The Bank of Korea upwardly revised the nation’s economic growth outlook for this year. It was the second upward revision this year following the previous one in April. However, the BOK unanimously decided to hold its key rate steady for July at 1.25 percent. We will take a closer look at the reasons leading up to the decision with Dr. Kim Wan-joong of Hana Institute of Finance. First off, we will look at the BOK’s new economic growth outlook for this year.
The BOK raised the economic growth outlook by 0.2 percentage points to 2.8 percent for this year following April’s increase. The biggest reason behind the upward revision is that the economic indexes for the first half have been better than expected, especially for the semiconductor, display, and oil refining industries. There has been an expansion of investment for these major export industries, while the real estate market boom has led to more investments in the construction sector. These all indicate an improvement for private sector indicators, which is a positive trend. The 0.2 percentage point increase also did not take into consideration the supplementary budget that is expected for the second half of this year, which is another favorable sign. However, unlike the first half, which had a base effect due to the rise in raw material and commodity prices, the second half is expected to see a slowdown in these effects, thus leading to a slowdown in the economic recovery as well.
The Bank of Korea announced that it raised the nation’s economic growth outlook to 2.8 percent. It was a 0.2 percentage point increase from the existing rate of 2.6 percent and also the second time that the BOK increased the outlook this year. Behind the increase was the booming international IT sector, leading to a 17 percent increase in exports in the second quarter, while facilities investment also showed a marked improvement since the end of last year. The BOK explained that the revised economic outlook did not take into consideration the effects of the Moon administration’s revised supplementary budget. If the supplementary budget bill passes the National Assembly, the growth outlook is expected to increase further to even reach the 3 percent range. However, some are saying that there is cause for concern as exports and facilities investment are concentrated in certain sectors, while the construction industry is also expected to experience slower growth in the second half due to crackdowns on the overheated real estate market. Because of these fears, the BOK kept the key rate steady.
The BOK’s Monetary Policy Board froze the key interest rate, keeping it steady for the 13th consecutive month since lowering it in June last year. Economic indexes have been positive thanks to the export and investment boom in the first half. However, it’s too early for a rate increase as there are suspicions on whether the domestic economy will continue its recovery into the second half, while the situation in the US makes it seem like the Fed’s rate hike will slow down in line with the issue of asset-to-investment contraction.
The Monetary Policy Board meeting last week was the first meeting since BOK governor Lee Ju-yeol’s comments from last month indicating that an adjustment may be needed. That is how the possibility of an interest rate increase was predicted, but the BOK has kept the rate at a record low of 1.25 percent for 13 consecutive months. The reason is because the economic recovery rate is not seen as fast enough due to a lackluster increase in consumption despite improvements in exports and investments. Also, Federal Reserve Chair Janet Yellen suggested gradual rate hikes, which has contributed to the BOK’s decision to keep the rate steady.
Recent employment figures show that the US economy is on a solid recovery track. As such, big changes are not expected in the Fed’s monetary policy stance, which also limits options for the BOK’s policy stance. Also, it is likely that the Fed will implement asset reinvestment reductions first before raising interest rates, which will slow down the reversal of domestic and foreign interest rates. As such, the BOK will not have a strong cause to raise the interest rate.
Korea’s key rate is expected to remain frozen for the time being. However, the BOK has indicated a rate increase already, with BOK governor Lee Ju-yeol saying the monetary policy will remain eased in efforts to support the economic recovery. In other words, it means the BOK will raise the interest rate when the circumstances permit. The BOK has been continuously hinting at a rate hike, but when will it actually carry it out?
I believe the conditions will be right for a rate increase in the second half of next year. Looking only at Korea’s current economic conditions, economic indexes are showing improvements in the short-term, but these improvements are centered around certain sectors in exports and the growth isn’t leading up to improvements in domestic demand. Also, with a surge in the amount of household debt, repayment burdens will limit the growth of household consumption and also limit inflationary pressures in terms of demand. However, with the reversal of domestic and foreign interest rates expected to become a major issue towards early 2018, the BOK will have to earnestly consider a gradual rate hike. The government is also expected to announce responses to household debt in August, but if household debt continues to surge or if the current phenomenon of real estate speculation focused on specific areas continues despite these measures, the BOK may hint at rate hikes earlier than expected.
The US and Korea currently have the same interest rate after the Fed raised rates last month. If the Fed decides on additional rate hikes while Korea keeps it steady, there is a chance that policy rates may reverse for the US and Korea. As such, the BOK has announced it will closely monitor the monetary policy and trade conditions of major countries. It also added that it will consider the increase in household debt as well as geopolitical risks. If there is a rate hike, vulnerable households with debt have a bigger burden in paying back their loans, which is why detailed and comprehensive countermeasures are required.
If the BOK does increase the benchmark rate down the line, the biggest problem would be household debt, which has snowballed in recent years. As such, if the interest rate increases, the burden of paying back the principal amount will increase, while the chances that the housing situation will enter into a long-term adjustment phase will grow. We also cannot rule out the possibility that the domestic economy will enter into a long-term recession. If the BOK increases the interest rate significantly in consideration of preparing for external shocks, the domestic private sector will only have limited means of responding to the effects, while people with low-income and low credit, as well as people who borrowed from multiple lenders, will be hit the hardest.
The BOK is seriously contemplating the timing of a rate increase, as well as its effects on the domestic economy. Before choosing to go ahead with the rate increase, it should try its best to block anticipated risk factors and actively consider countermeasures to best manage Korea’s financial markets.