[Q&A] Lee Ju-yeol: "All Options on the Table... Korea-US Currency Swap, an Excellent Safety Net"

Temporary Monetary Policy Committee Meeting of the Bank of Korea on the 16th
Base Interest Rate Cut from 1.25% to 0.75%... Lowered to 0% Range

[Asia Economy Reporter Jang Se-hee] Lee Ju-yeol, Governor of the Bank of Korea, stated, "The Korea-US currency swap is widely recognized as an excellent safety net that calms market instability, and it is an effective measure."

Governor Lee said at a press conference following the Monetary Policy Committee meeting on the 16th, "During the 2008 global financial crisis, when the domestic foreign exchange market was unstable, the Korea-US currency swap greatly contributed to stabilizing the market." He added, "Although it is difficult to mention specifics, we are well aware of its effectiveness and necessity, and recognize it as a means to quell foreign exchange market instability."

On the same day, the Bank of Korea held an emergency Monetary Policy Committee meeting and decided to lower the base interest rate by 0.50 percentage points to 0.75%. This decision will take effect from the 17th of this month.

Regarding the recent sharp increase in the cost of dollar procurement in the foreign exchange swap market, Governor Lee analyzed, "The recent sharp decline in swap rates reflects a deterioration in dollar procurement conditions in the funding market compared to before, along with a rise in credit default swap (CDS) premiums, indicating somewhat weakened external borrowing conditions." He also mentioned that the spread of risk-averse sentiment and increased demand for foreign currency funds by institutional investors played a role.

Currently, the foreign currency funding situation of domestic banks is understood to be without major problems, but due to the high level of uncertainty, the Bank of Korea plans to closely monitor the swap market and foreign currency funding market.

Regarding the background of the base rate cut, he said, "The degree of economic activity contraction is greater than initially expected, and with the spread of the novel coronavirus infection (COVID-19) worldwide, its impact is expected to be prolonged." He added, "The significant rate cut by the U.S. Federal Reserve (Fed) has provided the Bank of Korea with some room to respond more actively."

Below is a Q&A with Governor Lee

▲You made a surprise rate cut. Did you expect South Korea's economic growth rate to be in the 1% range this year?

=The Bank of Korea initially projected a growth rate of 2.1%, assuming that COVID-19 would peak around March and then subside. At that time, we did not anticipate the spread would increase so rapidly worldwide. It was indeed unexpected. Considering this, the actual figure is likely to be lower than initially forecasted. Naturally, it seems unlikely to reach that level. At present, it is neither possible nor important to present a specific growth path in numbers. However, I can say that the downside risk has increased compared to before.

▲If the situation worsens, are you considering liquidity supply on the scale of 30 trillion won as in the past?

=I believe the impact of COVID-19 on the real economy and financial markets is greater and more severe than ever before. So far, the financial intermediation function of financial institutions has not encountered significant problems, but we think it is necessary to prevent difficulties households face in raising funds. While liquidity itself cannot be definitively stated as 30 trillion won, we plan to maintain abundant market liquidity.

▲Considering monetary policy capacity, is there a possibility of further rate cuts?

=Generally, it is difficult to lower rates below the effective lower bound, but in reality, the effective lower bound is not fixed and can vary considerably depending on changes in domestic and international financial market conditions, especially changes in major countries' policy rates. The Bank of Korea is prepared to respond appropriately by considering various economic condition changes and utilizing all available measures.

▲Major countries are expanding liquidity supply by cutting base rates, but financial markets remain weak.

=The reason financial markets are unstable is that there is a perception that monetary policies alone cannot fundamentally stop the spread of COVID-19. Also, there is concern that if the COVID-19 situation does not end soon, it could lead to a global economic recession. The policy responses and cooperation of major governments and central banks are expected to help ease market anxiety.

▲Financial market stress has increased. Are there any overlooked risk factors?

=Since the global financial crisis, the corporate bond market worldwide has expanded by 50% over 10 years, reaching about 10 trillion dollars by the end of last year. Due to the spread of COVID-19, credit risk has increased, and corporate bond spreads and CDS spreads have more than doubled compared to the end of last year. The Fed's aggressive easing policies are expected to somewhat calm the corporate bond market. However, there is also a possibility of a negative scenario. About 50% of the corporate bond market consists of BBB-rated bonds, which are investment grade, but if their credit rating falls to speculative grade in the future, it could cause market instability. The possibility of large-scale sell-offs by investors cannot be ruled out.

▲There are concerns that the Bank of Korea's rate cut could increase pressure on the exchange rate and lead to foreign capital outflows.

=The won-dollar exchange rate is influenced by external interest rate differentials. Above all, it is mainly affected by investment sentiment, such as changes in safe-haven asset preferences in international financial markets. Considering the Fed's significant rate cuts, the pressure on the exchange rate to rise or capital outflows due to the rate cut are expected to be relatively limited. Given the high uncertainty and the possibility of unexpected developments, we will closely monitor such movements and take necessary measures.

▲The gap between the base rate and government bond yields is widening, which could cause a portfolio balance effect. What is your view on the Bank of Korea's need to purchase government bonds?

=Interest rate levels vary depending on the economic and inflation conditions of each country. Recently, the 3-year government bond yield has been below the base rate, and with the recent rate cut, downward pressure is expected to increase. If the easing stance of major countries continues, long-term interest rate rises are expected to be limited. If government bond yields rise, we will promptly take market stabilization measures such as bond purchases. If necessary, we plan to purchase bonds depending on market conditions.

▲There has been criticism that the Bank of Korea did not respond preemptively by keeping the base rate unchanged in February.

=Even now, I believe that keeping the base rate unchanged in February was an appropriate measure. The rate was held on the 27th of last month, during a period when confirmed cases were rapidly increasing. The peak was on the 29th, and for a considerable time, cases were increasing by hundreds daily. At that time, micro and selective measures addressing vulnerable sectors were much more effective. If we had cut rates then, it probably would not have influenced the market. Since monetary policy capacity is limited and zero rates are not achievable, adjusting the base rate requires careful timing. This is called the "timing theory," and many would agree that now is a much more appropriate time.

▲You previously expressed concerns about real estate price increases following rate cuts. What are your plans to address housing price volatility going forward?

=We always consider real estate as a factor when making policy decisions. Lowering the base rate ultimately reduces household borrowing costs and can increase housing demand. However, housing prices are influenced not only by interest rates but also by government policies, economic conditions, education policies, and other factors. Housing supply and demand are also important issues. Currently, the government has been striving for real estate price stability through macroprudential policies and will continue to do so consistently. In the short term, I do not expect housing prices to continue rising.

▲Will the regular Monetary Policy Committee meeting scheduled for the 4th of next month be held? What is your plan for the monetary policy trend in the first half of the year?

=The regular Monetary Policy Committee meeting scheduled for the 9th of next month is planned to proceed as scheduled. Given the high uncertainty in financial and economic conditions, we plan to operate monetary policy accommodatively to mitigate volatility.

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