Despite COVID-19 Impact, Bank of Korea Conserves Funds: "Let's Wait and See"

Cautious Amid Concerns Over Side Effects Such as Soaring Real Estate Prices and Rising Household Debt
Economic Growth Rate Forecast Revised Downward

[Image source=Yonhap News]

[Asia Economy Reporters Eunbyul Kim, Sehee Jang] Ultimately, the Bank of Korea chose to conserve its ammunition. While acknowledging the economic damage caused by the spread of the novel coronavirus infection (COVID-19), it judged that the solution was not a rate cut. This can also be interpreted as a decision to observe the situation further, given that there will be another opportunity to cut rates in April. The base interest rate has already fallen to a historic low, and side effects from rate cuts such as rising housing prices have also become a burden for the Bank of Korea.

In the monetary policy statement on the 27th, the Bank of Korea’s Monetary Policy Committee stated, "Going forward, the global economy and international financial markets are expected to be influenced by the speed of COVID-19 spread, the development of protectionism, and geopolitical risks," and added, "We will closely monitor the extent of COVID-19 spread, its impact on the domestic economy, changes in financial stability such as the increase in household debt, and decide whether to adjust the degree of easing." This shows the deep deliberation between the impact of COVID-19 and financial stability.

The market had already anticipated the Bank of Korea’s decision to hold rates. This was because on the 14th, Governor Lee Ju-yeol made hawkish (favoring monetary tightening) remarks to the market. After a macroeconomic and financial meeting, Governor Lee expressed a cautious stance on the need to cut the base rate due to COVID-19, saying, "We will closely observe the situation going forward, but we inevitably have to be cautious," showing a negative view on rate cuts. He also added, "There are side effects from additional rate cuts, so careful judgment is necessary." Even within the Bank of Korea, his remarks were considered unusually clear messages. Although the rate cut argument resurfaced as COVID-19 rapidly spread, the Bank of Korea ultimately chose to hold rates.

◆ Targeted Support for Affected Companies Rather Than Rate Cuts = On this day, the Bank of Korea’s decision reflected skepticism that rate cuts could not mitigate the damage caused by COVID-19. Lee In-ho, president of the Korean Economic Association, said, "The economy, which is constricted due to the epidemic, will not recover just because the base rate is lowered by 0.25 percentage points," and added, "It is right to hold rates to save ammunition for later use." This is why the Bank of Korea increased the limit of the Financial Intermediary Support Loan (FISL) by 5 trillion won instead of cutting rates. Unlike broadly supplying funds to the market through rate cuts, this has the advantage of targeting support to specific companies affected.

Another reason why additional rate cuts were difficult is that the base rate is already close to the effective lower bound (0.75?1.00%) as seen by the market. South Korea’s base rate is already inverted compared to the U.S., making further cuts practically difficult.

Concerns about rising housing prices and increasing household debt due to rate cuts also acted as burdens. The government has declared a "war on real estate speculation," and lowering rates could fuel housing price increases. The statement also noted, "The increase in household loans has slightly expanded, and housing prices showed relatively high rises mainly in the metropolitan area outside Seoul." Changseop Oh, a researcher at Hyundai Motor Securities, explained, "It appears the Bank of Korea focused on financial stability," and added, "It is analyzed that the Bank of Korea chose financial stability out of concern that rate cuts would lead to rising real estate prices and increased household debt." Concerns about household debt growing faster than income flared again. As of the end of last year, South Korea’s household credit balance was 1,600 trillion won, and housing mortgage loan increases in the fourth quarter of last year reached 12.6 trillion won. The household debt-to-nominal GDP ratio rose to 96.6% in the third quarter of last year, up from 95.6% in the previous quarter.

◆ Rate Cuts Inevitable if 'COVID Shock' Prolongs = However, expectations that the Bank of Korea will cut rates within the year are unlikely to disappear easily. This is because economic contraction caused by the COVID-19 crisis is increasingly reflected in economic indicators. Exports provisionally tallied from the 1st to the 20th of this month amounted to $26.3 billion, a 12.4% increase from the same period last year. However, the average daily export amount, considering working days, was $1.69 billion, a 9.3% decrease from the same period last year. The February Consumer Confidence Index (CCSI) also fell 7.3 points from the previous month to 96.9, the largest drop in 4 years and 8 months.

Low inflation, far below the Bank of Korea’s target (2.0%), also fuels expectations for rate cuts. There are concerns that the economy may enter a deflationary period. Although the Bank of Korea stated, "The consumer price inflation rate rose to the mid-1% range," the forecast for this year’s consumer price inflation remains at 1.0%.

This content was produced with the assistance of AI translation services.