[Weekly Review] Panic in Financial Markets Amid US Tightening Fears... Concerns Over Inflation Rise Due to Supplementary Budget

US Price Shock... Exchange Rates Soar and Stock Market Crashes
Government Announces Largest Ever Supplementary Budget... Inflation Rises
Concerns Over Exports Due to Rising Commodity Prices Including Oil

Citizens are shopping at Yeongcheon Market in Seodaemun-gu, Seoul. Photo by Moon Honam munonam@

As the fear of stagflation grows amid a price shock originating from the United States, financial markets are shaking. With renewed speculation that the U.S. Federal Reserve (Fed) might take a 'giant step' (a 0.75 percentage point increase in the benchmark interest rate) to curb inflation, concerns are rising, leading to a sharp rise in the won-dollar exchange rate and a steep drop in the stock market. In this situation, the Yoon Seok-yeol administration is pushing for the largest-ever supplementary budget, raising worries that domestic inflation could worsen further. The reduction in the current account surplus due to high oil prices and a strong won also poses a burden on the Korean economy.

◆ Continued U.S. Inflation... High-Intensity Tightening Inevitable = According to financial markets on the 14th, the U.S. Consumer Price Index (CPI) for April surged 8.3% year-on-year, exceeding market expectations of 8.1%, increasing the likelihood that the Fed will implement consecutive big steps in June and July to stabilize prices. Global investment bank Deutsche Bank recently explained in its economic outlook report that "the Fed is highly likely to raise the benchmark interest rate to around 5-6% annually, pressing hard on the tightening pedal to suppress inflation."

Accordingly, the Bank of Korea is also expected to raise interest rates at the Monetary Policy Committee meeting scheduled for the 26th. Currently, the U.S. benchmark interest rate is between 0.75% and 1.0%, while Korea's is 1.5%. Even if the Bank of Korea raises rates by 0.25 percentage points in May, if the Fed executes big steps in June and July, the Korea-U.S. interest rate differential will invert. This could lead to significant capital outflows from Korea, increasing economic damage, so there is also speculation that the Bank of Korea might continue raising rates through July following May. However, rapid rate hikes could trigger a recession, which is a growing concern for the Bank of Korea.

U.S. President Joe Biden mentioned the administration's measures against rising prices on the 10th (local time) at the White House South Court Auditorium. [Image source=Yonhap News]

◆ Unstable Exchange Rate... Yoon Chairs Review Meeting = The exchange rate surged due to factors such as the Fed's tightening, China's economic slowdown, and the prolonged Ukraine war. According to Seoul Foreign Exchange Brokerage on the previous day, the exchange rate closed at 1,284.20 won, down 4.40 won from the previous trading day's closing price. Risk asset preference partially recovered, somewhat calming the won's depreciation. However, during the day, it soared to 1,291 won, showing instability. A sharp decline in the won's value inevitably shocks Korea, which has a high dependence on the external economy.

There is also analysis in financial markets that the won-dollar exchange rate could rise to 1,300 won. An exchange rate of 1,300 won has not been seen since the 2009 global financial crisis. President Yoon Seok-yeol held a macro-financial situation review meeting at the International Financial Center in Jung-gu, Seoul, with Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho, Bank of Korea Governor Lee Chang-yong, and others. This reflects the serious assessment of inflation and exchange rate conditions. President Yoon emphasized, "Volatility in financial and foreign exchange markets is increasing due to rising prices and monetary policy responses from various countries," adding, "We must proactively respond to the crisis."

◆ Largest-Ever Supplementary Budget = The government is also pushing for the largest supplementary budget ever, raising concerns that inflation could worsen further. According to the Ministry of Economy and Finance, this supplementary budget amounts to 59.4 trillion won, which is 24.3 trillion won more than the previous record set by the third supplementary budget in 2020 (35.1 trillion won). Excluding 23 trillion won transferred to local governments as per relevant laws, the actual government expenditure is 36.4 trillion won. Of this, 72%, or 26.3 trillion won, will be used to support small business owners affected by COVID-19.

The problem is inflation. While Deputy Prime Minister Choo stated when announcing the supplementary budget that "since it will be financed without additional government bond issuance, the impact on macroeconomic factors such as interest rates and inflation is expected to be minimal," there is a high possibility that liquidity injected into the market will negatively affect prices. The government included a budget of 23 trillion won in the supplementary budget to provide loss compensation payments ranging from 6 million to 10 million won to 3.7 million small and medium-sized enterprises. Given the Bank of Korea's interest rate hike stance and the government's cash injection, debates over the mismatch between monetary and fiscal policies are expected to resurface.

Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho is speaking at the ruling party-government meeting on the second supplementary budget bill for small business loss compensation, held at the National Assembly on the 11th.
[Image source=Yonhap News]

◆ Decrease in Current Account Surplus = The current account surplus has also decreased due to the sharp rise in crude oil and other raw material prices. According to the Bank of Korea's provisional balance of payments statistics, the current account surplus in March was $6.73 billion (approximately 8.6 trillion won). This marks 23 consecutive months of surplus since May 2020, but the surplus amount decreased by $770 million compared to the same month last year ($7.5 billion). This was influenced by the goods balance surplus falling by $2.54 billion to $5.31 billion compared to a year earlier.

During this period, exports ($64.51 billion) increased by 16.9% ($9.35 billion), but imports ($59.2 billion) rose by 25.1% ($11.88 billion). The increase in imports was driven by a 52.3% surge in raw material import costs compared to the same month last year. Despite risks such as rising raw material prices and slowing growth in major countries, exports continue to grow steadily, so the surplus trend is expected to continue. However, there is a possibility that the current account could temporarily turn into a deficit in April. The Bank of Korea also stated, "Due to many variables, it is currently difficult to predict whether April will show a deficit or surplus."

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