"Need to Slow Down Interest Rate Hikes... Concerns Over Corporate and Household Delinquency Rates"

[Asia Economy Reporter Jin-ho Kim] As the Federal Reserve of the United States increases interest rates more aggressively, it is inevitable for the Bank of Korea to raise interest rates to stabilize prices, but there are claims that the pace of the hike needs to be adjusted. This is due to concerns that delinquency rates among companies and households will rise significantly.

On the 11th, the Korea Economic Research Institute stated this in a report titled "Developments in U.S. Financial Tightening and Implications for Interest Rate Policy."

The report assumes that interest rate hikes are inevitable given the continued high inflation rate, but it also analyzes that the burden caused by rising interest rates will be considerable. It diagnoses that the sharp increase in household interest burdens caused by continuous rate hikes will shrink consumption, accelerate economic recession, and further increase the possibility of stagflation.

While the risk of household debt is highlighted during the interest rate hike period due to Korea's high household debt, the report points out that the problem lies with corporate debt. From the first quarter of 2020 to the fourth quarter of 2021, the average growth rate of corporate loans from deposit banks (based on balance) was 2.44%, higher than the average growth rate of household loans at 1.95%.

Since the delinquency rate of corporate loans reacts more sensitively to loan interest rates than that of household loans, it is pointed out that when loan interest rates rise, the delinquency rate of corporate loans may increase more than that of household loans, potentially undermining bank soundness.

Based on empirical analysis using data from the first quarter of 2006 to the fourth quarter of 2021, it is estimated that a 1 percentage point increase in corporate loan interest rates would raise the corporate loan delinquency rate by about 0.2 percentage points, whereas the household loan delinquency rate would increase by about 0.1 percentage points. Senior Research Fellow Tae-gyu Lee pointed out, “Although the scale of household debt is very large and the burden from interest rate hikes is mainly discussed in terms of household debt, the possibility of debt deterioration due to rising interest rates may be greater in the corporate sector.”

The report also judges that further base rate hikes by the Bank of Korea are inevitable due to the continued high inflation rate, but it points out that there is no need to follow large hikes like the U.S. Fed’s big step (an increase of 0.5 percentage points or more at once). Since economic agents need time to adapt to interest rate hikes, too rapid an increase may do more harm than good.

Therefore, it recommends adjusting the pace of interest rate hikes within a level that the Korean economy can bear, considering side effects such as contraction of consumption and investment by households and companies, deterioration of financial soundness, and the resulting acceleration of economic slowdown.

It emphasized that if the pace of U.S. rate hikes is too fast, short-term policy rate inversion between Korea and the U.S. should be allowed. The report predicted that if the Fed continues to take consecutive big steps, it could surpass the current Korean base rate (1.5% as of April). Although there are concerns that rapid capital outflows and capital market instability could occur during a Korea-U.S. policy rate inversion, past experience suggests that the likelihood is low.

There were periods when Korea’s base rate was maintained higher than the U.S. base rate for a long time (July 2005 to August 2007, March 2018 to February 2020). However, during these periods, foreign net purchases of stocks showed volatility but no continuous capital outflow crisis occurred.

Senior Research Fellow Lee said, “Fed board members have analyzed in the past that there is an asymmetric effect between quantitative easing and quantitative tightening,” and added, “If past experiences are repeated, information about quantitative tightening may already be priced into market interest rates.” He further stated, “If signs of economic recession become clear and stagflation intensifies, quantitative tightening may not be sustainable for a long time,” indicating that policy uncertainty of the Fed still exists depending on economic conditions.

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