Bank of Korea's remaining card... Additional interest rate cut as early as May

Lowering Reserve Requirement Ratio Is a Last Resort

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] As the Bank of Korea kept the base rate unchanged on the 9th, attention is turning to the remaining options the central bank has. This is because additional measures may be necessary if the COVID-19 pandemic worsens further.

First, the current base rate of 0.75% could be lowered further. The market estimates the effective lower bound for South Korea, which is not a reserve currency country, to be around 0.5%. Therefore, the base rate could be cut by about 0.25 percentage points one more time.

If the base rate is lowered to the effective lower bound, traditional quantitative easing (QE)?where the central bank purchases government bonds to inject money into the market?could be implemented instead of unlimited liquidity supply through a "Korean-style quantitative easing." Professor Joonho Ham of Yonsei University Graduate School of International Studies, a former member of the Bank of Korea's Monetary Policy Committee, said, "If the COVID-19 situation continues, the Bank of Korea should consider lowering the base rate further and transitioning to full-scale quantitative easing." After the global crisis, the UK also implemented quantitative easing when its base rate was at 0.5%.

There is also the option to provide additional support to securities firms or banks. On the 2nd, Bank of Korea Governor Lee Ju-yeol stated, "We will consider lending to non-bank financial institutions under Article 80 of the Bank of Korea Act." This means the Bank of Korea is looking for ways to directly lend to securities companies and insurance firms. However, this requires agreement with the government.

Lowering the reserve requirement ratio for banks is another possibility. The reserve requirement ratio is the mandatory percentage of deposits that commercial banks must hold at the central bank to meet withdrawal demands. Reducing this ratio would increase the capacity of commercial banks to supply liquidity to the market through loans and other means. However, since it has never been lowered during past crises such as the Asian financial crisis or the global financial crisis, it is considered a last resort. A government official said, "Lowering the reserve requirement ratio involves all commercial banks, so the market impact would be much greater," adding, "This policy could increase liquidity not by trillions but by tens or hundreds of trillions of won."

The Bank of Korea could also send signals to the bond market. Although Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki has firmly stated that deficit bond issuance will not occur, if the COVID-19 situation worsens and deficit bonds are issued, additional purchases of government bonds by the Bank of Korea will be inevitable. Simple purchases of government bonds are one of the open market operations the Bank of Korea can use. The Bank of Korea conducted simple purchases of government bonds worth 1.5 trillion won (face value) on the 19th of last month. The Bank of Korea also conducted simple government bond purchases during the 2008 financial crisis and in 2016 when Donald Trump was elected US president.

Additionally, there is speculation that the Bank of Korea might directly supply funds to companies by purchasing corporate bonds and commercial paper (CP), but the Bank has stated this is impossible without government guarantees. Deputy Governor Yoon said, "Government guarantees require approval by the National Assembly. Whether public consensus can be formed is a separate matter."

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