Bank of Korea Saves Ammo Despite COVID-19 Impact... "Let's Wait and See a Bit More" (Comprehensive)

Economic Growth Forecast Revised from 2.3% to 2.1% This Year
Interest Rate Cut Deferred Due to Burdens Like Rising House Prices
Focused Support for Affected Companies Including Loan Limit Relaxation

[Asia Economy Reporters Eunbyul Kim and Sehee Jang] The Bank of Korea has downgraded its economic growth forecast for this year to 2.1% due to the impact of the novel coronavirus infection (COVID-19). However, it decided to keep the base interest rate unchanged at the current level of 1.25% per annum.

On the 27th, the Bank of Korea held a Monetary Policy Committee meeting and announced that it would maintain the base interest rate at the current level (1.25%). It also added that it lowered this year's domestic gross domestic product (GDP) growth forecast by 0.2 percentage points from the 2.3% expected in November last year.

The Bank of Korea stated, "Due to the spread of COVID-19, consumption has contracted and exports have slowed," and added, "We judge that there is high uncertainty in the future growth path due to the impact of COVID-19 and other factors." This acknowledges the economic damage caused by COVID-19. It also noted, "In the financial market, volatility of price variables has increased due to the spread of COVID-19," adding, "Long-term market interest rates and stock prices have fallen sharply, and the won-dollar exchange rate has risen significantly."

Bank of Korea Governor Lee Ju-yeol explained at a press conference immediately after the meeting that the growth forecast was estimated based on the assumption that COVID-19 would peak in March and then subside. He said, "The shock caused by COVID-19 will be greater than other infectious diseases," and predicted the possibility of negative growth in the first quarter.

Despite the downward revision of the economic forecast, the Bank of Korea's decision to keep the base interest rate unchanged appears to be based on the judgment that although the economic shock caused by COVID-19 is significant, the situation cannot be resolved by lowering interest rates. Previously, Governor Lee expressed the view that caution was needed regarding interest rate cuts despite the spread of COVID-19. Inside the Bank of Korea, his remarks were evaluated as an unusually clear message. Although calls for rate cuts resurfaced as COVID-19 rapidly spread recently, the Bank of Korea ultimately chose to maintain the rate.

Instead, the Bank of Korea prepared a plan to supply low-interest funds to companies affected by COVID-19. This involves utilizing the Financial Intermediation Support Loan (FISL), which falls under the Bank of Korea's monetary credit policy. At the Monetary Policy Committee meeting that day, the Bank of Korea decided to expand financial support for affected companies from 25 trillion won to 30 trillion won. It plans to provide 5 trillion won (equivalent to 10 trillion won in bank loans) to small and medium-sized enterprises (SMEs) engaged in service industries such as tourism, dining, and distribution, as well as small and medium-sized manufacturing companies facing difficulties in exporting to China due to raw material procurement issues.

[Image source=Yonhap News]

◆ Targeted Support for Affected Companies Rather Than Interest Rate Cuts = In the Monetary Policy Committee's resolution statement, the Bank of Korea said, "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 determine whether to adjust the degree of easing." This shows the deep deliberation between the impact of COVID-19 and financial stability.

The Bank of Korea's decision that day was influenced by skepticism that lowering interest rates would not mitigate the damage caused by COVID-19. Lee In-ho, president of the Korean Economic Association, said, "The economy, which has been constricted due to the epidemic, will not recover just because the base interest rate is lowered by 0.25 percentage points," and added, "It is right to keep the rate unchanged to save ammunition for later use." The Bank of Korea's decision to increase the limit of the Financial Intermediation Support Loan (FISL) by 5 trillion won instead of cutting interest rates is for this reason. Unlike broadly supplying funds to the market through rate cuts, this approach has the advantage of targeting support to specific affected companies.

Another reason why additional rate cuts were difficult is that the base interest rate is already close to the effective lower bound (0.75?1.00%) as seen by the market. South Korea's base interest 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 interest rate cuts also acted as a burden. With the government declaring a "war on real estate speculation," lowering rates could fuel housing price increases. The resolution statement also noted, "The increase in household loans has slightly expanded, and housing prices have shown a relatively high rise mainly in the metropolitan area outside Seoul." Governor Lee also said, "The government has introduced various policies to stabilize the real estate market, but it will take some time for them to take effect, and household loan growth remains high," adding, "We cannot confidently say that housing prices have stabilized now."

Researcher Oh Chang-seop of Hyundai Motor Securities explained, "It seems 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 interest rate cuts would lead to rising real estate prices and increasing 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 from 95.6% in the previous quarter.

◆ Interest 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 dollars, a 12.4% increase from the same period last year. However, the average daily export amount, considering working days, was 1.69 billion dollars, a 9.3% decrease from the same period last year. The February Consumer Confidence Index (CCSI) was 96.9, down 7.3 points from the previous month, marking the largest drop in 4 years and 8 months.

The low inflation rate, 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 has risen to the mid-1% range," the forecast for this year's consumer price inflation remains at 1.0%.

Researcher Kang Seung-won of NH Investment & Securities evaluated, "This rate freeze only postpones the timing of a cut to April."

Research fellow Cho Young-moo of LG Economic Research Institute pointed out, "COVID-19 has caused deaths worldwide and increased economic ties with China, raising concerns about simultaneous export slowdown and domestic production and consumption decline." Therefore, he explained the necessity of rate cuts, saying, "Even if the effect of rate cuts is not large in a worsening economic situation, it is not completely ineffective."

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