from robust global growth, which is forecast by international economic institutes to be about 3.7 percent this year and next.

Some analysts note the central bank has missed an opportune time to increase rates, saying a rate hike should have come in the third quarter at the latest, when economic indicators looked better.

“It might be more desirable to focus on bolstering domestic demand by putting off a rate increase as long as possible to cushion economic risks next year,” said Kim Hak-kyun, an analyst at Shinyoung Securities.

By Kim Kyung-ho (khkim@heraldcorp.com)