[KDI Economic Outlook] "Interest Rate Hike Not Yet... Easing Monetary Policy Should Be Maintained"

[Sejong=Asia Economy Reporter Kim Hyunjung] The Korea Development Institute (KDI), a government-funded research institute, stated that this year's fiscal response to overcome COVID-19 should be 'temporary and reversible,' and that accommodative monetary policy, such as maintaining interest rates, should be sustained for the time being. Structural expenditures like basic income require further discussion, and considering economic recovery and rising inflation, it is premature to raise interest rates.

On the 12th, KDI announced its "2021 Economic Outlook for the First Half" at the Government Complex Sejong, revealing these views. At the event, KDI Research Fellow Cho Deoksang explained, "Consumer price inflation may temporarily expand, mainly due to prices of agricultural, livestock, fishery products, and petroleum products, but considering that the recovery and inflation trends are not yet solid, it is necessary to maintain an accommodative stance."

Although export indicators are improving due to global economic recovery, sluggishness continues mainly in the service sector, so accommodative monetary policy should support the economy for the time being. Research Fellow Cho said, "Global economic improvement and rising international oil prices due to fluctuations in oil supply and demand will exert temporary upward pressure on consumer prices, but the core inflation rate, which mainly reflects domestic demand, still falls significantly below the inflation target (2.0%) despite base effects," adding, "It is unlikely that core inflation will exceed the target in the second quarter." He reiterated, "There is little need to adjust the monetary policy stance at this point."

He also advised maintaining the current base interest rate (0.5%). At the same event, KDI Economic Outlook Director Jeong Gyucheol said, "While respecting the decisions made by the Bank of Korea's Monetary Policy Committee, from KDI's perspective, there is little need to adjust the monetary policy stance (raise the base interest rate) this year."

Regarding financial regulatory easing measures such as the 'loan interest repayment deferral,' implemented as part of the government's COVID-19 response, KDI emphasized 'gradual normalization.' Although indicators of loan soundness have improved, with the non-performing loan (NPL) ratio to total loans decreasing (from 0.97% at the end of 2018 to 0.64% at the end of 2020), this may be a temporary effect due to regulatory easing. Furthermore, the proportion of loans to companies at high risk of default?those failing to meet two or more criteria among interest coverage ratio, debt repayment ratio, and debt ratio?reached 40.9%, the highest in the past three years.

KDI also stressed the need for voluntary debt restructuring led by the private sector. Research Fellow Cho said, "If borrowers are judged capable of overcoming the crisis, financial institutions have incentives to voluntarily implement debt restructuring. Therefore, instead of government-led mandatory debt restructuring, it is necessary to activate private-led debt restructuring through indirect policy support." He emphasized, "In the United States, despite the severe economic shock caused by the spread of COVID-19, 80% of total household debt restructuring was achieved through voluntary agreements between financial institutions and borrowers."

Regarding fiscal policy, KDI advised promptly executing already confirmed fiscal expenditures such as supplementary budgets and considering 'temporary and reversible' spending if the situation worsens. Research Fellow Cho stated, "Since the supplementary budget of 14.9 trillion won was confirmed in March, the immediate need for additional fiscal spending is not high, and efforts should focus on swiftly completing the execution of the supplementary budget," adding, "Even if additional fiscal measures are necessary, they should be limited to temporary and reversible expenditures." He particularly noted, "Structural and long-term expenditures should ideally be reflected in the main budget or medium-term plans later, along with securing corresponding fiscal revenues."

In the mid to long term, KDI urged establishing plans to reduce the sharply increased fiscal deficit and control the rising national debt to prevent prolonged fiscal burdens. According to the Ministry of Economy and Finance's 2020?2024 national fiscal management plan, total expenditures will significantly exceed total revenues by 2024, necessitating control. In fact, the managed fiscal balance to GDP ratio, which was -1.0% in 2017, worsened to -5.8% last year, and the national debt to GDP ratio surged from 36.0% to 44.0%.

KDI also indirectly mentioned the need for tax increase discussions. Research Fellow Cho explained, "If the rapid increase in national debt continues long-term, the capacity to respond to urgent fiscal needs in the future may weaken, so it is necessary to prepare plans to reduce the gap between fiscal expenditures and revenues," adding, "Despite efforts to control expenditure growth, structural fiscal expenditure expansion due to demographic changes is inevitable, so it is desirable to prepare revenue-raising measures in advance and reflect them in mid- to long-term fiscal plans."

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